nep-mon New Economics Papers
on Monetary Economics
Issue of 2009‒05‒23
25 papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Does FOMC Communication Help Predicting Federal Funds Target Rate Changes? By Bernd Hayo; Matthias Neuenkirch
  2. What Drives the Term Structure in the Euro Area? Evidence from a Model with Feedback By Zagaglia, Paolo
  3. The monetary policy rules and the inflation process in open emerging economies: evidence for 12 new EU members By Borek Vasicek
  4. IT Framework Design Parameters By Charles Freedman; Douglas Laxton
  5. FOMC Communication and Emerging Equity Markets By Bernd Hayo; Ali M. Kutan; Matthias Neuenkirch
  6. Inflation models, optimal monetary policy and uncertain unemployment dynamics: Evidence from the US and the euro area By Carlo Altavilla; Matteo Ciccarelli
  7. On the implementation of Markov-Perfect interest rate and money supply rules : global and local uniqueness By Michael Dotsey; Andreas Hornstein
  8. Asset Markets and Monetary Policy By Eckhard Platen; Willi Semmler
  9. Controllability and Persistence of Money Market Rates along the Yield Curve: Evidence from the Euro Area By Ulrike Busch; Dieter Nautz
  10. Inflation Targeting Under Imperfect Policy Credibility By Turgut Kisinbay; Ondra Kamenik; Ali Alichi; Charles Freedman; M. Johnson; Kevin Clinton; Huigang Chen; Douglas Laxton
  11. Do Money Or Oil And Crop Productivity Shocks Lead To Inflation: The Case Of Pakistan By Syed, Kanwar Abbas
  12. Monetary policy in Europe vs the US: what explains the difference? By Harald Uhlig
  13. Why Inflation Targeting? By Charles Freedman; Douglas Laxton
  14. Determinants of Inflation in GCC By Hanan Morsy; Magda E. Kandil
  15. Understanding Inflation Inertia in Angola By Nir Klein; Alexander Kyei
  16. "Stationary Monetary Equilibria with Strictly Increasing Value Functions and Non-Discrete Money Holdings Distributions: An Indeterminacy Result" By Kazuya Kamiya; Takashi Shimizu
  17. Optimal Reserves in the Eastern Caribbean Currency Union By Wendell A. Samuel; Mario Dehesa; Emilio Pineda
  18. Monetary Policy and the Dollar By Peter L. Rousseau
  19. Indian Currency and Beyond. The Legacy of the Early Economics of Keynes in the Times of Bretton Woods II By Anna M. Carabelli; Mario A. Cedrini
  20. Analysis on β and σ Convergences of East Asian Currencies By OGAWA Eiji; YOSHIMI Taiyo
  21. The Effect of Equity Market Integration on the Transmission Monetary Policy. Evidence from Australia By Cinzia Alcidi
  22. When is Monetary Policy All We Need? By Fabian Eser; Campbell Leith; Simon Wren-Lewis
  23. Effective exchange rates of the Bulgarian Lev 1879-1939 By Kalina Dimitrova; Martin Ivanov; Ralitsa Simeonova-Ganeva
  24. Trickle-Down Effects of Changing Value of Euro on US Economy By Bhattacharya, Sulagna
  25. Investigating Inflation Dynamics and Structural Change with an Adaptive ARFIMA Approach By Richard T. Baille; Claudio Morana

  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: We explain changes in the federal funds target rate using macroeconomic variables and Federal Open Market Committee (FOMC) communication indicators. Econometrically, we employ an ordered probit model of a Taylor rule to predict 75 target rate decisions between 1998 and 2006. We find, first, that FOMC communication is forward-looking, with a horizon that goes beyond the next meeting. Second, our communication indicators significantly explain target rate changes and improve explanatory power in and out of sample. Third, speeches by members of the Board of Governors and regional presidents have a statistically significant and equal-sized effect, whereas the less-frequent monetary policy reports and testimonies are insignificant. Fourth, our findings are robust to variations in the specification, including changes in the communication strategy as well as a measure of unambiguous communication. Finally, our communication indicator based on FOMC speeches performs better in explaining rate changes than do newswire reports of Fed communications.
    Keywords: Central Bank Communication, Federal Reserve Bank, Interest Rate Decision, Monetary Policy, Federal Funds Target Rate, Taylor Rule
    JEL: E43 E52 E58
    Date: 2009
  2. By: Zagaglia, Paolo (Dept. of Economics, Stockholm University)
    Abstract: I study a general-equilibrium model of the term structure where bond prices are an integral part of the monetary transmission mechanism. The model is estimated on quarterly Euro area data. I show that, besides shocks to the inflation target, also exogenous variations in money demand and bond supply can explain movements in long-term interest rates. I also find that taking into account the impact of bond yields on the macroeconomy generates superior in-sample and out-of-sample forecasts for output, inflation and for bond yields.
    Keywords: Monetary policy; yield curve; monetary transmission mechanism
    JEL: E43 E44 E52
    Date: 2009–05–13
  3. By: Borek Vasicek (Departament d'Economia Aplicada, Universitat Autonoma de Barcelona)
    Abstract: This paper has three objectives. First, it aims at revealing the logic of interest rate setting pursued by monetary authorities of 12 new EU members. Using estimation of an augmented Taylor rule, we find that this setting was not always consistent with the official monetary policy. Second, we seek to shed light on the inflation process of these countries. To this end, we carry out an estimation of an open economy Philips curve (PC). Our main finding is that inflation rates were not only driven by backward persistency but also held a forward-looking component. Finally, we assess the viability of existing monetary arrangements for price stability. The analysis of the conditional inflation variance obtained from GARCH estimation of PC is used for this purpose. We conclude that inflation targeting is preferable to an exchange rate peg because it allowed decreasing the inflation rate and anchored its volatility.
    Keywords: open emerging economies, monetary policy rules, open economy Phillips curve, conditional inflation variance
    JEL: E31 E52 E58 P24
    Date: 2009–05
  4. By: Charles Freedman; Douglas Laxton
    Abstract: This is the third chapter of a forthcoming monograph entitled "On Implementing Full-Fledged Inflation-Targeting Regimes: Saying What You Do and Doing What You Say." It examines a number of elements in the design of an inflation-targeting framework. These include the definition of the target variable, the relevance of core measures of inflation, and the advantages and disadvantages of point targets, point targets with a band, and range targets. It then discusses the choice of a long-term inflation rate, the target horizon, and the policy horizon.
    Keywords: Information technology , Inflation targeting , Monetary policy , Inflation , Inflation rates , Central banks , Data collection , Data analysis ,
    Date: 2009–04–23
  5. By: Bernd Hayo (Faculty of Business Administration and Economics, Philipps Universitaet Marburg); Ali M. Kutan (Southern Illinois University Edwardsville and the William Davidson Institute, Michigan); Matthias Neuenkirch (Faculty of Business Administration and Economics, Philipps Universitaet Marburg)
    Abstract: Using a GARCH model, we study the effects of Federal Funds target rate changes and FOMC communication on emerging equity market returns and volatility over the period 1998–2006. First, both types of news have a significant impact on market returns. Second, target rate changes are more important than informal communication. Third, the occurrence of monetary policy reports lowers price volatility. Finally, American emerging markets react more to U.S. news than non-American markets.
    Keywords: Central Bank Communication, Emerging Markets, Federal Reserve Bank, U.S. Monetary Policy
    JEL: E52 G14 G15
    Date: 2009
  6. By: Carlo Altavilla; Matteo Ciccarelli (-; -)
    Abstract: This paper explores the role that model uncertainty plays in determining the effect of monetary policy shocks on unemployment dynamics in the euro area and the US. We specify a range of BVARs that differ in terms of variables, lag structure, and the way the inflation process is modelled. For each model the central bank sets the interest rate minimizing a loss function. Given this solution, we quantify the impact of a monetary policy shock on unemployment for each model, and measure the degree of uncertainty as represented by the dispersion of both the policy rule parameters and the impulse response functions between models. The comparative evidence from the US and the euro area data indicates that model uncertainty is indeed an important feature, and that a model combination strategy might be a valuable advise to policymakers.
    Keywords: Inflation models, Unemployment, Model uncertainty, Taylor rule, Impulse response analysis
    JEL: C53 E24 E37
    Date: 2008–06–30
  7. By: Michael Dotsey; Andreas Hornstein
    Keywords: Monetary policy ; Interest rates
    Date: 2009
  8. By: Eckhard Platen (School of Finance and Economics, University of Technology, Sydney); Willi Semmler (Department of Economics, New School, New York and Center for Empirical Macroeconomics, Bielefeld University)
    Abstract: Monetary policy has pursued the concept of inflation targeting. This has been implemented in many countries. Here interest rates are supposed to respond to an inflation gap and output gap. Despite long term continuing growth of the world financial assets, recently, monetary policy, in particular in the U.S. after the subprime credit crisis, was challenged by severe disruptions and a meltdown of the financial market. Subsequently, academics have been in search of a type of monetary policy that does allow to in°uence in an appropriate manner the investor's behavior and, thus, the dynamics of the economy and its financial market. The paper suggests a dynamic portfolio approach. It allows one to study the interaction between investors` strategic behavior and monetary policy. The article derives rules that explain how monetary authorities should set the short term interest rate in interaction with inflation rate, economic growth, asset prices, risk aversion, asset price volatility, and consumption rates. Interesting is that the inflation rate needs to have a certain minimal level to allow the interest rate to be a viable control instrument. A particular target interest rate has been identified for the desirable optimal regime. If the proposed monetary policy rule is applied properly, then the consumption rate will remain stable and the inflation rate can be kept close to a minimal possible level. Empirical evidence is provided to support this view. Additionally, in the case of an economic crisis the proposed relationships indicate in which direction to act to bring the economy back on track.
    Keywords: risk aversion; interest rate; dynamic portfolio; consumption rate; inflation; monetary policy; benchmark approach
    JEL: G10 G13
    Date: 2009–04–01
  9. By: Ulrike Busch; Dieter Nautz
    Abstract: Controllability of longer-term interest rates requires that the persistence of their deviations from the central bank's policy rate (i.e. the policy spreads) remains suciently low. This paper applies fractional integration techniques to assess the persistence of policy spreads of euro area money market rates along the yield curve. Independently from anticipated policy rate changes, there is strong evidence for all maturities that policy spreads exhibit long memory. We show that recent changes in the operational framework and the communication strategy of the European Central Bank have significantly decreased the persistence of euro area policy spreads and, thus, have enhanced the central bank's influence on longer-term money market rates.
    Keywords: Long memory and fractional integration, controllability and persistence of interest rates, new operational framework of the ECB
    JEL: C22 E43 E52
    Date: 2009–05
  10. By: Turgut Kisinbay; Ondra Kamenik; Ali Alichi; Charles Freedman; M. Johnson; Kevin Clinton; Huigang Chen; Douglas Laxton
    Abstract: This paper presents a model for Inflation Targeting under imperfect policy credibility. It modifies the conventional model in three ways: an endogenous policy credibility process, by which monetary policy can gain or lose credibility over time; non-linearities in the inflation equation and in the credibility generating process; and an explicit loss function. The model highlights problems associated with the practice of setting a series of rigid near-term inflation targets. Also, unfavorable supply shocks pose a difficult problem: an appropriate response involves an interest rate increase, some loss of output, and a period of increased inflation. A delayed response can result in a prolonged period of stagflation.
    Keywords: Inflation targeting , Emerging markets , Monetary policy , Disinflation , Demand , Price increases , Economic models ,
    Date: 2009–04–28
  11. By: Syed, Kanwar Abbas
    Abstract: The worst economic outcomes have been argued as a result of the mismanagement in money supply especially in 1929’s Great Depression, 1970’s Stagflation and 2008’s Economic depression in the global economy. However, economic recessions tend to appear after oil price phenomenon. In particular, the global inflationary pressures of 2008 became severe with the spikes up in oil prices as well as crop productivity shocks in the world economy including Pakistan. The object of the present paper is to discuss inflation in the framework of Monetary and external Oil Price Shocks, Crop Productivity Propositions, Inflation Inertia, and real GDP growth. The empirical studies broadly uphold the monetary explanation of inflation in the Pakistan’s economy. This paper offers the policy implication that the combination of monetary as well as productivity management is required to arrest inflationary pressures in the economy. In addition, we find the comprehensive evidence that food inflation is also a monetary phenomenon in the Pakistan’s economy. On the other hand, the continuous persistence in inflation inertia does not hold as a result of the absence of autocorrelation in money supply in AR (2) or higher process in the data. Oil prices in terms of domestic currency highlight the fact that the transmission channel of world shocks via exchange rate fluctuations leaves significant impacts upon domestic inflation in the economy.
    Keywords: Money; Inflation; Oil; Productivity
    JEL: B22
    Date: 2009–04–10
  12. By: Harald Uhlig
    Abstract: This paper compares monetary policy in the US and EMU during the last decade, employing an estimated hybrid New Keynesian cash-in-advance model, driven by five shocks. It appears that the difference between the two monetary policies between 1998 and 2006 is due to both surprises in productivity as well as surprises in wage demands, moving interest rates in opposite directions in Europe and the US, but not due to a more sluggish response in Europe to the same shocks or to different monetary policy surprises.
    JEL: E32 E50 E52 E58 E63
    Date: 2009–05
  13. By: Charles Freedman; Douglas Laxton
    Abstract: This is the second chapter of a forthcoming monograph entitled "On Implementing Full-Fledged Inflation-Targeting Regimes: Saying What You Do and Doing What You Say." We begin by discussing the costs of inflation, including their role in generating boom-bust cycles. Following a general discussion of the need for a nominal anchor, we describe a specific type of monetary anchor, the inflation-targeting regime, and its two key intellectual roots-the absence of long-run trade-offs and the time-inconsistency problem. We conclude by providing a brief introduction to the way in which inflation targeting works.
    Keywords: Inflation targeting , Monetary policy , Inflation , Economic models ,
    Date: 2009–04–23
  14. By: Hanan Morsy; Magda E. Kandil
    Abstract: Inflationary pressures have heightened in the oil-rich Gulf Cooperation Council (GCC) since 2003. This paper studies determinants of inflation in GCC, using an empirical model that includes domestic and external factors. Inflation in major trading partners appears to be the most relevant foreign factor. In addition, oil revenues have reinforced inflationary pressures through growth of credit and aggregate spending. In the short-run, binding capacity constraints also explain higher inflation given increased government spending. Nonetheless, by targeting supply-side bottlenecks, the increase in government spending is easing capacity constraints and will ultimately help to moderate price inflation.
    Keywords: Inflation , Cooperation Council for the Arab States of the Gulf , External shocks , Domestic liquidity , Monetary policy , Currency pegs , Exchange rate depreciation , Economic models , Cross country analysis ,
    Date: 2009–04–22
  15. By: Nir Klein; Alexander Kyei
    Abstract: In recent years, the decline in inflation in Angola has stalled and further steps may be needed to attain the authorities' medium term goal of meeting the Southern African Development Community (SADC) convergence criteria of a low single digit inflation rate. A Vector Error Correction (VEC) model, which analyzes the factors that affect the inflationary process in Angola, suggests that the inflation path has been largely affected by exchange rate movements. This implies that greater exchange rate flexibility that facilitates a gradual appreciation would be instrumental to moderate price growth through reducing the price of imports and limiting liquidity injection by the National Bank of Angola (BNA). Additionally, the analysis shows that excess liquidity, which is measured by positive deviations of M2 from its equilibrium level, adds to demand pressures, and contributes to inflation with a lag. This underlines the importance of closely monitoring the growth of monetary aggregates as well as improving liquidity management.
    Keywords: Inflation , Angola , Inflation rates , Monetary aggregates , Oil exports , Commodity price fluctuations , Exchange rates , Excess liquidity , Liquidity management , Economic models , Data analysis ,
    Date: 2009–05–12
  16. By: Kazuya Kamiya (Faculty of Economics, University of Tokyo); Takashi Shimizu (Faculty of Economics, Kansai University)
    Abstract: In this paper, we present a search model with divisible money in which there exists a continuum of monetary equilibria with strictly increasing continuous value functions and with non-discrete money holdings distributions.
    Date: 2009–03
  17. By: Wendell A. Samuel; Mario Dehesa; Emilio Pineda
    Abstract: Recent turbulence in global and Caribbean regional financial markets underscore the importance of reassessing the adequacy of international reserves held by the Eastern Caribbean Central Bank (ECCB). Using the Jeanne (2007) optimization framework, this paper finds that international reserves held by the ECCB are generally adequate for a variety of external current account and capital account shocks. However, the ECCB would be challenged in the event of moderate to severe deposit outflows.
    Keywords: Reserves , Eastern Caribbean Currency Union , Emerging markets , Monetary unions , Capital flows , Economic models ,
    Date: 2009–04–22
  18. By: Peter L. Rousseau
    Abstract: In this essay I propose that the adoption of the U.S. dollar as a common currency shortly after the ratification of the Federal Constitution and the accompanying transition from a fiat to specie standard was a pivotal moment in the nation’s early history and marked an improvement over the monetary systems of colonial America and under the Articles of Confederation. This is because the dollar and all that came with it monetized the modern sector of the U.S. economy and tied the supply of money more closely to the capital market and the provision of credit―feats that were not possible in an era when colonial legislatures were unable to credibly commit to controlling paper money emissions. The switch to a specie standard was at the time necessary to promote domestic and international confidence in the nascent financial system, and paved the way for the long transition to the point when the standard was no longer required.
    JEL: E42 E44 N11 N21
    Date: 2009–05
  19. By: Anna M. Carabelli; Mario A. Cedrini (SEMEQ Department - Faculty of Economics - University of Eastern Piedmont)
    Abstract: In the paper, we revisit the focus and method of “Indian Currency and Finance” (1913) and the rationale of Keynes's proposal for an international monetary system combining cheapness with stability. In particular, we centre on the management of exchange reserve and the pattern of relationships between creditor and debtor countries, to suggest that Keynes's fresh look at Asia in the first years of the twentieth century may provide useful hints for an overall rethinking of the major faults of today's Bretton Woods II system as well as the rationale for a global monetary reform.
    Keywords: John Maynard Keynes, Indian Currency and Finance, international economic order, exchange reserves
    JEL: B31 B40 F02 F31
    Date: 2009–05
  20. By: OGAWA Eiji; YOSHIMI Taiyo
    Abstract: This paper focuses on recent events which include the RMB reform in China and the global financial crisis to investigate statistically recent diverging trends among East Asian currencies. For the purpose, their weighted average value (Asian Monetary Unit: AMU) and their deviations (AMU Deviation Indicators) from benchmark levels are used to analyze both β and σ convergences of East Asian currencies. Our analytical results show that the monetary authority of China has still kept stabilizing the exchange rate of the Chinese yuan against only the US dollar even though it announced its adoption of a managed floating exchange rate system with reference to a currency. Analytical results on β and σ convergences show that deviations among the East Asian currencies have been diverging in recent years, especially after 2005. The widening deviations reflect not the RMB reform but recent international capital flows and the global financial crisis. In addition, it is important as its background that the monetary authorities of the countries are adopting a variety of exchange rate systems. In other words, a coordination failure in adopting exchange rate systems among these monetary authorities increases volatility and misalignment of intra-regional exchange rates in East Asia.
    Date: 2009–05
  21. By: Cinzia Alcidi (IUHEID, The Graduate Institute of International and Development Studies, Geneva)
    Abstract: This paper investigates the effects of equity market integration on the transmission of monetary policy shocks. Based on the assumption that financial market liberalization and integration lead to falling portfolio holding costs, we analyze its effect on a two-country DSGE model with staggered prices and endogenous portfolio choice under incomplete markets. The model predicts that the reaction of stock prices, output and RER becomes muted upon impact and less persistence with falling portfolio holding costs. To test for a similar pattern in the data, we estimate a VAR with rolling coefficients for Australia, which provides a good case study. We identify a monetary policy shock with the sign restriction approach. The impulse responses generated by the data are consistent with the prediction of the model and imply that equity market liberalization seems to weaken the impact of monetary policy, at least on stock prices.
    Keywords: Endogenous portfolio, Monetary policy, Financial liberalization, FAVAR
    JEL: E52 C32 F21 F36
    Date: 2009–03
  22. By: Fabian Eser; Campbell Leith; Simon Wren-Lewis
    Abstract: We consider optimal monetary and fiscal policies in a New Keynesian model of a small open economy with sticky prices and wages. In this benchmark setting monetary policy is all we need - analytical results demonstrate that variations in government spending should play no role in the stabilization of shocks. In extensions we show, firstly, that this is even true when allowing for inflation inertia through backward-looking rule-of-thumb price and wage-setting, as long as there in no discrepancy between the private and social evaluation of the marginal rate of substitution between consumption and leisure. Secondly, the optimal neutrality of government spending is robust to the issuance of public debt. In the presence of debt government spending will deviate from the optimal steady-state but only to the extent required to cover the deficit, not to provide any additional macroeconomic stabilization. However, unlike government spending variations in tax rates can play a complementary role to monetary policy, as they change relative prices rather than demand.
    Keywords: Monetary policy, Fiscal policy, Macroeconomic stabilization, Dynamic general equilibrium, Sticky prices, Sticky wages, Rule-of-thumb behaviour, Debt, Countercyclical policy
    JEL: E5 E6 C62
    Date: 2009
  23. By: Kalina Dimitrova; Martin Ivanov; Ralitsa Simeonova-Ganeva
    Abstract: The paper constructs the first series of nominal and real effective exchange rates of the Bulgarian Lev from its establishment in 1879 until 1939. The dynamics of both indicators during the Classical Gold Standard fits the general picture of exchange rate development of other European countries while their movements in the Interwar years reflects the exchange rate policy of the monetary authority and the price effects of the Great Depression. The study also provides econometric estimation of the impact of the real effective exchange rates and foreign demand on Bulgaria’s real export performance allowing for some policy implications.
    Date: 2009–05
  24. By: Bhattacharya, Sulagna
    Abstract: Historically, the US Dollar had been accepted as the strongest currency and it had no competition at the regional or global level. But inception of Euro changed this unique stature and status enjoyed by USD. With introduction of Euro as the common currency, the European Union became USA’s closest competitor in terms of economic size, performance, indicators and political and economic clout. Over time, value of euro started appreciating and accordingly, Euro/USD exchange rate which is fully floating, started rising. A rising Euro affects the US economy in three ways: directly, indirectly and through a cascading effect caused by an interaction of these direct and indirect influences. This paper attempts to identify and explore the effects of an appreciating Euro on some select economic indicators of the US, both historically and projected. It also establishes the relationship between some of these indicators which are not directly cross-related, by analyzing the impact of the Euro on the economy’s most sensitive economic parameters. Section I briefly touches upon the scope and objective of this paper. Section II introduces the concept of exchange rate, different exchange rate regimes and determinants of exchange rates. Section III views the historical relationship between the Euro/USD exchange rate and the most important macroeconomic indictors of the US economy. Section IV explores the projected impact of potential future Euro/USD exchange rate on the same indictors and explains the linkages. Section V concludes.
    Keywords: Euro; Appreciation; US Economy; Trickle-Down;Exchange Rate;Currency
    JEL: F42 E27 E52 F31
    Date: 2009–05–17
  25. By: Richard T. Baille; Claudio Morana
    Abstract: Previous models of monthly CPI inflation time series have focused on possible regime shifts, non-linearities and the feature of long memory. This paper proposes a new time series model, named Adaptive ARFIMA; which appears well suited to describe inflation and potentially other economic time series data. The Adaptive ARFIMA model includes a time dependent intercept term which follows a Flexible Fourier Form. The model appears to be capable of succesfully dealing with various forms of breaks and discontinities in the conditional mean of a time series. Simulation evidence justifies estimation by approximate MLE and model specfication through robust inference based on QMLE. The Adaptive ARFIMA model when supplemented with conditional variance models is found to provide a good representation of the G7 monthly CPI inflation series.
    Keywords: ARFIMA; FIGARCH, long memory, structural change, inflation, G7.
    JEL: C15 C22
    Date: 2009–05

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.