nep-mon New Economics Papers
on Monetary Economics
Issue of 2009‒02‒28
thirty-one papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Domestic or U.S. News: What Drives Canadian Financial Markets? By Bernd Hayo; Matthias Neuenkirch
  2. Monetary Policy Regimes and the Term Structure of Interest Rates By Bikbov, Ruslan; Chernov, Mikhail
  3. Inflation Targeting as the New Golden Standard By Spivak, Avia; Sussman, Nathan
  4. Inflation Inertia and Optimal Delegation of Monetary Policy By Keiichi Morimoto
  5. Monetary Policy and Inflation Modeling in a More Open Economy in South Africa By Aron, Janine; Muellbauer, John
  6. Endogenous Policy Announcement and Accountability for Inflation Target By Keiichi Morimoto
  7. Country-Specific Risk Premium, Taylor Rules, and Exchange Rates By Annicchiarico , Barbara; Piergallini, Alessandro
  8. Extracting inflation expectations and inflation risk premia from the term structure: a joint model of the UK nominal and real yield curves By Joyce, Michael; Lildholdt, Peter; Sorensen, Steffen
  9. Monetary Policy Trade-Offs in an Estimated Open-Economy DSGE Model By Adolfson, Malin; Laséen, Stefan; Lindé, Jesper; Svensson, Lars E O
  10. Some Issues in Modeling and Forecasting Inflation in South Africa By Aron, Janine; Muellbauer, John
  11. Deep Habits and the Dynamic Effects of Monetary Policy Shocks By Ravn, Morten O.; Schmitt-Grohé, Stephanie; Uribe, Martín; Uusküla, Lenno
  12. Re-Evaluating Swedish Membership in EMU: Evidence from an Estimated Model By Söderström, Ulf
  13. A Measure for Credibility: Tracking US Monetary Developments By Demertzis, Maria; Marcellino, Massimiliano; Viegi, Nicola
  14. Central Bank Misperceptions and the Role of Money in Interest Rate Rules By Beck, Günter; Wieland, Volker
  15. What Impact Does Inflation Targeting Have on Unemployment? By Jose Angelo Divino
  16. Monetary Geography Before the Industrial Revolution By Flandreau, Marc; Galimard, Christophe; Jobst, Clemens; Nogués Marco, Maria Del Pilar
  17. Central Bank Communication and Multiple Equilibria By Kozo Ueda
  18. US Volatility Cycles of Output and Inflation, 1919-2004: A Money and Banking Approach to a Puzzle By Benk, Szilárd; Gillman, Max; Kejak, Michal
  19. Financial Market Integration Under EMU By Jappelli, Tullio; Pagano, Marco
  20. When Can Central Banks Anchor Expectations? Policy communication and controllability By Acocella, Nicola; Di Bartolomeo, Giovanni; Hughes Hallett, Andrew
  21. Interbank Market Liquidity and Central Bank Intervention By Franklin Allen; Elena Carletti; Douglas Gale
  22. A Further Look at the 2004 Reform of the Operational Framework of the ECB By Marzo, Massimiliano; Zagaglia, Paolo
  23. Optimal Monetary Policy using a VAR By Polito, Vito; Wickens, Michael R
  24. Imperfect Competition in the Inter-Bank Market for Liquidity as a Rationale for Central Banking By Acharya, Viral V; Gromb, Denis; Yorulmazer, Tanju
  25. The Dynamic Effects of Monetary Policy: A Structural Factor Model Approach By Forni, Mario; Gambetti, Luca
  26. A Convergence Model of the Term Structure of Interest Rates By Viktors Ajevskis; Kristine Vitola
  27. Sales and Monetary Policy By Guimarães, Bernardo; Sheedy, Kevin D.
  28. Assessing Indexation-Based Calvo Inflation Models By Jean-Marie Dufour; Lynda Khalaf; Maral Kichian
  29. A Faith-based Initiative: Does a Flexible Exchange Rate Regime Really Facilitate Current Account Adjustment? By Chinn, Menzie David; Wei, Shang-Jin
  30. Fear of Floating and Pegging: A Simultaneous Choice Model of De Jure and De Facto Exchange Rate Regimes By von Hagen, Jürgen; Zhou, Jizhong
  31. Ten Years of EMU: convergence, divergence and new policy priorities By Nikos Christodoulakis

  1. By: Bernd Hayo (Faculty of Business Administration and Economics, Philipps-University Marburg); Matthias Neuenkirch (Faculty of Business Administration and Economics, Philipps-University Marburg)
    Abstract: Using a GARCH model, we study the effects of Canadian and U.S. central bank communication and macroeconomic news on Canadian bond, stock, and foreign exchange market returns and volatility. First, news in both categories and from both countries has an impact on all financial markets. Canadian and U.S. price shocks and monetary policy news are less important than shocks relating to the real economy. Second, Canadian central bank communication is more relevant than its U.S. counterpart, whereas in the case of macro news that originating from the United States dominates. Third, we find evidence that the impact of Canadian news reaches its maximum when the Canadian target rate departs from the Federal Funds target rate (2002–2004). The introduction of fixed announcement dates (FAD) does not cause a noticeable break in the data. Finally, Canadian and U.S. target rate changes lead to higher price volatility, and so does other U.S. news. Other Canadian news, however, lowers price volatility.
    Keywords: Bank of Canada, Central Bank Communication, Federal Reserve Bank, Financial Markets, Macroeconomic News, Monetary Policy
    JEL: E52 G14 G15
    Date: 2009
  2. By: Bikbov, Ruslan; Chernov, Mikhail
    Abstract: This paper proposes to investigate whether US monetary policy changed over time by evaluating evidence from the entire yield curve. A regime-switching no-arbitrage term structure model relies on inflation, output and the short interest rate as factors. In a departure from the finance literature, the model is complemented with identifying assumptions that allow the private sector (inflation and output dynamics) to be separated from monetary policy (short interest rate). The model posits regime changes in the volatility of exogenous output and inflation shocks, in the monetary policy rule, and in the volatility of monetary shocks. The monetary policy regimes cannot be identified correctly if the yield curve is ignored during estimation. Counterfactual analysis uses the disentangled regimes in policy and shocks to understand their importance for the great moderation. The low-volatility regime of exogenous shocks during the last two decades plays an important role, while monetary policy contributes by trading off asymmetric responses of output and inflation under different regimes.
    Keywords: great moderation; monetary policy; regime switches; structural VAR; term structure model
    JEL: C52 E43
    Date: 2008–12
  3. By: Spivak, Avia; Sussman, Nathan
    Abstract: Financial globalization has seen the emergence of a new monetary standard based on inflation targeting. At the same time the most financially advanced economies moved away from exchange rate targeting which also characterized the previous era of globalization - the era of the Classical Gold Standard. Does the new financial environment of free capital flows constrain the independence of central banks to conduct monetary policy? We argue, and show empirically, that credible inflation targeting allows central banks to conduct an independent monetary policy as manifested in their ability to deviate from the world (Fed) interest rate. This new regime, with exchange rate flexibility, generates sufficient short term volatility that prevents short term arbitrage against central banks that deviate from the Fed rate. In contrast, during the Gold Standard only limited deviation was possible within the 'gold points'. On the other hand, the credibility of inflation targeting regime is as good as gold in anchoring inflation expectations for the long run as manifested in strong co-movement and similar levels of long term borrowing rates- just as was the case during the gold standard. We conclude that inflation targeting allows more flexibility than the Gold Standard to conduct monetary policy in the short run and has similar benefits for long term stability. We suggest that it is the new golden rule.
    Keywords: Credibility; Exchange rate variability; Gold standard; Inflation targeting
    JEL: E31 E4 E42 E43 E44 E58 F3 F33
    Date: 2008–10
  4. By: Keiichi Morimoto (Graduate School of Economics, Osaka University)
    Abstract: This paper analyzes the relationship between the optimal weight on output gap in the central bankfs loss function and the degree of inertia in a hybrid version of New Keynesian model with a pure discretionary inflation targeting. I present the policy recommendations as to the weight on output gap in the presence of endogenous persistence in inflation dynamics. Especially, I show that under endogenous persistence of inflation dynamics, even in discretionary monetary policy regime, a Rogofffs (1985) conservative central banker does not necessarily improve social welfare.
    Keywords: hybrid New Keynesian model; inflation targeting; policy weight
    JEL: E52 E58
    Date: 2009–02
  5. By: Aron, Janine; Muellbauer, John
    Abstract: South Africa in the 1990s became globally more integrated after years of isolation. Opening the trade and capital accounts gave impetus to a monetary policy regime change to inflation targeting from 2000, after a costly transitional period of monetary mismanagement with low policy transparency. Changes in openness can, however, disrupt the inflation forecasting on which targeting monetary policies depend. This chapter demonstrates how the central bank’s own producer price inflation equation in its core model can be improved by taking account of greater openness, using both innovative time-series openness measures and a more conventional measure. The model has a greatly improved fit and stability over longer samples when also including the real exchange rate and the interest rate differential (making explicit the exchange rate channel of monetary transmission) and asymmetric food price inflation. Moreover, there is a role for the level of the output gap rather than simply a short-run effect, as in the central bank’s model. This helps mitigate the arguments in current South African debate regarding the apparent unconcern of inflation targeting policy for the level of economic activity.
    Keywords: inflation dynamics; modelling producer prices; trade openness
    JEL: C22 E31 F13 F41
    Date: 2008–10
  6. By: Keiichi Morimoto (Graduate School of Economics, Osaka University)
    Abstract: In this paper, I show that accountability for inflation target will improve social welfare when the central bank makes transparency-opaqueness choices endogenously. The key elements are uncertainty of the firmsf informational quality, the opacity bias of constrained discretionay monetary policy under noisy information, and the role of harmful noisy public information. Based on the qualitative and quantitative result, I present a policy recommendation as to policy announcements and inflation targeting regime.
    Keywords: asymmetric information, economic transparency, inflation targeting
    JEL: D82 E52 E58
    Date: 2009–02
  7. By: Annicchiarico , Barbara; Piergallini, Alessandro
    Abstract: The adoption of a Taylor-type monetary policy rule and an inflation target for emerging market economies that choose a flexible exchange rate regime is often advocated. This paper investigates the issue of exchange rate determination when interest-rate feedback rules are implemented in a continuous-time optimizing model of a small open economy facing an imperfect global capital market. It is demonstrated that when a risk premium on external debt affects the monetary policy transmission mechanism, the Taylor principle is not a necessary condition for determinacy of equilibrium. On the other hand, it is shown that exchange rate dynamics critically depends on whether monetary policy is active or passive.
    Keywords: Risk Premium on Foreign Debt; Taylor Rules; Exchange Rate Dynamics.
    JEL: F32 E52 F31
    Date: 2009
  8. By: Joyce, Michael (Bank of England); Lildholdt, Peter; Sorensen, Steffen
    Abstract: This paper analyses the nominal and real interest rate term structures in the United Kingdom over the fifteen-year period that the UK monetary authorities have pursued an explicit inflation target, using a four-factor essentially affine term structure model. The model imposes no-arbitrage restrictions across nominal and real yields, enabling us to decompose nominal forward rates into expected real short rates, expected inflation, real term premia and inflation risk premia. We find that inflation risk premia and longer-term inflation expectations fell significantly when the Bank of England was made operationally independent in 1997. The 'conundrum' of unusually low long-term real rates that began in 2004 is mainly attributed by the model to a fall in real term premia, though a significant part of the fall is left unexplained. The relative inability of the model to fit long real forwards during much of this recent period may reflect strong pension fund demand for index-linked bonds. Moreover, the model decompositions suggest that these special factors affecting the index-linked market may also partly account for the contemporaneous rise in longer-horizon inflation breakeven rates.
    Keywords: Inflation expectations; inflation risk premia; affine term structure model
    JEL: C40 E43 E52
    Date: 2009–02–16
  9. By: Adolfson, Malin; Laséen, Stefan; Lindé, Jesper; Svensson, Lars E O
    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.
    Keywords: impulse responses; instrument rules; open-economy DSGE models; Optimal monetary policy; output gap; potential output
    JEL: E52 E58
    Date: 2008–12
  10. By: Aron, Janine; Muellbauer, John
    Abstract: Inflation targeting central banks will be hampered without good models to assist them to be forward-looking. Many current inflation models fail to forecast turning points adequately, because they miss key underlying long-run influences. The world is on the cusp of a dramatic turning point in inflation. If inflation falls rapidly, such models can underestimate the speed at which interest rates should fall, damaging growth. Our forecasting models for the new measure of producer price inflation suggest methodological lessons, and build in conflicting pressures on SA inflation from exchange rate depreciation, terms of trade shocks, collapsing oil, food and other commodity prices, and other shocks. Our US and SA forecasting models for consumer price inflation underline the methodological points, and suggest the usefulness of thinking about sectoral trends. Finally, we apply the sectoral approach to understanding the monetary policy implications of introducing a new CPI measure in SA that uses imputed rents rather than interest rates to capture housing costs.
    Keywords: forecasting inflation; homeowner costs in the CPI; PPI inflation; South Africa
    JEL: C22 C51 C52 C53 E31 E52 E58
    Date: 2009–02
  11. By: Ravn, Morten O.; Schmitt-Grohé, Stephanie; Uribe, Martín; Uusküla, Lenno
    Abstract: This paper introduces deep habits into a sticky-price sticky-wage economy and asks whether the countercyclical markup movements induced by deep habits is helpful for accounting for the dynamic effects of monetary policy shocks. We find that this is the case: When allowing for deep habits, the model can account very precisely for the persistent impact of monetary policy shocks on aggregate consumption and for the impact on inflation that other models have hard a time explaining. In particular, the model can account both for the price puzzle and for inflation persistence. We also show that the deep habits mechanism and nominal rigidities are complementary: The deep habits model can account for the dynamic effects of monetary policy shock at low to moderate levels of nominal rigidities. We show that the results are stable over time and are not caused by monetary policy changes.
    Keywords: countercyclical markup; deep habits; inflation persistence; monetayr policy shocks; price puzzle
    JEL: E21 E31 E32 E52
    Date: 2009–01
  12. By: Söderström, Ulf
    Abstract: I revisit the potential costs and benefits for Sweden of joining the Economic and Monetary Union (EMU) of the European Union. I first show that the Swedish business cycle since the mid-1990s has been closely correlated with the Euro area economies, suggesting that common shocks have been an important driving force of business cycles in Europe. However, evidence from an estimated model of the Swedish economy instead suggests that country-specific shocks have been important for fluctuations in the Swedish economy since 1993, implying that EMU membership could be costly. The model also indicates that the exchange rate has to a large extent acted to destabilize, rather than stabilize, the Swedish economy, pointing to the costs of independent monetary policy with a flexible exchange rate. Finally, counterfactual simulations of the model suggest that Swedish inflation and GDP growth might have been slightly higher if Sweden had been a member of EMU since the launch in 1999, but also that GDP growth might have been more volatile. The evidence is therefore not conclusive about whether or not participation in the monetary union would be advantageous for Sweden.
    Keywords: DSGE model; Monetary union; Open economy; Optimum Currency Area
    JEL: E42 E58 F41
    Date: 2008–12
  13. By: Demertzis, Maria; Marcellino, Massimiliano; Viegi, Nicola
    Abstract: Our objective is to identify a way of checking empirically the extent to which expectations are de-coupled from inflation, how well they might be anchored in the long run, and at what level. This methodology allows us then to identify a measure for the degree of anchorness, and as anchored expectations are associated with credibility, this will serve as a proxy for credibility. We apply this methodology to the US history of inflation since 1963 and examine how well our measure tracks the periods for which credibility is known to be either low or high. Of particular interest to the validity of the measure is the start of the Great Moderation. Following the narrative of a number of well documented incidents in this period, we check how well our measure captures both the evolution of credibility in US monetary policy, as well as reactions to inflation scares.
    Keywords: anchors for expectations; credibility; Great Inflation; Great Moderation
    JEL: E52 E58
    Date: 2008–11
  14. By: Beck, Günter; Wieland, Volker
    Abstract: Research with Keynesian-style models has emphasized the importance of the output gap for policies aimed at controlling inflation while declaring monetary aggregates largely irrelevant. Critics, however, have argued that these models need to be modified to account for observed money growth and inflation trends, and that monetary trends may serve as a useful cross-check for monetary policy. We identify an important source of monetary trends in form of persistent central bank misperceptions regarding potential output. Simulations with historical output gap estimates indicate that such misperceptions may induce persistent errors in monetary policy and sustained trends in money growth and inflation. If interest rate prescriptions derived from Keynesian-style models are augmented with a cross-check against money-based estimates of trend inflation, inflation control is improved substantially.
    Keywords: monetary policy under uncertainty; money; output gap uncertainty; quantity theory; Taylor rules
    JEL: E32 E41 E43 E52 E58
    Date: 2008–08
  15. By: Jose Angelo Divino (Catholic University of Brasilia)
    Abstract: IPC One Pager 51 argued that inflation targeting has only slim prospects of success. This One Pager presents the findings of a recent empirical study of the impact of inflation targeting in a cross section of developing and emerging countries. The reasons usually given to justify adoption of this policy regime are transparency and credibility in monetary policy, the reduction of uncertainty, and implementation of the institutional and economic reforms required by the new regime. For developing and emerging countries, however, the economic benefits of inflation targeting are not yet well documented. (...)
    Keywords: What Impact Does Inflation Targeting Have on Unemployment?
    Date: 2009–02
  16. By: Flandreau, Marc; Galimard, Christophe; Jobst, Clemens; Nogués Marco, Maria Del Pilar
    Abstract: In this article, we study Europe's monetary geography on the eve of the Industrial Revolution. Our unit of analysis is the city and we explore inter-city linkages. Important findings include a considerable degree of integration and multilateralism with monetary centers having already emerged as vehicles for international settlements, before the Industrial Revolution.
    Keywords: history; international currency; international monetary system; network analysis
    JEL: F33 N23
    Date: 2009–02
  17. By: Kozo Ueda (Institute for Monetary and Economic Studies, Deputy Director and Bank of Japan (Email: kouzou.ueda
    Abstract: We construct a simple model in which a central bank communicates with money market traders. We demonstrate that there exist multiple equilibria. In one equilibrium, traders truthfully reveal their own information, and by learning this, the central bank can make better forecasts. Another equilibrium is a gdog-chasing-its-tailh equilibrium in Blinder (1998). Traders mimic the central bankfs forecast, so the central bank simply observes its own forecast from traders. The latter equilibrium is socially worse in that inflation variability becomes larger. We also demonstrate that too high transparency of central banks is bad because it yields the gdog-chasing-its-tailh equilibrium, and that central banks should conduct continuous monitoring or emphasize that their forecasts are conditional because doing so eliminates the gdog- chasing-its-tailh equilibrium.
    Keywords: Transparency, disclosure, coordination
    JEL: C72 D83 E52
    Date: 2009–02
  18. By: Benk, Szilárd; Gillman, Max; Kejak, Michal
    Abstract: The post-1983 moderation coincided with an ahistorical divergence in the money aggregate growth and velocity volatilities away from the downward trending GDP and inflation volatilities. Using an en dogenous growth monetary DSGE model, with micro-based banking production, enables a contrasting characterization of the two great volatility cycles over the historical period of 1919-2004, and enables this puzzle to be addressed more easily. The volatility divergence is explained by the upswing in the credit volatility that kept money supply variability from translating into inflation and GDP volatility.
    Keywords: Growth; Inflation; Money and credit shocks; Volatility
    JEL: E13 E32
    Date: 2009–01
  19. By: Jappelli, Tullio; Pagano, Marco
    Abstract: The single most important policy-induced innovation in the international financial system since the collapse of the Bretton-Woods regime is the institution of the European Monetary Union. This paper provides an account of how the process of financial integration has promoted financial development in the euro area. It starts by defining financial integration and how to measure it, analyzes the barriers that can prevent it and the effects of their removal on financial markets, and assesses whether the euro area has actually become more integrated. It then explores to which extent these changes in financial markets have influenced the performance of the euro-area economy, that is, its growth and investment, as well as its ability to adjust to shocks and to allow risk-sharing. The paper concludes analyzing further steps that are required to consolidate financial integration and enhance the future stability of financial markets.
    Keywords: EMU; financial market integration
    JEL: G20
    Date: 2008–12
  20. By: Acocella, Nicola; Di Bartolomeo, Giovanni; Hughes Hallett, Andrew
    Abstract: Rational expectations are often used as a strong argument against policy activism, as they may undermine or neutralize the policymaker’s actions. Although this sometimes happens, rational expectations do not always imply policy invariance or ineffectiveness. In fact, in certain circumstances rational expectations can enhance our power to control an economy over time. In those cases, policy announcements, properly communicated, can be used to extend the impact of conventional policy instruments. In this paper we present a general forward-looking policy framework and use it to provide a formal justification for attempting to anchor expectations, and as a possible justification for publishing interest rate forecasts or tax rate projections. This approach allows us to test when policymakers can and cannot expect to be able to manage expectations.
    Keywords: controllability; fiscal policy; monetary policy; policy neutrality; Rational expectations
    JEL: C61 C62 E52 E61 E62
    Date: 2008–12
  21. By: Franklin Allen; Elena Carletti; Douglas Gale
    Abstract: We develop a simple model of the interbank market where banks trade a long term, safe asset. We show that when there is a lack of opportunities for banks to hedge aggregate and idiosyncratic liquidity shocks, the interbank market is characterized by excessive price volatility. In such a situation, a central bank can implement the constrained efficient allocation by using open market operations to fix the short term interest rate. The model shows also that market freezes, where banks stop trading with each other, can be a feature of the constrained efficient allocation if there is sufficient uncertainty about aggregate liquidity demand compared to idiosyncratic liquidity demand.
    Keywords: interbank market, liquidity, central bank intervention, open market operations
    JEL: G18 G21
    Date: 2009
  22. By: Marzo, Massimiliano (Università di Bologna); Zagaglia, Paolo (Dept. of Economics, Stockholm University)
    Abstract: This note reconsiders the impact of the reform of the operational framework of the European Central Bank that took place in March 2004. We estimate a bivariate GARCH model with the overnight rate and 1-year swap rate, where identifying restrictions are imposed on the conditional variance. Differently from previous studies, we use a measure of structural correlation to show that the 1-year swap segment has decoupled from the overnight rate as the two rates do not co-vary any longer.
    Keywords: Money Market; Multivariate GARCH; Structural Identification
    JEL: C22 E58
    Date: 2009–02–15
  23. By: Polito, Vito; Wickens, Michael R
    Abstract: In this paper we propose a new way to formulate optimal policy based on a quadratic intertemporal welfare function where the dynamic constraint is based on a VAR model of the economy which we call the PVAR method. We argue that the VAR under control should not be derived simply by replacing the VAR equation for the policy instruments by an optimal control rule because this alters the stochastic structure of the VAR. Instead, one should first transform the VAR in order to condition the non-policy variables on the policy instruments, then use the resulting sub-system as the dynamic constraint, and finally construct the VAR under control by combining this sub-system with the resulting optimal policy rule. In this way the original stochastic structure of the VAR is retained. In comparing the two approaches we explain the theoretical advantages of the PVAR over the standard method and we illustrate the methods by examining the formulation of optimal monetary policy for the US. We suggest that since the whole process is easily automated, the PVAR method may provide a useful benchmark for use in real time against which to compare other, probably far more labour intensive, policy choices.
    Keywords: monetary policy; optimal control; VAR models
    JEL: C2 C6 E5
    Date: 2008–09
  24. By: Acharya, Viral V; Gromb, Denis; Yorulmazer, Tanju
    Abstract: We study liquidity transfers between banks through the interbank borrowing and asset sale markets when (i) surplus banks providing liquidity have market power, (ii) there are frictions in the lending market due to moral hazard, and (iii) assets are bank-specific. We show that when the outside options of needy banks are weak, surplus banks may strategically under-provide lending, thereby inducing inefficient sales of bank-specific assets. A central bank can ameliorate this inefficiency by standing ready to lend to needy banks, provided it has greater information about banks (e.g., through supervision) compared to outside markets, or is prepared to extend loss- making loans. The public provision of liquidity to banks, in fact its mere credibility, can thus improve the private allocation of liquidity among banks. This rationale for central banking finds support in historical episodes preceding the modern era of central banking and has implications for recent debates on the supervisory and lender-of-last-resort roles of central banks.
    Keywords: Asset specificity; Central bank; Competition; Interbank lending; Lender of last resort; Market power
    JEL: D62 E58 G21 G28 G38
    Date: 2008–10
  25. By: Forni, Mario; Gambetti, Luca
    Abstract: We use the structural factor model proposed by Forni, Giannone, Lippi and Reichlin (2007) to study the effects of monetary policy. The advantage with respect to the traditional vector autoregression model is that we can exploit information from a large data set, made up of 112 US monthly macroeconomic series. Monetary policy shocks are identified using a standard recursive scheme, in which the impact effects on both industrial production and prices are zero. Such a scheme, when applied to a VAR including a suitable selection of our variables, produces puzzling results. Our main findings are the following. (i) The maximal effect on bilateral real exchange rates is observed on impact, so that the “delayed overshooting” or “forward discount” puzzle disappears. (ii) After a contractionary shock prices fall at all horizons, so that the price puzzle is not there. (iii) Monetary policy has a sizable effect on both real and nominal variables. Such results suggest that the structural factor model is a promising tool for applied macroeconomics.
    Keywords: Delayed Overshooting Puzzle; Monetary Policy; Price Puzzle; Structural Factor Model
    JEL: C32 E32 E52 F31
    Date: 2008–12
  26. By: Viktors Ajevskis; Kristine Vitola
    Abstract: This paper develops a convergence model of the term structure of interest rates in the context of entering the EMU. Compared with the other models developed so far in this field, our model specification ensures convergence of the domestic short-term interest rates to the euro area ones. We achieve this convergence by stating that the spread between the domestic and euro short-term interest rates follows the Brownian bridge process. We also develop an econometric counterpart of the theoretical model. To address the problem of nonstationarity and nonlinearity of the model, the extended Kalman filter for coefficient estimation is applied.
    Keywords: term structure of interest rates, the Brownian bridge, the EMU, nonlinear Kalman filter
    JEL: E43 F36 G12 G15
    Date: 2009–02–09
  27. By: Guimarães, Bernardo; Sheedy, Kevin D.
    Abstract: A striking fact about prices is the prevalence of "sales": large temporary price cuts followed by a return exactly to the former price. This paper builds a macroeconomic model with a rationale for sales based on firms facing consumers with different price sensitivities. Even if firms can vary sales without cost, monetary policy has large real effects owing to sales being strategic substitutes: a firm's incentive to have a sale is decreasing in the number of other firms having sales. Thus the flexibility of prices at the micro level due to sales does not translate into flexibility at the macro level.
    Keywords: monetary policy; nominal rigidities; sales
    JEL: E3 E5
    Date: 2008–08
  28. By: Jean-Marie Dufour; Lynda Khalaf; Maral Kichian
    Abstract: Using identification-robust methods, the authors estimate and evaluate for Canada and the United States various classes of inflation equations based on generalized structural Calvo-type models. The models allow for different forms of frictions and vary in their assumptions regarding the type of price indexation adopted by firms. Point and confidence-set parameter estimates are obtained based on the inversion of identification-robust test statistics. Focus is maintained on the structural aspect of the model with formal imposition of the restrictions that map the theoretical model into the econometric one. The results show that there is some statistical merit to using indexation-based Calvo-type models for inflation. However, some identification difficulties are also uncovered with considerable uncertainty associated with estimated parameter values. In particular, we find that implausibly-high frequency of price re-optimization values cannot be ruled out from our identification-robust confidence sets.
    Keywords: Inflation and prices; Econometric and statistical methods
    JEL: C13 C52 E31
    Date: 2009
  29. By: Chinn, Menzie David; Wei, Shang-Jin
    Abstract: The assertion that a flexible exchange rate regime would facilitate current account adjustment is often repeated in policy circles. In this paper, we compile a data set encompassing data for over 170 countries over the 1971-2005 period, and examine whether the rate of current account reversion depends upon the de facto degree of exchange rate fixity, as measured by two popular indices. We find that there is no strong, robust, or monotonic relationship between exchange rate regime flexibility and the rate of current account reversion, even after accounting for the degree of economic development, the degree of trade and capital account openness. We also find that the endogenous selection of exchange rate regimes does not explain the observed lack of correlation.
    Keywords: current account imbalances; fixed exchange rate; floating exchange rate; real exchange rate
    JEL: F3
    Date: 2008–12
  30. By: von Hagen, Jürgen; Zhou, Jizhong
    Abstract: We present an analysis of the determinants of de jure and de facto exchange rate regimes based on a panel probit model with simultaneous equations. The model is estimated using simulation-based maximum likelihood methods. The empirical results suggest a triangular structure of the model such that the choice of de facto regimes depends on the choice of de jure regimes but not vice versa. This gives rise to a novel interpretation of regime discrepancies.
    Keywords: de facto exchange rate regimes; developing countries; simultaneous equations
    JEL: C35 F33 F41
    Date: 2008–10
  31. By: Nikos Christodoulakis
    Abstract: As the tenth anniversary of EMU is approaching, a debate is underway as to whether the single currency has promoted or hindered convergence among the countries of the Eurozone. On the one hand, there is wide agreement on the fact that asymmetric shocks have subsided after the creation of the single currency and that FDI has been substantially promoted both in and outside of EMU as a result of reduced exchange rate volatility, more integration and better institutional functioning. But if one moves to examine the catching-up process between the less and more-affluent countries of the Eurozone, the evidence in support for convergence is fading away after the EMU was initiated in 1999. A process of divergence in per capita GDP is underway, in contrast with the substantial progress that has taken place during the nineties. Regional convergence is also found to wane, though the evidence is not as conclusive. Moreover, post-EMU divergence in per capita GDP appears to be far more pronounced than that of per capita GNI, due to the risk-sharing strategies implemented after the EMU to face asymmetric shocks and the resulted relocation of capital. Another worrying development in the Eurozone is the emergence of unprecedented CA deficits in the Southern Eurozone countries, while the Northern Eurozone group enjoys substantial surpluses. Although both groups of countries have attracted increased FDI flows after EMU, there seems to be a sharp differentiation regarding size and composition. In the Southern countries, the housing sector has attracted relatively more investment than the production sector, while the reverse seems to be the case in the Northern group. Thus, investment in the Northern (Southern) Eurozone countries increased the traded (non-traded) output and caused an improvement (deterioration) in the trade balance. To face such imbalances, new policy priorities are required in the Eurozone that put more emphasis on convergence and competitiveness.
    Keywords: Eurozone; economic integration; convergence; business cycles.
    Date: 2009–01

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