nep-mon New Economics Papers
on Monetary Economics
Issue of 2009‒09‒26
forty-five papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. How did we get to inflation targeting and where do we go now? a perspective from the U.S. experience By Daniel L. Thornton
  2. Price level targeting and stabilization policy By Aleksander Berentsen; Christopher J. Waller
  3. Money and the Transmission of Monetary Policy By Seth Carpenter; Selva Demiralp
  4. The identification of the response of interest rates to monetary policy actions using market-based measures of monetary policy shocks By Daniel L. Thornton
  5. Evaluating Monetary Policy By Lars E.O. Svensson
  6. Sticky Wages, Incomplete Pass-Through and Inflation Targeting: What is the Right Index to Target? By Salem M. Abo-Zaid
  7. Greenspan’s Legacy and Bernanke’s attitude to the Financial Crisis By John Ryan; Adam Koronowski
  8. Asset Prices and Monetary Policy By Ichiro Fukunaga; Masashi Saito
  9. Monetary Policy, Inflation Expectations and the Price Puzzle By Efrem Castelnuovo; Paolo Surico
  10. A Historical Analysis of Central Bank Independence in Latin America: The Colombian Experience, 1923-2008 By Adolfo Meisel; Juan David Barón
  12. Intergenerational Transmission of Inflation Aversion: Theory and Evidence By Farvaque, Etienne; Mihailov, Alexander
  13. Money demand in the euro area: new insights from disaggregated data By Setzer, Ralph; Wolff, Guntram B.
  14. Optimal stabilization policy with endogenous firm entry By Aleksander Berentsen; Christopher J. Waller
  15. Monetary Policy, Forex Markets and Feedback Under Uncertainity in an Opening Economy By Ashima Goyal
  16. Oligopolistic Competition and Optimal Monetary Policy By Ester Faia
  17. Public investment, distortionary taxes and monetary policy transparency. By Meixing Dai; Moïse Sidiropoulos
  18. The Mechanics of Central Bank Intervention in Foreign Exchange Markets By Basu, Kaushik
  19. Micro data on nominal rigidity, inflation persistence and optimal monetary policy By Engin Kara
  20. Money and capital: a quantitative analysis By S. Boragan Aruoba; Christopher J. Waller; Randall Wright
  21. Monetary Policy and the Dollar By Peter L. Rousseau
  22. Random matching and money in the neoclassical growth model: some analytical results By Christopher J. Waller
  23. Dynamic taxation, private information and money By Christopher J. Waller
  24. Inflation Perceptions and Expectations in the Euro Area: The Role of News. By Cristian Badarinza; Marco Buchmann
  25. Disagreement among Forecasters in G7 Countries By Jonas Dovern; Ulrich Fritsche; Jiri Slacalek
  26. Credit spreads and monetary policy By Vasco Cúrdia; Michael Woodford
  27. Measuring Central Bank Communication: An Automated Approach with Application to FOMC Statements By David O. Lucca; Francesco Trebbi
  28. Liquidity risk, credit risk, and the Federal Reserve's responses to the crisis By Asani Sarkar
  29. Nominal Rigidities, Monetary Policy and Pigou Cycles By Stephane Auray; Paul Gomme; Shen Guo
  30. On Global Currencies By Frankel, Jeffrey
  31. Monetary and fiscal policy under deep habits By Campbell Leith; Ioana Moldovan; Raffaele Rossi
  32. Exchange-Rate Pass Through, Openness, Inflation, and the Sacrifice Ratio By Joseph P. Daniels; David D. VanHoose
  33. Sources of exchange rate fluctuations: are they real or nominal? By Luciana Juvenal
  34. What Makes Currencies Volatile? An Empirical Investigation By Michael Bleaney; Manuela Francisco
  35. The Monetary Transmission Mechanism in the Euro Area: A VAR-Analysis for Austria and Germany By Bernard Bartels
  36. Monetary Aggregates and the Business Cycle By Sustek, Roman
  37. Towards a Common European Monetary Union Risk Free Rate By Sergio Mayordomo; Juan Ignacio Peña; Eduardo S. Schwartz
  38. Analysis of a network structure of the foreign currency exchange market By Jaroslaw Kwapien; Sylwia Gworek; Stanislaw Drozdz; Andrzej Gorski
  39. Adjustment in EMU: Is Convergence Assured? By Sebastian Dullien; Ulrich Fritsche; Ingrid Groessl; Michael Paetz
  40. Real-time inflation forecasting in a changing world By Jan J. J. Groen; Richard Paap; Francesco Ravazzolo
  41. Euro area money demand: empirical evidence on the role of equity and labour markets. By Gabe J. de Bondt
  42. (The Effect of) Monetary and Exchange Rate Policies (on Development) By Eduardo Levy Yeyati; Federico Sturzenegger
  43. The formation of inflation expectations: an empirical analysis for the UK By David G. Blanchflower; Conall MacCoille
  44. Optimal intervention in the foreign exchange market when interventions affect market dynamics By Alec N. Kercheval; Juan F. Moreno
  45. Bubbles, External Imbalances & Demand for International Liquidity in the Bretton Woods II System By Andrea Ricci

  1. By: Daniel L. Thornton
    Abstract: This paper advances the hypothesis that the transition from there-is-little-central-banks-can-do-to-control-inflation to inflation targeting occurred because central banks, especially the Federal Reserve, demonstrated that central banks can control inflation rather than a consequence of marked improvement in the professions understanding of how monetary policy controls inflation. As consequence, monetary theorists and central bankers have returned to a Phillips curve framework for formulating and evaluating the monetary policy. I suggest that the return to the Phillips curve framework endangers the continued effectiveness, and perhaps even viability, of inflation targeting, recommend three steps that inflation-targeting central banks should take to preserve and strengthen inflation targeting.
    Keywords: Monetary policy ; Phillips curve ; Inflation targeting
    Date: 2009
  2. By: Aleksander Berentsen; Christopher J. Waller
    Abstract: We construct a dynamic stochastic general equilibrium model to study optimal monetary stabilization policy. Prices are fully flexible and money is essential for trade. Our main result is that if the central bank pursues a price-level target, it can control inflation expectations and improve welfare by stabilizing short-run shocks to the economy. The optimal policy involves smoothing nominal interest rates which effectively smooths consumption across states.
    Keywords: Monetary policy ; Econometric models
    Date: 2009
  3. By: Seth Carpenter (Board of Governors of the Federal Reserve System); Selva Demiralp
    Abstract: The transmission mechanism of monetary policy has received extensive treatment in the macroeconomic literature. Most models currently used for macroeconomic analysis exclude money or else model money demand as entirely endogenous. Nevertheless, academic research and many textbooks continue to use the money multiplier concept in discussions of money. We explore the institutional structure of the transmission mechanism beginning with open market operations through to money and loans to document that the mechanism does not work through the standard multiplier model or the bank lending channel. Our analysis, however, does not reflect on the existence of a broader credit channel
    Keywords: Monetary transmission mechanism, money multiplier, lending channel
    JEL: E51 E52
    Date: 2009–09
  4. By: Daniel L. Thornton
    Abstract: It is common practice to estimate the response of asset prices to monetary policy actions using market-based measures of monetary policy shocks, such as the federal funds futures rate. I show that because interest rates and market-based measures of monetary policy shocks respond simultaneously to all news and not simply news about monetary policy actions, market-based measures of monetary policy shocks yield biased estimates of the response of interest rates to monetary policy actions. I propose a methodology that corrects for this "joint-response bias." The results indicate that the response of Treasury yields to monetary policy actions is considerably weaker than previously estimated. In particular, there is no statistically significant response of longer-term Treasury yields before February 2000 and no statistically significant response of any Treasury rate after.
    Keywords: Prices ; Monetary policy ; Federal funds rate
    Date: 2009
  5. By: Lars E.O. Svensson
    Abstract: Evaluating inflation-targeting monetary policy is more complicated than checking whether inflation has been on target, because inflation control is imperfect and flexible inflation targeting means that deviations from target may be deliberate in order to stabilize the real economy. A modified Taylor curve, the forecast Taylor curve, showing the tradeoff between the variability of the inflation-gap and output-gap forecasts can be used to evaluate policy ex ante, that is, taking into account the information available at the time of the policy decisions, and even evaluate policy in real time. In particular, by plotting mean squared gaps of inflation and output-gap forecasts for alternative policy-rate paths, it may be examined whether policy has achieved an efficient stabilization of both inflation and the real economy and what relative weight on the stability of inflation and the real economy has effectively been applied. Ex ante evaluation may be more relevant than evaluation ex post, after the fact. Publication of the interest-rate path also allows the evaluation of its credibility and the effectiveness of the implementation of monetary policy.
    JEL: E52 E58
    Date: 2009–09
  6. By: Salem M. Abo-Zaid
    Abstract: This paper studies monetary policy rules in a small open economy with Inflation Targeting, incomplete pass-through and rigid nominal wages. The paper shows that, when nominal wages are fully flexible and pass-through is low to moderate, the monetary authority should target the consumer price index (CPI) rather than the Domestic Price Index (DPI). When pass-through is high, an economy with high degrees of nominal wage rigidity and wage indexation should either target the CPI or fully stabilize nominal wages. The results of the paper suggest that, by committing to a common monetary policy in a common-currency area, some countries may not be following the right monetary policy rules.
    Keywords: Monetary policy rules; Inflation Targeting ; Consumer Price Index; Domestic Price Index; Exchange rate pass-through; Nominal wage rigidity; Open economy.
    JEL: E31 E52 E58 E61 F31
    Date: 2009–09–23
  7. By: John Ryan (Hult International Business School); Adam Koronowski (Warsaw University)
    Abstract: The Federal Reserve System or the Fed is one of the most prestigious institutions in the world. Founded by the Federal Reserve Act in 1913, the Fed has the responsibility of setting the monetary policy of the U.S. The Fed’s actions affect the money supply in the U.S. market which has a direct influence on interest rates, growth and inflation. To better understand the role of the Fed we will first describe its structure and organization. We will then see who is really behind the central bank’s actions and who holds the reins of power inside the institution that plays the most important role in financial markets throughout the world. The monetary policy implemented by the Fed is closely monitored by major financial markets and institutions as it affects directly investments and security prices. We will explain clearly how the Fed conducts its monetary policy using three major tools to either decrease or increase money supply: open market operations, adjusting the discount rate and adjusting the reserve requirement ratio. We examine the main objectives of the Fed’s monetary policies and how those objectives maintain a “conflict of interest” relationship. A special interest we devote to a possible negative role that monetary policy may play in fuelling excessive asset price booms and we ask whether monetary policy should contradict the growth of asset price bubbles. Finally we examine the policies of the former chairman of the Fed Alan Greenspan (1987-2006) which contributed to the current crisis. We also assess the reaction to the crisis of the monetary policy of Ben Bernanke.
    Keywords: Federal Reserve, Monetary Policy, Alan Greenspan, Ben Bernanke, Wall Street, financial crisis, Asset price inflation
    JEL: E32 E44 E50 E51 E52 E58 E61 G18
    Date: 2009
  8. By: Ichiro Fukunaga (Director, Research and Statistics Department, Bank of Japan (E-mail:; Masashi Saito (Deputy Director, Research and Statistics Department, Bank of Japan (E-mail:
    Abstract: How should central banks take into account movements in asset prices in the conduct of monetary policy? We provide an analysis to address this issue using a dynamic stochastic general equilibrium model incorporating both price rigidities and financial market imperfections. Our findings are twofold. First, in the presence of these two sources of distortion in the economy, central banks face a policy tradeoff between stabilizing inflation and the output gap. With this tradeoff, central banks could strike a better balance between both objectives if they took variables other than inflation, such as asset prices, into consideration. Second, these benefits decrease when central banks rely on limited information about the underlying sources of asset price movements and cannot judge which part of the observed asset price movements reflects inefficiencies in the economy.
    Keywords: asset prices, monetary policy, financial frictions, policy tradeoffs
    JEL: E44 E52
    Date: 2009–09
  9. By: Efrem Castelnuovo (University of Padua); Paolo Surico (London Business School)
    Abstract: This paper re-examines the VAR evidence on the price puzzle and proposes a new theoretical interpretation. Using actual data and two identification strategies based on zero restrictions and model-consistent sign restrictions, we find that the positive response of prices to a monetary policy shock is historically limited to the sub-samples that are typically associated with a weak interest rate response to inflation. Using pseudo data generated by a sticky price model of the U.S. economy, we then show that the structural VARs are capable of reproducing the price puzzle only when monetary policy is passive. The omission in the VARs of a variable capturing expected inflation is found to account for the price puzzle observed in simulated and actual data.
    JEL: E30 E52
    Date: 2009–09
  10. By: Adolfo Meisel; Juan David Barón
    Abstract: This paper explores the relationship between central bank independence and inflation in Latin America, using as a case study the experience of Colombia (1923-2008). Since its creation, in 1923, Colombia’s central bank has undergone several reforms that have changed its objectives and degree of independence. Between 1923 and 1951, it was private and independent, with a legal commitment to price stability. In 1962 monetary responsibilities were divided between a government-dominated Monetary Board, in charge of monetary policy, and the central bank, which carried them out. In the early 1990s, the bank recovered its independence and its focus on price stability. Inflation varied substantially during these subperiods. The analysis shows that central bank independence, combined with a commitment to price stability, renders the best results in terms of price stability.
    Date: 2009–09–06
  11. By: Ankita Mishra; Vinod Mishra
    Abstract: This article looks at the preconditions that an emerging economy needs to fulfill, before it can adopt inflation targeting as a monetary policy regime. The study is conducted using the Indian economy as a case study. We conduct an in-depth sector-wise analysis of the Indian economy to evaluate the independence of India's monetary policy from fiscal, external, structural and financial perspectives. Dominance from any of these sectors may divert monetary policy from the objective of maintaining price stability in the economy. Our analysis suggests that among the four dominance issues, the issue of 'structural dominance??? is the most acute for India. Supply shocks, hitting the economy due to structural bottlenecks, pose a major threat to the independent conduct of monetary policy. This study concludes that inflation band targeting with a wide target range would be a feasible monetary policy option for India.
    Keywords: India, Inflation Targeting, Monetary policy, Fiscal Dominance, VAR, GFVD
    JEL: E52 E58 E47
    Date: 2009–05–01
  12. By: Farvaque, Etienne (Université de Lille 1); Mihailov, Alexander (University of Reading)
    Abstract: This paper studies the transmission of preferences in an overlapping-generations model with heterogeneous mature agents characterized by different degrees of inflation aversion. We show how the dynamics of a society's degree of inflation aversion and the implied degree of central bank independence depend on the direction and speed of changes in the structure of the population's preferences, themselves a function of parent socialization efforts in response to observed inflation. We then construct a survey-based measure of inflation aversion and provide empirical support for our analytical and simulation results. Available cross-section evidence confirms that a nation's demographic structure, in particular variation in the share of retirees as a proxy for the more inflation-averse type, is a key determinant of inflation aversion, together with experience with past inflation and the resulting collective memory embodied in monetary institutions.
    Keywords: intergenerational transmi; evolving preferences ; inflation aversion ; central bank independence ; collective memory
    JEL: D72 D83 E31 E58 H41
    Date: 2009–09
  13. By: Setzer, Ralph; Wolff, Guntram B.
    Abstract: Conventional money demand specifications in the euro area have become unstable since 2001. We specify a money demand equation in deviations of individual euro area Member States variables from the euro area average and show that the income elasticity as well as the interest rate semi-elasticity remain stable. The corresponding deep parameters of the utility function have not changed. Aggregate money demand instability does therefore not result from altered standard factors determining the preference for holding money. Instead, other factors determine the aggregate monetary overhang. Since monetary developments cannot easily be explained by changing preferences, they should be closely monitored and might be a sign of imbalances.
    Keywords: Money demand; M3; national contributions; euro area
    JEL: E51 E52 E41
    Date: 2009–03–05
  14. By: Aleksander Berentsen; Christopher J. Waller
    Abstract: We study optimal monetary stabilization policy in a dynamic stochastic general equilibrium model where money is essential for trade and firm entry is endogenous. We do so when all prices are flexible and also when some are sticky. Due to an externality affecting firm entry, the central bank deviates from the Friedman rule. Calibration exercises suggest that the nominal interest rate should have been substantially smoother than the data if preference shocks were the main disturbance and much more volatile if productivity was the driving shock. This result is a direct consequence of policy actions to control entry.
    Keywords: Monetary policy ; Econometric models
    Date: 2009
  15. By: Ashima Goyal
    Abstract: Options for monetary policy arising from interactions between it and Indian foreign exchange (FX) markets. A brief survey covers recent rapid changes providing a snapshot of current microstructure, and of monetary policy institutions. The survey brings out the growing links between money and FX markets, the sophistication and variety of participants and institutions in markets that are now deep and liquid, and policy trilemmas in dealing with large cross border flows in a rapidly growing emerging market, where fundamentals are uncertain. [DRG Study Series No. 32].
    Keywords: Indian, foreign exchange, markets, microstructure, FX markets, money, monetary policy, emerging market, economy, volatility, balance sheet, RBI, data sets, exchange rates, Macroeconomic, export, uncertainity, real sector
    Date: 2009
  16. By: Ester Faia
    Abstract: The literature has shown that product market frictions and firms dynamic play a crucial role in reconciling standard DSGE with several stylized facts. This paper studies optimal monetary policy in a DSGE model with sticky prices and oligopolistic competition. In this model firms’ monopolistic rents induce both intra-temporal and intertemporal time-varying wedges which induce inefficient fluctuations of employment and consumption. The monetary authority faces a trade-off between stabilizing inflation and reducing inefficient fluctuations, which is resolved by using consumer price inflation as a state contingent sale subsidy. An analysis of the welfare gains of alternative rules show that targeting mark-ups and asset prices might improve upon a strict inflation targeting
    Keywords: product market frictions, oligopolistic competition, optimal monetary policy
    JEL: E3 E5
    Date: 2009–09
  17. By: Meixing Dai; Moïse Sidiropoulos
    Abstract: In a two-period model with distortionay taxes and public investment, we re-examine the interaction between monetary policy transparency and fiscal bias. We find that the optimal choices of tax rate and public investment allow eliminating the effects of fiscal bias and hence neutralize the impact of monetary policy opacity (lack of political transparency) on the level and variability of inflation and output, independently of the institutional quality. Our results are robust to alternative specifications of the game between the private sector, the government and the central bank.
    Keywords: Central bank transparency, distortionay taxes, public investment, fiscal bias.
    JEL: E52 E58 E62 E63 H21 H30
    Date: 2009
  18. By: Basu, Kaushik (Cornell University)
    Abstract: Central banks in developing countries, wanting to devalue the domestic currency, usually intervene in the foreign exchange market by buying up foreign currency using domestic money--often backing this up with sterilization to counter inflationary pressures. Such interventions are usually effective in devaluing the currency but lead to a build up of foreign exchange reserves beyond what the central bank may need. The present paper analyzes the 'mechanics' of such central bank interventions and, using techniques of industrial organization theory, proposes new kinds of interventions which have the same desired effect on the exchange rate, without causing a build up of reserves.
    JEL: D43 F31 G20 L31
    Date: 2009–01
  19. By: Engin Kara (National Bank of Belgium, Research Department)
    Abstract: The popular Calvo model with indexation (Christiano, Eichenbaum and Evans, 2005) and sticky information (Mankiw and Reis, 2002) model have guided much of the monetary policy discussion. The strength of these approaches is that they can explain the persistence of inflation. However, both of these theories are inconsistent with the micro data on prices. In this paper, I evaluate the consequences of implementing policies that are optimal from the perspective of models that overlook the micro-data. To do so, I employ a Generalized Taylor Economy (GTE) (Dixon and Kara, 2007). While there is no material difference between the GTE and its popular alternatives in terms of inflation persistence, a difference arises when it comes to the micro-data: the GTE is consistent with the micro-data. The findings reported in the paper suggest that policy conclusions are significantly affected by whether persistence arises in a manner consistent with the micro-data and that policies that are optimal from the perspective of the models that are inconsistent with the microdata can lead to large welfare losses in the GTE
    Keywords: Inflation persistence, DSGE models, Optimal Monetary Policy
    JEL: E1 E3 E52
    Date: 2009–09
  20. By: S. Boragan Aruoba; Christopher J. Waller; Randall Wright
    Abstract: We study the effects of money (anticipated inflation) on capital formation. Previous papers on this topic adopt reduced-form approaches, putting money in the utility function or imposing cash in advance, but use otherwise frictionless models. We follow a literature that is more explicit about the frictions making money essential. This introduces several new elements, including a two-sector structure with centralized and decentralized markets, stochastic trading opportunities, and bargaining. We show how these elements matter qualitatively and quantitatively. Our numerical results differ from findings in the reduced-form literature. The analysis reduces the previously large gap between mainstream macro and monetary theory.
    Keywords: Money ; Monetary theory ; Capital ; Search theory
    Date: 2009
  21. By: Peter L. Rousseau (Department of Economics, Vanderbilt University)
    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 nationÕs 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 creditø 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.
    Keywords: Colonial money, early US growth, quantity theory of money, backing theory, monetization
    JEL: N11 N21 E42 E44
    Date: 2009–09
  22. By: Christopher J. Waller
    Abstract: I use the monetary version of the neoclassical growth model developed by Aruoba, Waller and Wright (2008) to study the properties of the model when there is exogenous growth. I first consider the planner's problem, then the equilibrium outcome in a monetary economy. I do so by first using proportional bargaining to determine the terms of trade and then consider competitive price taking. I obtain closed form solutions for the balanced growth path of all variables in all cases. I then derive closed form solutions for the transition paths under the assumption of full depreciation and, in the monetary economy, a non-stationary interest rate policy.
    Keywords: Monetary policy ; Econometric models
    Date: 2009
  23. By: Christopher J. Waller
    Abstract: The objective of this paper is to study optimal fiscal and monetary policy in a dynamic Mirrlees model where the frictions giving rise to money as a medium of exchange are explicitly modeled. The framework is a three period OLG model where agents are born every other period. The young and old trade in perfectly competitive centralized markets. In middle age, agents receive preference shocks and trade amongst themselves in an anonymous manner. Since preference shocks are private information, in a record-keeping economy, the planner's constrained allocation trades off efficient risk sharing against production efficiency in the search market. In the absence of record-keeping, the government uses flat money as a substitute for dynamic contracts to induce truthful revelation of preferences. Inflation affects agents' incentive constraints and so distortionary taxation of money may be needed as part of the optimal policy even if lump-sum taxes are available.
    Keywords: Money ; Taxation
    Date: 2009
  24. By: Cristian Badarinza (Goethe University, House of Finance, Grueneburgweg 1, 60323 Frankfurt am Main, Germany.); Marco Buchmann (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: The aim of this study is to assess empirically to what extent the degree of heterogeneity of consumers’ inflation perceptions and expectations is driven by the flow of information related to current and future price developments in the euro area. We conduct the analysis both on an aggregate level for the euro area as well as for a set of countries using panel techniques. We find that the degree to which consumers’ expectations are discordant is negatively related to news intensity. Moreover, the results suggest that the absolute bias in expectations decreases as news become more intense and this effect has become more pronounced since the introduction of the common currency. JEL Classification: D12, D84, E31.
    Keywords: Inflation Expectations, Heterogeneity, Survey data, Euro Area, News.
    Date: 2009–09
  25. By: Jonas Dovern (Kiel Economics); Ulrich Fritsche (Department for Socioeconomics, Department for Economics, University of Hamburg); Jiri Slacalek (European Central Bank)
    Abstract: Using the Consensus Economics dataset with individual expert forecasts from G7 countries we investigate determinants of disagreement (crosssectional dispersion of forecasts) about six key economic indicators. Disagreement about real variables (GDP, consumption, investment and unemployment) has a distinct dynamic from disagreement about nominal variables (in ation and interest rate). Disagreement about real variables intensifes strongly during recessions, including the current one (by about 40 percent in terms of the interquartile range). Disagreement about nominal variables rises with their level, has fallen after 1998 or so (by 30 percent), and is considerably lower under independent central banks (by 35 percent). Cross-sectional dispersion for both groups increases with uncertainty about the underlying actual indicators, though to a lesser extent for nominal series. Countryby- country regressions for inflation and interest rates reveal that both the level of disagreement and its sensitivity to macroeconomic variables tend to be larger in Italy, Japan and the United Kingdom, where central banks became independent only around the mid-1990s. These findings suggest that more credible monetary policy can substantially contribute to anchoring of expectations about nominal variables; its eects on disagreement about real variables are moderate.
    Keywords: disagreement, survey expectations, monetary policy, forecasting
    JEL: E31 E32 E37 E52 C53
    Date: 2009–09
  26. By: Vasco Cúrdia; Michael Woodford
    Abstract: We consider the desirability of modifying a standard Taylor rule for a central bank's interest rate policy to incorporate either an adjustment for changes in interest rate spreads (as proposed by Taylor [2008] and McCulley and Toloui [2008]) or a response to variations in the aggregate volume of credit (as proposed by Christiano et al. [2007]). We then examine how, under those adjustments, policy would respond to various types of economic disturbances, including those originating in the financial sector that increase equilibrium spreads and contract the supply of credit. We conduct our analysis using a simple DSGE model with credit frictions (Curdia and Woodford 2009), comparing the equilibrium responses to various disturbances under the modified Taylor rules with those under a policy that would maximize average expected utility. According to our model, a spread adjustment can improve on the standard Taylor rule, but the optimal size of the adjustment is unlikely to be as large as the one proposed, and the same type of adjustment is not desirable regardless of the source of variation in credit spreads. A response to credit is less likely to be helpful, and its desirable size (and even sign) is less robust to alternative assumptions about the nature and persistence of economic disturbances.
    Keywords: Taylor's rule ; Interest rates ; Monetary policy ; Credit
    Date: 2009
  27. By: David O. Lucca; Francesco Trebbi
    Abstract: We present a new automated, objective and intuitive scoring technique to measure the content of central bank communication about future interest rate decisions based on information from the Internet and news sources. We apply the methodology to statements released by the Federal Open Market Committee (FOMC) after its policy meetings starting in 1999. Using intra-day financial quotes, we find that short-term nominal Treasury yields respond to changes in policy rates around policy announcements, whereas longer-dated Treasuries mainly react to changes in policy communication. Using lower frequency data, we find that changes in the content of the statements lead policy rate decisions by more than a year in univariate interest rate forecasting and vector autoregression (VAR) models. When we estimate Treasury yield responses to the shocks identified in the VAR, we find communication to be a more important determinant of Treasury rates than contemporaneous policy rate decisions. These results are consistent with the view that the FOMC releases information about future policy rate actions in its statements and that market participants incorporate this information when pricing longer-dated Treasuries. Finally, we decompose realized policy rate decisions using a forward-looking Taylor rule model. Based on this decomposition, we find that FOMC statements contain significant information regarding both the predicted rule-based interest rate and the Taylor-rule residual component, and that content of the statements leads the residual by a few quarters.
    JEL: E43 E52 E58
    Date: 2009–09
  28. By: Asani Sarkar
    Abstract: In responding to the severity and broad scope of the financial crisis that began in 2007, the Federal Reserve has made aggressive use of both traditional monetary policy instruments and innovative tools in an effort to provide liquidity. In this paper, I examine the Fed's actions in light of the underlying financial amplification mechanisms propagating the crisis--in particular, balance sheet constraints and counterparty credit risk. The empirical evidence supports the Fed's views on the primacy of balance sheet constraints in the earlier stages of the crisis and the increased prominence of counterparty credit risk as the crisis evolved in 2008. I conclude that an understanding of the prevailing risk environment is necessary in order to evaluate when central bank programs are likely to be effective and under what conditions the programs might cease to be necessary.
    Keywords: Credit ; Liquidity (Economics) ; Risk ; Federal Reserve Bank of New York ; Bank supervision
    Date: 2009
  29. By: Stephane Auray (EQUIPPE (EA 4018), Universités Lille Nord de France (ULCO), GREDI, Université de Sherbrooke and CIRP\Eacute;E.); Paul Gomme (Concordia University and CIREQ); Shen Guo (China Academy of Public Finance and Public Policy, Central University of Finance and Economics, Beijing, China)
    Abstract: A chief goal of the Pigou cycle literature is to generate a boom in response to news of a future increase in productivity, and a bust if this improvement does not in fact take place. We find that monetary policy can generate Pigou cycles in a two sector model with durables and non-durables, and nominal price rigidities -- even when the Ramsey-optimal policy displays no such cycles. Estimated interest rate rules are a good fit to data simulated under the Ramsey policy, implying that policymakers could come close to replicating the Ramsey-optimal policy.
    Keywords: Pigou cycles; monetary policy
    JEL: E3 E5 E4
    Date: 2009–07–02
  30. By: Frankel, Jeffrey (Harvard University)
    Abstract: I approach the state of global currency issues by identifying eight concepts that I see as having recently "peaked" and eight more that I see as currently rising in relevance. Those that I see as having already seen their best days are: the G-7, global savings glut, corners hypothesis, proliferating currency unions, inflation targeting (narrowly defined), exorbitant privilege, Bretton Woods II, and currency manipulation. Those that I see as receiving increased emphasis in the future are: the G-20, the IMF, SDR, credit cycle, reserves, intermediate exchange rate regimes, commodity currencies, and multiple international currency system.
    Date: 2009–09
  31. By: Campbell Leith; Ioana Moldovan; Raffaele Rossi
    Abstract: Recent work on optimal policy in sticky price models suggests that demand management through fiscal policy adds little to optimal monetary policy. We explore this consensus assignment in an economy subject to ‘deep’ habits at the level of individual goods where the counter-cyclicality of mark-ups this implies can result in government spending crowding-in private consumption in the short run. We explore the robustness of this mechanism to the existence of price discrimination in the supply of goods to the public and private sectors. We then describe optimal monetary and fiscal policy in our New Keynesian economy subject to the additional externality of deep habits and explore the ability of simple (but potentially nonlinear) policy rules to mimic fully optimal policy.
    Keywords: Monetary Policy, Fiscal Policy, Deep Habits, New Keynesian
    JEL: E21 E63 E61
    Date: 2009–09
  32. By: Joseph P. Daniels (Center for Global and Economic Studies, Marquette University); David D. VanHoose (Hanmaker School of Business, Baylor University)
    Abstract: Considerable recent work has reached mixed conclusions about whether and how globalization affects the inflation-output trade-off and realized inflation rates. In this paper, we utilize cross-country data to provide evidence of interacting effects between a greater extent of exchange-rate pass through and openness to international trade as factors that we find both contribute to lower inflation. The interplay between the inflation effects of pass through and openness suggest that both factors may influence the terms of the output-inflation trade-off. We develop a simple theoretical model showing how both pass through and openness can interact to influence the sacrifice ratio, and we empirically explore the nature of the interplay between the two variables as factors influencing the sacrifice ratio. Our results indicate that a greater extent of pass through depresses the sacrifice ratio and that once the extent of pass through is taken into account alongside other factors that affect the sacrifice ratio, the degree of openness to international trade exerts an empirically ambiguous effect on the sacrifice ratio.
    Keywords: Pass Through, Openness, Sacrifice Ratio
    JEL: F40 F41 F43
    Date: 2009–09
  33. By: Luciana Juvenal
    Abstract: I analyze the role of real and monetary shocks on the exchange rate behavior using a structural vector autoregressive model of the US vis-à-vis the rest of the world. The shocks are identified using sign restrictions on the responses of the variables to orthogonal disturbances. These restrictions are derived from the predictions of a two-country DSGE model. I find that monetary shocks are unimportant in explaining exchange rate fluctuations. By contrast, demand shocks explain between 23% and 38% of exchange rate variance at 4-quarter and 20-quarter horizons, respectively. The contribution of demand shocks plays an important role but not of the order of magnitude sometimes found in earlier studies. My results, however, support the recent focus of the literature on real shocks to match the empirical properties of real exchange rates.
    Keywords: Foreign exchange rates ; Vector autoregression
    Date: 2009
  34. By: Michael Bleaney (School of Economics, University of Nottingham, Nottingham); Manuela Francisco (Universidade do Minho - NIPE)
    Abstract: Real effective exchange rate volatility is examined for 90 countries using monthly data from January 1990 to June 2006. Volatility decreases with openness to international trade and per capita GDP, and increases with inflation, particularly under a horizontal peg or band, and with terms - of - trade volatility. The choice of exchange rate regime matters. After controlling for these effects, and independent float adds at least 45% to the standard deviation of the real effective exchange rate, relative to a conventional peg, but must other regimes make little difference. The results are robust to alternative volatility measures and to sample selection bias.
    Keywords: Exchange rate regimes; Inflation; Volatility
    JEL: F31
    Date: 2009
  35. By: Bernard Bartels
    Abstract: With the transition to the European Monetary Union (EMU), the instrument of monetary policy for individual member countries has been abolished. This step has led to serious challenges for the diferent states to stabilize their economies to various economic shocks. Diferent labor market rigidities lead to diferent responses to monetary impulses in the countries. This paper deals with this problem by setting up a VAR-analysis to investigate the diferent shocks on Germany and Austria. The results show that Germany experiences less uctuation in growth and unemployment than Austria which can be assigned to higher labor market rigidities
    Keywords: monetary transmission mechanism, vector autoregression
    JEL: D21 F14 L22
    Date: 2009–06
  36. By: Sustek, Roman
    Abstract: In the U.S. business cycle, a monetary aggregate consisting predominantly of sight deposits strongly leads output, time deposits strongly lag output, and a monetary aggregate consisting of both types of deposits tends to be coincident with the cycle. Such movements are observed both before and after the 1979 monetary policy change. Similar dynamics are obtained in a model with multi-stage production and purchase-size heterogeneity when agents optimally choose their mix of cash, checkable, and time deposits used in transactions. The causality in the model runs from real activity to money, rather than the other way around.
    Keywords: Monetary aggregates; business cycle; general equilibrium
    JEL: E32 E51 E41
    Date: 2009–09–02
  37. By: Sergio Mayordomo; Juan Ignacio Peña; Eduardo S. Schwartz
    Abstract: A common European bond would yield a common European Monetary Union risk free rate. We present tentative estimates of this common risk free for the European Monetary Union countries from 2004 to 2009 using variables motivated by a theoretical portfolio selection model. First, we analyze the determinants of EMU sovereign yield spreads and find significant effects of the credit quality, macro, correlation, and liquidity variables. However, their effects are different before and after the current financial crisis, being stronger in the latter period. Robustness tests with different data frequencies, benchmarks, liquidity variables, cross section regressions and balanced panels confirm the initial results. We propose four different estimates of the common risk free rate and show that, in most cases, this common rate could imply savings in borrowing costs for all the countries involved.
    JEL: E43 E44 G15
    Date: 2009–09
  38. By: Jaroslaw Kwapien; Sylwia Gworek; Stanislaw Drozdz; Andrzej Gorski
    Abstract: We analyze structure of the world foreign currency exchange (FX) market viewed as a network of interacting currencies. We analyze daily time series of FX data for a set of 63 currencies, including gold, silver and platinum. We group together all the exchange rates with a common base currency and study each group separately. By applying the methods of filtered correlation matrix we identify clusters of closely related currencies. The clusters are formed typically according to the economical and geographical factors. We also study topology of weighted minimal spanning trees for different network representations (i.e., for different base currencies) and find that in a majority of representations the network has a hierarchical scale-free structure. In addition, we analyze the temporal evolution of the network and detect that its structure is not stable over time. A medium-term trend can be identified which affects the USD node by decreasing its centrality. Our analysis shows also an increasing role of euro in the world's currency market.
    Date: 2009–06
  39. By: Sebastian Dullien (HTW Berlin -- University of Applied Sciences); Ulrich Fritsche (Department for Socioeconomics, Department for Economics, University of Hamburg); Ingrid Groessl (Department for Socioeconomics, Department for Economics, University of Hamburg); Michael Paetz (Department for Economics, University of Hamburg)
    Abstract: Using a modified version of the model presented by Belke and Gros (2007), we analyze the stability of adjustment in a currency union. Using econometric estimates for parameter values we check the stability conditions for the 11 original EMU countries and Greece. We found significant instability in the model for a large number of countries. We then simulate the adjustment process for some empirically observed parameter values and find that even for countries with relatively smooth adjustment, the adjustment to a price shock in EMU might take several decades.
    Keywords: EMU, convergence, stability, inflation
    JEL: E32 E61 C32
    Date: 2009–09
  40. By: Jan J. J. Groen; Richard Paap; Francesco Ravazzolo
    Abstract: This paper revisits inflation forecasting using reduced-form Phillips curve forecasts, that is, inflation forecasts that use activity and expectations variables. We propose a Phillips-curve-type model that results from averaging across different regression specifications selected from a set of potential predictors. The set of predictors includes lagged values of inflation, a host of real-activity data, term structure data, nominal data, and surveys. In each individual specification, we allow for stochastic breaks in regression parameters, where the breaks are described as occasional shocks of random magnitude. As such, our framework simultaneously addresses structural change and model uncertainty that unavoidably affect Phillips-curve-based predictions. We use this framework to describe personal consumption expenditure (PCE) deflator and GDP deflator inflation rates for the United States in the post-World War II period. Over the full 1960-2008 sample, the framework indicates several structural breaks across different combinations of activity measures. These breaks often coincide with policy regime changes and oil price shocks, among other important events. In contrast to many previous studies, we find less evidence of autonomous variance breaks and inflation gap persistence. Through a real-time out-of-sample forecasting exercise, we show that our model specification generally provides superior one-quarter-ahead and one-year-ahead forecasts for quarterly inflation relative to an extended range of forecasting models that are typically used in the literature.
    Keywords: Inflation (Finance) ; Forecasting ; Phillips curve ; Regression analysis
    Date: 2009
  41. By: Gabe J. de Bondt (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This study presents empirical evidence on the long-run motives for holding euro area money by focusing on the role of equity and labour markets. Equity positively affects money demand through wealth effects, as equities are a significant store of household wealth and thus part of a financial transaction motive. Negative substitution effects through the expected return on equity reflect a speculative motive from the equity market. A precautionary motive from the labour market is captured by the annual change in the unemployment rate. The main conclusion is that equity and labour markets do matter for money. All three new elements, in particular housing and financial wealth, have been found statistically and economically significant in explaining M3 since 1983. These findings are robust across different proxies for the augmented motives and a shorter sample period starting in 1994. JEL Classification: E41, G11, C32.
    Keywords: euro area money demand, wealth, equity return, precautionary motive.
    Date: 2009–09
  42. By: Eduardo Levy Yeyati; Federico Sturzenegger
    Abstract: To the extent that they exert a critical influence on the macroeconomic environment, monetary and exchange rate policies (MERP) are relevant for development. However, the analytical economic literature often sees nominal variables as being irrelevant for the real economy, while the multiplicity of channels examined by the empirical literature complicates the task of deriving usable policy implications. To tackle this development dimension, we focus on the aspects that we consider more relevant to the policy design from the perspective of a small open economy. Specifically, this chapter attempts to answer the following question: What exchange rate regime and monetary policy framework is more conducive to achieving development policy objectives in a particular country today, and why? We map the direct and indirect links from MERP to key development objectives, and discuss the main findings and how it relates with the empirical evidence to provide an up-to-date perspective of the policy debate and derive criteria for policy choices.
    Date: 2009
  43. By: David G. Blanchflower; Conall MacCoille
    Abstract: This paper uses micro-data from three surveys for the UK to consider how individuals form inflation expectations. Generally, we find significant non-response bias in all surveys, with non-respondents especially likely to be young, female, less educated and with lower incomes. A number of demographic generalizations can be made based on the surveys. Inflation expectations rise with age, but the more highly educated and home owners tend to have lower inflation expectations. These groups are also more likely to be accurate in their estimates of official inflation twelve months ahead, and have less backward-looking expectations.
    JEL: E4 E5
    Date: 2009–09
  44. By: Alec N. Kercheval; Juan F. Moreno
    Abstract: We address the problem of optimal Central Bank intervention in the exchange rate market when interventions create feedback in the rate dynamics. In particular, we extend the work done on optimal impulse control by Cadenillas and Zapatero to incorporate temporary market reactions, of random duration and level, to Bank interventions, and to establish results for more general rate processes. We obtain new explicit optimal impulse control strategies that account for these market reactions, and show that they cannot be obtained simply by adjusting the intervention cost in a model without market reactions.
    Date: 2009–09
  45. By: Andrea Ricci (Dipartimento di Economia e Metodi Quantitativi, Università di Urbino (Italy))
    Abstract: Global structural factors both monetary and real played a prominent role in the burst of subprime crisis: 1) the Bretton Woods II international monetary system; 2) the reduction of US real investment return compared with competing countries. We develop a theoretical model to analyze the impact of these factors and macroeconomic policies on US current account and asset prices. The excess saving of U.S. nonfinancial corporations from 2000-2001 has undermined the stability of the Bretton Woods II system. Accommodative US monetary and fiscal policies have mitigated the imbalances but in the long term structural factors have prevailed. Only a recovery of US real capital profitability can ensure long run coexistence between present model of global development and current international monetary system.
    Keywords: Current Account, Bretton Woods II, External imbalances, Saving Investment, International Liquidity, Asset Prices.
    JEL: F41 F32 E41 E42
    Date: 2009

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