nep-mon New Economics Papers
on Monetary Economics
Issue of 2009‒03‒22
thirty-one papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Uncertainty and fiscal policy in an asymmetric monetary union By Carsten Hefeker; Blandine Zimmer
  2. Using Taylor Rule to Explain Effects of Institutional Changes in Central Banks By Aleksandra Maslowska
  3. Money growth rule and macro-financial stability under inflation-targeting regime. By Meixing DAI; Moïse SIDIROPOULOS
  4. Central Bank Transparency: Causes, Consequences and Updates By Nergiz Dincer; Barry Eichengreen
  5. Taxation, Corruption and the Exchange Rate Regime By Carsten Hefeker
  6. Interest rate transmission mechanism of the monetary policy in the selected EMU candidate countries (SVAR approach) By Mirdala, Rajmund
  7. The term structure of inflation expectations By Tobias Adrian; Hao Wu
  8. Do China and oil exporters influence major currency configurations? By Marcel Fratzscher; Arnaud Mehl
  9. Monetary policy transparency and inflation persistence in a small open economy. By Meixing DAI; Moïse SIDIROPOULOS; Eleftherios Spyromitros
  10. Implementing Optimal Monetary Policy: Objectives and Rules By Huiping Yuan; Stephen M. Miller
  11. Fiscal Policy in a Monetary Union in the Presence of Uncertainty about the Central Bank Preferences. By Meixing DAI; Moïse SIDIROPOULOS
  12. Consistent Targets and Optimal Monetary Policy: Conservative Central Banker Redux By Stephen M. Miller; Huiping Yuan
  13. Yield curve in an estimated nonlinear macro model By Taeyoung Doh
  14. Assessing Monetary Policy Efficiency in the ASEAN-5 Countries By Arief Ramayandi
  15. Cape Verde: The Case for Euroization By João Loureiro; Manuel M. F. Martins; Ana Paula Ribeiro
  16. How successful is the G7 in managing exchange rates? By Marcel Fratzscher
  17. Decomposing the declining volatility of long-term inflation expectations By Todd E. Clark; Troy Davig
  18. How Far From the Euro Area? Measuring Convergence of Inflation Rates in Eastern Europe By Bettina Becker; Stephen G. Hall
  19. Time variation in the inflation passthrough of energy prices By Todd E. Clark; Stephen J. Terry
  20. The Effects of Monetary Policy in the Czech Republic: An Empirical Study By Magdalena Morgese Borys; Roman Horvath
  21. Unions Power, Collective Bargaining and Optimal Monetary Policy By Ester Faia; Lorenza Rossi
  22. Inflation Targeting as a Means of Achieving Disinflation By Saborowski, Christian
  23. The Making of Optimal and Consistent Policy: An Implementation Theory Framework for Monetary Policy By Huiping Yuan; Stephen M. Miller
  24. China's Renminbi Currency Logistics Network: A Brief Introduction By Smith, Reginald
  25. The Making of Optimal and Consistent Policy: An Analytical Framework for Monetary Models By Huiping Yuan; Stephen M. Miller; Langnan Chen
  26. Real Convergence and Inflation: Long-Term Tendency vs. Short-Term Performance By Leon Podkaminer
  27. AIG and the Fed: Prologue to future financial regulation? By Tatom, John
  28. Exchange Rate Forecasting, Order Flow and Macroeconomic Information By Rime, Dagfinn; Sarno, Lucio; Sojli, Elvira
  29. Monthly pass-through ratios By Marlene Amstad; Andreas M. Fischer
  30. Where Do the Newest EU Member States Stand on the Road to Monetary Integration? By Elena Bojesteanu; Gabriel Bobeica
  31. Choice of Exchange Rate System and Macroeconomic Volatility of Three Emerging Asian Countries By Hui-Boon Tan; Lee-Lee Chong

  1. By: Carsten Hefeker (University of Siegen, Department of Economics, Hoelderlinstrasse 3, 57068 Siegen, Germany); Blandine Zimmer (University of Siegen, Department of Economics, Hoelderlinstrasse 3, 57068 Siegen, Germany)
    Abstract: We examine monetary and fiscal interactions in a monetary union model with uncertainty due to imperfect central bank transparency. It is first shown that monetary uncertainty discourages excessive taxation and may thus reduce average inflation and output distortions. However, as countries enter the monetary union, this tax-restraining effect of uncertainty is mitigated. The monetary union may hence lead to higher fiscal distortions in some member countries, depending on governments’ spending targets and on the change in the degree of uncertainty implied by common monetary policy.
    Keywords: Monetary union, fiscal policy, transparency of monetary policy, asymmetries
    JEL: E58 E63 F36
    Date: 2009
  2. By: Aleksandra Maslowska (Department of Economics and Public Choice Research Centre, University of Turku)
    Abstract: In this paper we trace changes in monetary policy caused by institutional amendments in legal acts of central banks. We estimate coefficients of the Taylor Rule for central banks of Sweden, United Kingdom, Switzerland and EU15 to shed some light on monetary policy ex ante and ex post significant improvements in central bank independence. Results presented suggest differences in accommodating monetary policy in countries and support the idea that initial level of CBI matters for reactions to variability both of inflation and output gap. A preindependence period characterizes with strong inflation targeting features, whereas a post-independence time resembles more discretionary type of monetary policy. As a spin-off from our original idea, we find that changing properties of inflation in the last decade make econometric analysis more difficult
    Keywords: Taylor rule, central bank independence, interest rate rules
    JEL: E52
    Date: 2009–03
  3. By: Meixing DAI; Moïse SIDIROPOULOS
    Abstract: Recent financial crises and central banks’ interventions to ensure liquidity on the monetary markets around the world have shown that using interest rate as instrument of monetary policy can be insufficient. Using an aggregate dynamic macro-economic model, we study how to combine inflation targeting with monetary targeting to warrant macro-economic and financial stability. A commitment to a long-run money growth rate corresponding to the inflation target could reinforce the credibility of central bank announcements and the role of inflation target as strong and credible nominal anchor for private inflation expectations. We show that, using Friedman’s k-percent money growth rule to help anchoring inflation expectations under inflation-targeting regime can generate dynamic instability in output, inflation, assets prices as well as real money demand. Alternatively, a well-specified monetary targeting rule that responds negatively to the evolution of expected inflation allows achieving macro-economic and financial stability.
    Keywords: inflation targeting, monetary targeting, stock prices, macro-economic and financial stability, Friedman’s k-percent money growth rule.
    JEL: E41 E44 E52 E58
    Date: 2009
  4. By: Nergiz Dincer; Barry Eichengreen
    Abstract: We present updated estimates of central bank for 100 countries up through 2006 and use them to analyze both the determinants and consequences of monetary policy transparency in an integrated econometric framework. We establish that there has been significant movement in the direction of greater central bank transparency in recent years. Transparent monetary policy arrangements are more likely in countries with strong and stable political institutions. They are more likely in democracies, with their culture of transparency. Using these political determinants as instruments for transparency, we show that more transparency monetary policy operating procedures is associated with less inflation variability though not also with less inflation persistence.
    JEL: E0 E58
    Date: 2009–03
  5. By: Carsten Hefeker (University of Siegen, Department of Economics, Hoelderlinstrasse 3, 57068 Siegen, Germany)
    Abstract: The paper analyzes the relation between institutional quality, such as corruption, in a country and its monetary regime. It is shown that a credibly fixed exchange rate to a low inflation country, like a currency board, can reduce corruption and improve the fiscal system. A monetary union, however, has ambiguous effects. I find that that there is convergence between countries with regard to the level of corruption.
    Keywords: Exchange Rate Regime, Monetary Policy, Fiscal Policy, Seigniorage, Corruption, Developing and Transition Countries.
    JEL: D72 E63 F33
    Date: 2009
  6. By: Mirdala, Rajmund
    Abstract: The stable macroeconomic environment, as one of the primary objectives of the Visegrad countries in the 1990s, was partially supported by the exchange rate policy. Fixed exchange rate systems within gradually widen bands (Czech republic, Slovak republic) and crawling peg system (Hungary, Poland) were replaced by the managed floating in the Czech republic (May 1997), Poland (April 2000), Slovak republic (October 1998) and fixed exchange rate to euro with broad band in Hungary (October 2001). Higher macroeconomic and banking sector stability allowed countries from the Visegrad group to implement the monetary policy strategy based on the interest rate transmission mechanism. Continuous harmonization of the monetary policy framework (with the monetary policy of the ECB) and the increasing sensitivity of the economy agents to the interest rates changes allowed the central banks from the Visegrad countries to implement monetary policy strategy based on the key interest rates determination. In the paper we analyze the impact of the central banks’ monetary policy in the Visegrad countries on the selected macroeconomic variables in the period 1999-2008 implementing SVAR (structural vector autoregression) approach. We expect that the higher sensitivity of the selected macroeconomic indicators of the EMÚ candidate countries to the national monetary policy shocks would indicate the higher exposure of the selected countries to the ECB monetary policy impulses after the euro adoption in the future.
    Keywords: monetary policy, short-term interest rates, structural vector autoregression, variance decomposition, impulse-response function
    JEL: C32 E52
    Date: 2009–02
  7. By: Tobias Adrian; Hao Wu
    Abstract: We present estimates of the term structure of inflation expectations, derived from an affine model of real and nominal yield curves. The model features stochastic covariation of inflation with the real pricing kernel, enabling us to extract a time-varying inflation risk premium. We fit the model not only to yields, but also to the yields' variance-covariance matrix, thus increasing identification power. We find that model-implied inflation expectations can differ substantially from break-even inflation rates when market volatility is high. Our model's ability to be updated weekly makes it suitable for real-time monetary policy analysis.
    Keywords: Inflation risk ; Asset pricing ; Financial markets ; Stochastic analysis
    Date: 2009
  8. By: Marcel Fratzscher; Arnaud Mehl
    Abstract: This paper analyses the impact of the shift away from a US dollar focus of systemically important emerging market economies (EMEs) on configurations between the US dollar, the euro and the yen. Given the difficulty that fixed or managed US dollar exchange rate regimes remain pervasive and reserve compositions mostly kept secret, the identification strategy of the paper is to analyse the market impact on major currency pairs of official statements made by EME policy-makers about their exchange rate regime and reserve composition. Developing a novel database for 18 EMEs, we find that such statements not only have a statistically but also an economically significant impact on the euro, and to a lesser extent the yen against the US dollar. The findings suggest that communication hinting at a weakening of EMEs' US dollar focus contributed substantially to the appreciation of the euro against the US dollar in recent years. Interestingly, EME policy-makers appear to have become more cautious in their communication more recently. Overall, the results underscore the growing systemic importance of EMEs for global exchange rate configurations.
    Keywords: Foreign exchange rates ; Monetary policy ; International finance ; Financial markets
    Date: 2009
  9. By: Meixing DAI; Moïse SIDIROPOULOS; Eleftherios Spyromitros
    Abstract: Using a New Keynesian small open economy model, we examine the effects of central bank transparency on inflation persistence. We have found that more opacity could reinforce the effect of persistent shocks on the level and variability of endogenous variables if the difference between the interest elasticity of domestic goods demand and the degree of trade openness is sufficiently large or sufficiently low, judging on structural parameters characterising the economy, the central bank preference and its initial degree of opacity. Our result implies that, under perfect capital mobility, a high degree of domestic financial development is a good reason for increasing transparency.
    Keywords: Central bank’s transparency, open economy, inflation persistence.
    JEL: E52 E58 F41
    Date: 2009
  10. By: Huiping Yuan (Department of Finance, Xiamen University); Stephen M. Miller (Department of Economics, University of Nevada, Las Vegas)
    Abstract: We observe that the inconsistency of optimal policy comes from inconsistency of the social loss function with respect to the economic structure. Accordingly, this paper designs the central bank loss functions and rules, which are consistent with the economic structure and serve as mechanisms to implement optimal policy. We minimize the social loss function and use the idea of implementation theory, in designing the central bank loss functions and policy rules. Both ways result in identical central bank loss functions and policy rules. We also examine four equivalent methods of implementing optimal monetary policy, committing to the social loss function, using discretion with the central bank long-run and short-run loss functions, and following monetary policy rules. The same outcomes emerge from these different policymaking methods because the central bank actually follows the same (similar) policy rules. To some extent, policy rules appear more basic and flexible than social and central bank loss functions. In addition, we observe that the short-run natural employment target eliminates both the average and the state-contingent inflation biases, and a liberal, not conservative, preference eliminates the stabilization bias. As a result, under the designed central bank loss function discretionary policy proves optimal for social welfare. In conclusion, the social loss function, the central bank long-run and short-run loss functions, and monetary policy rules imply a complete regime for implementing optimal policy.
    Keywords: Optimal Policy, Central Bank Loss Functions, Policy Rules
    JEL: E42 E52 E58
    Date: 2009–03
  11. By: Meixing DAI; Moïse SIDIROPOULOS
    Abstract: In this paper, we examine the link between political transparency of a common central bank (CCB) and decentralized supply-side fiscal policies in a monetary union. We find that the opacity of a conservative CCB has a restrictive effect on national fiscal policies since each government internalizes the influence of its actions on the common monetary policy and thus reinforces the disciplinary effect of institutional constraints such as the Stability and Growth Pact on national fiscal authorities. However, more opacity could imply higher inflation and unemployment when the union is large enough and induce higher inflation and output-gap variability. An enlargement of the union incites national governments to increase tax rate, and weakens the disciplinary effects of opacity on member countries if fiscal policymaking is relatively decentralized and the CCB quite conservative. It induces an increase in the level of inflation and unemployment, and could increase inflation and outputgap variability.
    Keywords: central bank transparency; supply-side fiscal policy; monetary union.
    JEL: E50 E52 E58 E63
    Date: 2009
  12. By: Stephen M. Miller (Department of Economics, University of Nevada, Las Vegas); Huiping Yuan (Department of Finance, Xiamen University)
    Abstract: Kydland and Prescott (1977) consider the issue of the time-inconsistency of optimal policy and its source. Our paper provides additional insight on this issue. They develop a simple model of monetary policy making, where the central bank needs some commitment technique to achieve optimal monetary policy over time. Although not their main focus, they illustrate the difference between consistent and optimal policy in a sequential-decision one-period world. In our solution, the government appoints a central bank or delegates to the central bank an objective function that differs from the social welfare function. The central bank’s welfare function causes the consistent policy implemented by the central bank to prove optimal for society. The optimal institutional design for the Kydland-Prescott sequential-decision one-period model requires the appointment or delegation to a completely conservative central banker.
    Keywords: Consistent policy, Optimal policy, Consistent targets
    JEL: E42 E52 E58
    Date: 2009–03
  13. By: Taeyoung Doh
    Abstract: What moves the yield curve? This paper specifies and estimates a dynamic stochastic general equilibrium (DSGE) model solved using a second order approximation to equilibrium conditions to answer this question. From the empirical analysis of U.S. data from 1983:Q1 to 2007:Q4, I find that the monetary policy response to the inflation gap defined by the difference between expected inflation and the inflation target of the central bank is a key channel transmitting macro shocks to the yield curve and that the degree of nominal rigidity determines which macro shocks are more important determinants of the yield curve. With the low degree of nominal rigidity, the inflation target of the central bank drives persistent movements of inflation and the yield curve while fluctuations of markups do so with the high degree of nominal rigidity. Although the estimated linear model puts nearly zero probability on the low degree of nominal rigidity, there is a positive probability mass in the nonlinear model. The analysis in this paper suggests caution on interpreting estimation results in which nonlinear terms of the DSGE model solution are ignored.
    Date: 2009
  14. By: Arief Ramayandi (Center for Economics and Development Studies Dept. of Economics, Padjadjaran University)
    Abstract: This paper investigates whether or not monetary policy has been conducted efficiently in five selected ASEAN economies. It derives a utility-consistent social loss function, as a metric for welfare, to assess monetary policy efficiency in a small open economy model. An optimal monetary policy that minimises the social loss function is solved using information on structural parameters estimated for a model that represents each of the selected ASEAN-5 countries. The results are largely consistent with common wisdom in the literature, where policies based on credible commitment give the best welfare outcome. The paper further examines the welfare implications of the currently adopted simple monetary policy feedback rule for each of the sample economies. This exercise points out that there is room for improving the performance of monetary policy in each country, and it should be explored further. It also suggests the possibility that monetary authorities in the sample countries may be optimising over an objective function that di§er from the social welfare function derived in the paper.
    Keywords: ASEAN, monetary policy, optimal policy rules, social welfare function
    JEL: E52 E58 C61 F41
    Date: 2009–03
  15. By: João Loureiro (CEMPRE, Faculdade de Economia, Universidade do Porto); Manuel M. F. Martins (CEMPRE, Faculdade de Economia, Universidade do Porto); Ana Paula Ribeiro (CEMPRE, Faculdade de Economia, Universidade do Porto)
    Abstract: After 10 years of a fixed exchange rate against the euro and a deepening integration with the European Union (EU), the authorities of Cape Verde maintain a strong commitment to nominal stability and are now considering the official euroization of the country. Compared to the current pegging, euroization could be costly if the economic conditions of Cape Verde were to require control over the interest rates and the exchange rate. Given the strong economic and financial integration between Cape Verde and Europe, and the fact that Cape Verde records inflation rates at levels that are similar to those of the European Monetary Union (EMU), the relevant issue is whether the European Central Bank (ECB) monetary policy fits the needs of Cape Verde. In order to answer this question, we empirically assess the synchronization between the business cycle of Cape Verde and the business cycle of the EMU. For that purpose, we compute output gaps and then use conventional correlation measures as well as other indicators recently suggested in the literature. Replicating the methodology for each of the current 27 EU members, our results show that Cape Verde ranks better than several EU countries and even better than some EMU countries. We thus argue that there is a strong case for the euroization of Cape Verde. Euroization would secure the benefits already attained with the pegging to the euro and would warrant additional benefits, most likely with no relevant costs stemming from inappropriate ECB monetary policies.
    Keywords: Africa, Cape Verde, European Monetary Union, Euroization, Business Cycles
    JEL: E32 E58
    Date: 2009–03
  16. By: Marcel Fratzscher
    Abstract: The paper assesses the extent to which the Group of Seven (G7) has been successful in its management of major currencies since the 1970s. Using an event-study approach, the paper finds evidence that the G7 has been overall effective in moving the US dollar, yen and euro in the intended direction at horizons of up to three months after G7 meetings, but not at longer horizons. While the success of the G7 is partly dependent on the market environment, it is also to a significant degree endogenous to the policy process itself. The findings indicate that the reputation and credibility of the G7, as well as its ability to form and communicate a consensus among individual G7 members, are important determinants for the G7's ability to manage major currencies. The paper concludes by analyzing the factors that help the G7 build reputation and consensus, and by discussing the implications for global economic governance.
    Keywords: Group of Seven countries ; Foreign exchange rates ; International economic relations ; Monetary policy
    Date: 2009
  17. By: Todd E. Clark; Troy Davig
    Abstract: The level and volatility of survey-based measures of long-term inflation expectations have come down dramatically over the past several decades. To capture these changes in inflation dynamics, we embed both short- and long-term expectations into a medium-scale VAR with stochastic volatility. The model documents a marked decline in the volatility of expectations, but also reveals a shift in the factors driving their movement. Throughout the 1980s and early 1990s, the majority of the variance in long-term expectations were driven by 'own' shocks. Beginning in the mid-1990s, however, the factors explaining the variance of long-term expectations began shifting amidst an overall decline in volatility. At the end of the sample in 2008, innovations to measures of inflation and output account for the majority of the remaining low-level of volatility in long-term expectations. We document a shift in monetary policy towards more systematic behavior that precedes the shift in the factors driving long-term expectations.
    Date: 2009
  18. By: Bettina Becker (Department of Economics, Loughborough University); Stephen G. Hall (Department of Economics, University of Leicester)
    Abstract: We present a common factor framework of convergence which we implement using principal components analysis. We apply this technique to a dataset of monthly inflation rates of EMU and the Eastern European New Member Countries (NMC) over 1996-2007. In the earlier years, the NMC rates moved independently from an average of the three best performing countries over the past twelve months, while they moved somewhat closer in line with them in the later years. Looking at the sample of the EMU and NMC countries as a whole, there is evidence of a formation of convergence clubs across the two groups.
    Keywords: Convergence, inflation rates, European Monetary Union, principal components analysis.
    JEL: C22 F31
    Date: 2009–03
  19. By: Todd E. Clark; Stephen J. Terry
    Abstract: From Bayesian estimates of a vector autoregression (VAR) which allows for both coefficient drift and stochastic volatility, we obtain the following three results. First, beginning in approximately 1975, the responsiveness of core inflation to changes in energy prices in the United States fell rapidly and remains muted. Second, this decline in the passthrough of energy inflation to core prices has been sustained through a recent period of markedly higher volatility of shocks to energy inflation. Finally, reduced energy inflation passthrough has persisted in the face of monetary policy which quickly became less responsive to energy inflation starting around 1985.
    Date: 2009
  20. By: Magdalena Morgese Borys (CERGE-EI); Roman Horvath (Czech National Bank and Charles University, Prague)
    Abstract: In this paper, we examine the effects of Czech monetary policy on the economy within the VAR, structural VAR, and factor-augmented VAR frameworks. We document a well-functioning transmission mechanism similar to the euro area countries, especially in terms of persistence of monetary policy shocks. Subject to various sensitivity tests, we find that a contractionary monetary policy shock has a negative effect on the degree of economic activity and the price level, both with a peak response after one year or so. Regarding prices at the sectoral level, tradables adjust faster than non-tradables, which is in line with microeconomic evidence on price stickiness. There is no price puzzle, as our data come from a single monetary policy regime. There is a rationale in using the real-time output gap instead of current GDP growth, as using the former results in much more precise estimates. The results indicate a rather persistent appreciation of the domestic currency after a monetary tightening, with a gradual depreciation afterwards.This paper was presented at the 18th International Conference of the International Trade and Finance Association, meeting at Universidade Nova de Lisboa, Lisbon, Portugal, on May 23, 2008.
    Date: 2008–07–29
  21. By: Ester Faia; Lorenza Rossi
    Abstract: We study the design of optimal monetary policy (Ramsey policies) in a model with sticky prices and unionized labour markets. Collective wage bargaining and unions monopoly power tend to dampen wage fluctuations and to amplify employment fluctuations relatively to a DNK model with walrasian labour markets. The optimal monetary policy must trade-off counteracting forces. On the one side deviations from zero inflation allow the policy maker to smooth inefficient employment fluctuations. On other side, the presence of wage mark-ups and wage stickiness produce inflationary pressures that require aggressive inflation targeting. Overall we find that the Ramsey planner deviates from full price stability and that an optimal rule targets inflation the real economic activity alongside inflation
    Keywords: optimal monetary policy, labour market unionization, threat points
    JEL: E0 E4 E5 E6
    Date: 2009–03
  22. By: Saborowski, Christian (University of Warwick)
    Abstract: In this paper, we take an analytical approach to examine possible adverse effects of the use of inflation targeting as a disinflation regime. The idea is that a strict interpretation of an inflation target may preserve inflationary distortions after price stability is attained. We show that such a policy not only creates a slump in output but may increase macroeconomic volatility substantially in a model in which wages are subject to a Taylor staggering structure.
    Keywords: Disinflation ; Inflation Targeting ; Wage Staggering
    JEL: E4 E5
    Date: 2009
  23. By: Huiping Yuan (Department of Finance, Xiamen University); Stephen M. Miller (Department of Economics, University of Nevada, Las Vegas)
    Abstract: This paper shows that optimal policy and consistent policy outcomes require the use of control-theory and game-theory solution techniques. While optimal policy and consistent policy often produce different outcomes even in a one-period model, we analyze consistent policy and its outcome in a simple model, finding that the cause of the inconsistency with optimal policy traces to inconsistent targets in the social loss function. As a result, the social loss function cannot serve as a direct loss function for the central bank. Accordingly, we employ implementation theory to design a central bank loss function (mechanism design) with consistent targets, while the social loss function serves as a social welfare criterion. That is, with the correct mechanism design for the central bank loss function, optimal policy and consistent policy become identical. In other words, optimal policy proves implementable (consistent).
    Keywords: Optimal policy, Consistent policy, Implementation theory
    JEL: E42 E52 E58
    Date: 2009–03
  24. By: Smith, Reginald
    Abstract: Currency logistics is becoming a field of increasing interest and importance both in government and academic circles. In this paper, a basic description of China's nationwide logistics network for the Renminbi is discussed and analyzed. In addition to its basic structure, its key problems such as production costs, inventory levels, and transportation and storage security are discussed.
    Keywords: currency; logistics; China; money supply
    JEL: E42 E58
    Date: 2008–11–30
  25. By: Huiping Yuan (Department of Finance, Xiamen University); Stephen M. Miller (Department of Economics, University of Nevada, Las Vegas); Langnan Chen (Institute for Economics, Sun Yat-sen University)
    Abstract: This paper shows that optimal policy and consistent policy outcomes require the use of control-theory and game-theory solution techniques. While optimal policy and consistent policy often produce different outcomes even in a one-period model, we analyze consistent policy and its outcome in a simple model, finding that the cause of the inconsistency with optimal policy traces to inconsistent targets in the social loss function. Control theory can identify the optimal plan and, thus, the optimal economic outcomes. Then, we can seek a consistent plan that coincides with the optimal plan through institutional design. That is, the optimal plan can indicate how to design the optimal institution, through which we implement the optimal plan with a consistent plan.
    Keywords: Optimal policy, Consistent policy, Institutional design
    JEL: E42 E52 E58
    Date: 2009–03
  26. By: Leon Podkaminer (The Vienna Institute for International Economic Studies, wiiw)
    Abstract: The cross-country relationship between the relative price level and the relative GDP level is found to be significant and stable for EU member states over the period 1997-2006. The joint dynamics of price and GDP levels tend to gravitate towards the regression line but there is no shorter-term trade-off between fast real convergence and low inflation. Contrary to popular perception high inflation is not necessary for fast convergence. Moreover the trajectories of certain euro area states indicate that giving up one's national currency is risky: it may stop convergence or even precipitate divergence. Problems may also emerge when the initial parity is weak. In addition, the inability to nominally devalue may prove very costly. However retaining one's national currency is not risk-free, even if domestic inflation is low, and even though subsequent corrective devaluations remain possible. While participation in the euro area has proved troublesome for some countries, it is in the interest of all member states to deepen wage and fiscal policy integration in order to help overcome the stagnation experienced in those euro area states that suffer from strongly overvalued price levels.
    Keywords: real convergence, relative price level, inflation, euro, EU
    JEL: E31 F15 F43 O47
    Date: 2008–12
  27. By: Tatom, John
    Abstract: Financial sector regulatory reform has been a leading national issue since the U.S. Treasury issued its Blueprint for reform in spring (2008). The mortgage foreclosure and financial crises reinforced popular interest in whether the U.S. regulatory framework was deficient and how to fix the regulatory framework. Meanwhile, some key decisions in the United States, particularly concerning the failure and bailout of AIG and some investment banks in fall 2008, have established precedents for a new regulatory framework and policies. Where policymakers go from here is not certain, but the ideas on the table and the direction of policy suggest that the role of the Federal Reserve (Fed) in financial regulation will become central, at least in critical periods. This paper reviews the calls for a new “financial stability” regulator and the potential role of the Fed as such a regulator. It argues that the takeover of AIG provides a useful example and precursor of the Fed’s suitability in that role. Section 1 explains the Fed’s role as regulator and the relationship of the Fed’s lender of last resort function to systemic risk. It also addresses recent changes in the notion of systemic risk and systemically significant firms in concluding that there is a remaining case for a new regulator of such risk. Section II reviews the financial problems of AIG and the changing intervention of the Fed and the U.S. Treasury in AIG. The last section takes up some related issues, the role of a central bank versus a Financial Stability Authority in regulating banks or systemic risk, the potential role of the Fed or a another federal regulator in regulating the insurance industry and the risk to Fed independence from extending its regulatory role to cover systemic risk. The Fed’s actions with regard to AIG provide strong evidence that broadening the too big to fail policy or broadening the Fed’s lender of last resort policy to include non-bank firms pose strong conflicts for the achievement of the objectives of monetary policy or of financial stability. Moreover, the loss experience of AIG indicates the problems of fragmented or absent federal regulation of insurers for regulatory reform.
    Keywords: Financial Regulation; Central Banking; Systemic Risk;
    JEL: E58 G28
    Date: 2009–02–28
  28. By: Rime, Dagfinn; Sarno, Lucio; Sojli, Elvira
    Abstract: This paper adds to the research efforts that aim to bridge the divide between macro and micro approaches to exchange rate economics by examining the linkages between exchange rate movements, order flow and expectations of macroeconomic variables. The basic hypothesis tested is that if order flow reflects heterogeneous expectations about macroeconomic fundamentals, and currency markets learn about the state of the economy gradually, then order flow can have both explanatory and forecasting power for exchange rates. Using one year of high frequency data collected via a live feed from Reuters for three major exchange rates, we find that: i) order flow is intimately related to a broad set of current and expected macroeconomic fundamentals; ii) more importantly, order flow is a powerful predictor of daily movements in exchange rates in an out-of-sample exercise, on the basis of economic value criteria such as Sharpe ratios and performance fees implied by utility calculations.
    Keywords: exchange rates; forecasting; macroeconomic news; microstructure; order flow
    JEL: F31 F41 G10
    Date: 2009–03
  29. By: Marlene Amstad; Andreas M. Fischer
    Abstract: This paper estimates monthly pass-through ratios from import prices to consumer prices in real time. Conventional time series methods impose restrictions to generate exogenous shocks on exchange rates or import prices when estimating pass-through coefficients. Instead, a natural experiment based on data releases defines our shock to foreign prices. Our estimation strategy follows an event-study approach based on monthly releases in import prices. Projections from a dynamic common factor model with daily panels before and after monthly releases of import prices define the shock. This information shock allows us to recover a monthly pass-through ratio. We apply our identification procedure to Swiss prices and find strong evidence that the monthly pass-through ratio is around 0.3. Our real-time estimates yield higher pass-through ratios than time series estimates.
    Keywords: Monetary policy ; Econometric models ; Foreign exchange rates ; Prices
    Date: 2009
  30. By: Elena Bojesteanu (Academy of Economic Studies (Romania)); Gabriel Bobeica (Academy of Economic Studies (Romania))
    Abstract: The present study sheds light on important aspects of monetary integration in the European Union involving the newest member states. It assesses the degree to which they satisfy the business cycle correlation criteria. Our results demonstrate that there is a common business cycle in the Euro area and that most of the candidate countries exhibit convergence with this group, with the remarkable exception of Estonia, Lithuania, Slovakia and Romania. Bulgaria shows better achievements than Romania in terms of business cycle synchronization with the Euro zone.This paper was presented at the 18th International Conference of the International Trade and Finance Association meeting at Universidade Nova de Lisboa, Lisbon, Portugal, on May 23, 2008.
    Date: 2008–08–06
  31. By: Hui-Boon Tan (Nottingham University Business School - Malaysia Campus); Lee-Lee Chong (Faculty of Management, Malaysia Multimedia University)
    Abstract: This study highlights the importance of choice of exchange rate system to macroeconomic stability of small- open countries based on the outcomes of the recent exchange rate regime switches of three small Asian countries during the post Asian financial crisis period. The three selected countries are Indonesia, Malaysia and Thailand, which have high similarities in their economic structures, but have reacted very differently in mitigating the economic distortion of the 1997 financial crisis, in particular in the adoption of exchange rate system. By focussing on macroeconomic volatilities of these countries, our results show that the amplified volatilities due to the crisis were not stabilised by switching the system to a more flexible regime. For instance, Thailand and Indonesia had switched their system from a managed-float to an independent-float, and as a result, the volatilities were increased instead of reduced after the switch. The volatilities, however, were effectively stabilised after the countries made the second switch - from the independent-float back to the managed-float with pre-announcement. For Malaysia, a switch from the managed-float to the pegged system successfully reduced the volatilities. The exchange rate misalignments of the countries, except Indonesia, were also reduced when the countries switched from a flexible to a more fixed system. These empirical findings thus strongly support central banks of small-open economies to adopt a more fixed, such as the managed-float system, rather than a flexible, such as the independentfloat. However, the managed-float system needs to couple with efficient management to ensure a smooth and stable regime.
    Keywords: Exchange rate regimes; Macroeconomic volatility; Financial crisis; Exchange rate misalignment
    JEL: E42 E44 F31
    Date: 2008–06

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