nep-mon New Economics Papers
on Monetary Economics
Issue of 2009‒10‒03
twenty-six papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. The impact of the European Monetary Union on inflation persistence in the euro area By Meller, Barbara; Nautz, Dieter
  2. Essential interest-bearing money By David Andolfatto
  3. Inflation Targeting in Latin America: Toward a Monetary Union? By Marc Hofstetter
  4. Controllability and persistence of money market rates along the yield curve: evidence from the euro area By Busch, Ulrike; Nautz, Dieter
  5. Testing the Monetary Policy Rule in the US: A Reconsideration of the Fed's Behaviour By Minford, Patrick; Ou, Zhirong
  6. Fear of depression - Asymmetric monetary policy with respect to asset markets By Hoffmann, Andreas
  7. Capital constraints, counterparty risk, and deviations from covered interest rate parity By Niall Coffey; Warren B. Hrung; Asani Sarkar
  8. Inflation and unemployment in the long run By Aleksander Berentsen; Guido Menzio; Randall Wright
  9. Price discovery on traded inflation expectations: does the financial crisis matter? By Schulz, Alexander; Stapf, Jelena
  10. Inflation and output volatility under asymmetric incomplete information. By Giacomo Carboni; Martin Ellison
  11. Monetary Business Cycle Accounting By Sustek, Roman
  12. Optimal Monetary Policy and Downward Nominal Wage Rigidity in Frictional Labor Markets. By Abo-Zaid, Salem
  14. Inflation and growth: new evidence from a dynamic panel threshold analysis By Kremer, Stephanie; Bick, Alexander; Nautz, Dieter
  15. Firm entry and monetary policy transmission under credit rationing By Kobayashi, Teruyoshi
  16. The Monetary Policy Implications of Behavioral Asset Bubbles By ap Gwilym, Rhys
  17. Households Forming Inflation Expectations: Who Are the 'Active' and 'Passive' Learners? By J. Easaw J.; R. Golinelli
  18. Exchange rates during the crisis By Weber, Sebastian; Wyplosz, Charles
  19. The Distribution Analysis of the Inflation Components of Turkey By A. Nazif Catik; A. Özlem Önder
  20. Money and capital as competing media of exchange in a news economy By David Andolfatto; Fernando M. Martin
  21. A Note on the Anchoring Effect of Explicit Inflation Targets By Jan Libich
  22. Liquidity, innovation and growth By Aleksander Berentsen; Mariana Rojas Breu; Shouyong Shi
  23. European hoarding: currency use among immigrants in Switzerland By Andreas M. Fischer
  24. Lessons from the Portuguese Political-Economic Transition to the Euro (1986-1999) By Miguel Rocha de Sousa
  25. Wavelet Based Volatility Clustering Estimation of Foreign Exchange Rates By A. N. Sekar Iyengar
  26. Is there a need for a coded language in central banking? By Muchlinski, Elke

  1. By: Meller, Barbara; Nautz, Dieter
    Abstract: This paper uses the European Monetary Union (EMU) as a natural experiment to investigate whether more effective monetary policy reduces the persistence of inflation. Taking into account the fractional integration of inflation, we confirm that inflation dynamics differed considerably across Euro area countries before the start of EMU. Since 1999, however, results obtained from panel estimation indicate that the degree of long run inflation persistence has converged. In line with theoretical predictions, we find that the persistence of inflation has significantly decreased in the Euro area probably as a result of the more effective monetary policy of the ECB.
    Keywords: Monetary Policy Effectiveness and Inflation Persistence,Panel Test for Fractional Integration,Change in Inflation Persistence
    JEL: C22 C23 E31
    Date: 2009
  2. By: David Andolfatto
    Abstract: I examine optimal monetary policy in a Lagos and Wright [A unified framework for monetary theory and policy analysis, J. Polit. Econ. 113 (2005) 463?484] model where trade is centralized and all exchange is voluntary. I identify a class of incentive feasible policies that improve welfare beyond what is achievable with zero intervention. Any policy in this class necessarily entails a non-negative inflation rate and a strictly positive nominal interest rate. Despite the absence of a lump-sum tax instrument, there exists an incentive-feasible policy that implements the first-best allocation.
    Keywords: Money theory ; Econometric models
    Date: 2009
  3. By: Marc Hofstetter
    Abstract: In recent years, five of the main economies in Latin America —Brazil, Chile, Mexico, Colombia and Peru— have adopted Inflation Targeting regimes. In the context of these converging monetary strategies, would the IT nations in the region be better o adopting a common currency? Would they be better o if they dollarize? Would a common currency be a better alternative than dollarization? The answers to these questions are yes, yes and maybe.
    Date: 2009–08–04
  4. By: Busch, Ulrike; Nautz, Dieter
    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 sufficiently 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 in 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
  5. By: Minford, Patrick (Cardiff Business School); Ou, Zhirong (Cardiff Business School)
    Abstract: We calibrate a standard New Keynesian model with three alternative representations of monetary policy - an optimal timeless rule, a Taylor Rule and another with interest rate smoothing - with the aim of testing which if any can match the data according to the method of indirect inference. We find that the only model version that fails to be strongly rejected is the optimal timeless rule. Furthermore this version can also account for the widespread finding of apparent 'Taylor Rules' and 'interest rate smoothing' in the data, even though neither represents the true monetary policy.
    Keywords: Monetary policy; Kew Keynesian model; the 'target rule'; Taylor-type rules; Bootstrap simulation; VAR; Indirect inference; Wald statistic
    JEL: E12 E17 E42 E52 E58
    Date: 2009–09
  6. By: Hoffmann, Andreas
    Abstract: The paper suggests that during Greenspan’s incumbency the fear of depression caused the Federal Reserve to lower interest rates rapidly when asset price developments suggested a crisis potential. Whereas, when asset markets were growth-supporting, it did not raise interest rates. This asymmetry contributed to a downward-trend in interest rates which pushed US interest rates down to zero in the current crisis.
    Keywords: Fear of depression; Monetary policy; Taylor rule; Asset prices
    JEL: E58 E52 D82
    Date: 2009–09–15
  7. By: Niall Coffey; Warren B. Hrung; Asani Sarkar
    Abstract: We provide robust evidence of a deviation in the covered interest rate parity (CIP) relation since the onset of the financial crisis in August 2007. The CIP deviation exists with respect to several different dollar-denominated interest rates and exchange rate pairings of the dollar vis-a-vis other currencies. The results show that our proxies for margin conditions and for the cost of capital are significant determinants of the CIP deviations, especially during the crisis period. The supply of dollars by the Federal Reserve to foreign central banks via reciprocal currency arrangements (swap lines) reduced CIP deviations at this time. Following the bankruptcy of Lehman Brothers, uncertainty about counterparty risk became a significant determinant of CIP deviations, and the swap lines program no longer affected the CIP deviations significantly. These results indicate a breakdown of arbitrage transactions in the international capital markets that owes partly to lack of capital and partly to heightened counterparty credit risk. Central bank interventions helped reduce the funding liquidity risk of global institutions.
    Keywords: Interest rates ; Currency substitution ; Foreign exchange rates ; Swaps (Finance) ; Banks and banking, Central
    Date: 2009
  8. By: Aleksander Berentsen; Guido Menzio; Randall Wright
    Abstract: We study the long-run relation between money, measured by inflation or interest rates, and unemployment. We first document in the data a positive relation between these variables at low frequencies. We then develop a framework where unemployment and money are both modeled using microfoundations based on search and bargaining theory, providing a unified theory for analyzing labor and goods markets. The calibrated model shows that money can account for a sizable fraction of trends in unemployment. We argue it matters, qualitatively and quantitatively, whether one uses monetary theory based on search and bargaining, or an alternative ad hoc specification.
    Date: 2009–09
  9. By: Schulz, Alexander; Stapf, Jelena
    Abstract: We analyze contributions of different markets to price discovery on traded inflation expectations and how it changed during the financial crisis. The quicker information is processed on one market and the less one market is disrupted by the financial crisis the more valuable is its information for central banks and market participants. We use a new high frequency data set on inflation-indexed and nominal government bonds as well as inflation swaps to calculate information shares of break-even inflation rates in the euro area and the US. For maturities up to 5 years new information comes from both the swap and the bond markets. For longer maturities the swap market provides less and less information in the euro area. In the US where the market volume of inflation-linked bonds is large the bond market dominates the price discovery process for all maturities. The severe financial crisis that spread out in Autumn 2008 drove a wedge between bond and swap break-even inflation rates in both currencies. Price discovery ceased to take place on the swap market. Disruptions coming from the short-end of the market even separated price formation on both segments for maturities of up to 6 years in the US. Against the backdrop of the most severe financial crisis in decades contributions to price formation concentrated a lot more on the presumably safest financial instrument: government bonds.
    Keywords: Inflation-linked bonds,inflation swaps,price discovery,financial crisis
    JEL: E43 F37 G15
    Date: 2009
  10. By: Giacomo Carboni (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Martin Ellison (Department of Economics, University of Oxford, Manor Road Building, Oxford, OX1 2UQ, United Kingdom.)
    Abstract: The assumption of asymmetric and incomplete information in a standard New Keynesian model creates strong incentives for monetary policy transparency. We assume that the central bank has better information about its objectives than the private sector, and that the private sector has better information about shocks than the central bank. Transparency has the potential to trigger a virtuous circle in which all agents find it easier to make inferences and the economy is better stabilised. Our analysis improves upon existing work by endogenising the volatility of both output and inflation. Improved transparency most likely manifests itself in falling output volatility. JEL Classification: E32, E37, E52.
    Keywords: Imperfect credibility, Asymmetric information, Signal extraction.
    Date: 2009–09
  11. By: Sustek, Roman
    Abstract: This paper investigates the quantitative importance of various types of frictions for inflation and nominal interest rate dynamics by extending business cycle accounting to monetary models. Representing a variety of real and nominal frictions as `wedges' to standard equilibrium conditions allows a quantitative assessment of those frictions. Decomposing the data into movements due to these wedges shows that frictions that are equivalent to wedges in TFP and equilibrium conditions for asset markets are essential. In contrast, wedges in equilibrium conditions for capital accumulation and the resource constraint, and wedges capturing distortionary effects of sticky prices, play only a secondary role.
    Keywords: Business cycle accounting; inflation; nominal interest rate
    JEL: E43 E32 E31 E52
    Date: 2009–09–25
  12. By: Abo-Zaid, Salem
    Abstract: Recent empirical evidence suggests that nominal wages in the U.S. are downwardly rigid. This paper studies optimal monetary policy in a labor search and matching framework under the presence of Downward Nominal Wage Rigidity (DNWR). The study shows that when nominal wages are downwardly rigid, optimal monetary policy targets a positive inflation rate; the annual long-run inflation rate is around 2 percent. Positive inflation in this environment “greases the wheels” of the labor market by facilitating real wage adjustments, and hence it eases job creation and prevents excessive increase in unemployment. In addition, there is an asymmetry in the response of the economy to positive and negative productivity shocks, particularly those of large sizes. Finally, the optimal long-run inflation rate predicted by this study is considerably higher than in otherwise neoclassical labor markets, suggesting that the nature of the labor market in which DNWR is studied can matter for policy recommendations.
    Keywords: Downward Nominal Wage Rigidity; Optimal Monetary Policy; Long Run Inflation Rate; Labor Market Frictions; Labor Search and Matching.
    JEL: E5 E4 E3
    Date: 2009–09–24
  13. By: Kühl Teles, Vladimir; Zaidan, Marta
    Abstract: The goal of this paper is to evaluate the validity of the Taylor principle for inflation control in 12 developing countries that use inflationtargeting regimes: Brazil, Chile, Colombia, Hungary, Israel, Mexico,Peru, Philippines, Poland, South Africa, Thailand and Turkey. The test is based on a state-space model to determine when each country hasfollowed the principle; then a threshold unit root test is used to verify if the stationarity of the deviation of the expected inflation from itstarget depends on compliance with the Taylor principle. The results show that such compliance leads to the stationarity of the deviation of the expected inflation from its target in all cases. Furthermore, in mostcases, non-compliance with the Taylor principle leads to nonstationary deviation of the expected inflation.
    Date: 2009–08–26
  14. By: Kremer, Stephanie; Bick, Alexander; Nautz, Dieter
    Abstract: We introduce a dynamic panel threshold model to shed new light on the impact of inflation on long-term economic growth. The empirical analysis is based on a large panel-data set including 124 countries during the period from 1950 to 2004. For industrialized countries, our results confirm the inflation targets of about 2% set by many central banks. For non-industrialized countries, we estimate that inflation hampers growth if it exceeds 17%. Below this threshold, however, the impact of inflation on growth remains insignificant. Therefore, our results do not support growth-enhancing effects of inflation in developing countries.
    Keywords: Inflation Thresholds,Inflation and Growth,Dynamic Panel Threshold Model
    JEL: E31 C23 O40
    Date: 2009
  15. By: Kobayashi, Teruyoshi
    Abstract: This paper presents an additional credit channel for monetary policy that would arise in the presence of credit rationing. I formally examine a situation in which new entry firms have no choice but to borrow funds from a financial intermediary to cover entry costs, taking into account the fact that most of the small and young firms are bank dependent in practice. It turns out that the presence of nominal debt contracts allows the central bank to influence firm entry and thereby aggregate output through its effect on the severity of credit rationing even in the absence of price stickiness. This is because a decrease in the nominal interest rate reduces the cost of funds for lending, which enables financial intermediaries to extend credit to less creditworthy firms. This ``credit rationing effect" is absent in the conventional balance-sheet channel, where loan rates are determined such that credit demand is equal to credit supply.
    Keywords: credit channel; credit rationing; firm entry; monetary policy transmission.
    JEL: E32 E52 E44
    Date: 2009–09–28
  16. By: ap Gwilym, Rhys
    Abstract: I introduce behavioral asset pricing rules into a wider dynamic stochastic general equilibrium framework. Asset price bubbles emerge endogenously within the model. I find that in this model the only monetary policy that would be likely to enhance welfare is a counter-intuitive 'running with the wind' policy. I conclude that the optimal policy is highly dependent on the nature of the behavioral rules that are stipulated. Given that monetary authorities have limited information about the ways in which agents actually behave, a systematic monetary policy response to asset price misalignments is unlikely to enhance welfare.
    Date: 2009–09
  17. By: J. Easaw J.; R. Golinelli
    Date: 2009–08
  18. By: Weber, Sebastian; Wyplosz, Charles
    Abstract: Nearly two years after the onset of the financial crises, many central banks have brought their policy interest rates down to, or close to zero. Various governments have seen their budget deficits soar. Both policies have affected exchange rates, partly through market expectations. With a majority of exchange rates officially floating, exchange rate movements do not necessarily reflect official decisions as was the case in the 1930s. Yet, also in the 2008 crisis, authorities have directly intervened in the foreign exchange market, sometimes in order to defend a falling currency but in other instances with the aim to limit appreciation pressure, akin of competitive devaluations. This paper documents the exchange rate interventions during the height of the 2008/09 financial crisis and identifies the countries which have particular high incentives to intervene in the foreign exchange market to competitively devalue their currency. While various countries had increased incentives to devalue, we find that direct exchange rate interventions have been rather limited and contagion of devaluation has been restricted to one regionally contained case. However, sharp market-driven exchange rate movements have reshaped competitive positions. It appears that these movements have so far not seriously disrupted global trade. After all, a world crisis is likely to require widespread exchange rate adjustments as different countries are affected in different ways and have different capacities to weather the shocks.
    Keywords: Currencies and Exchange Rates,Debt Markets,Emerging Markets,Economic Stabilization,Economic Theory&Research
    Date: 2009–09–01
  19. By: A. Nazif Catik (Department of Economics, Ege University); A. Özlem Önder (Department of Economics, Ege University)
    Abstract: This paper investigates distribution of inflation items using various measures of skewness and kurtosis for Turkey covering the period 1996-2007. Considering sensitivity of traditional distribution measures to outlying observations robust skewness and kurtosis are also computed as a novelty. Analysis results mainly reveal that inflation components are right skewed and fat tailed as documented by the previous studies. However due to possible effects of the outliers traditional measures, in particular skewness, are lagging behind the robust measures in identifying underlying dispersion. Therefore one can say that weighted mean inflation used to measure general price changes is not trustworthy and a biased estimator of central location. Our results further suggest that core measures based on constant and symmetric trimming applied by the previous studies for Turkey is somewhat deficient since skewness of the data is ignored in the estimation process. Therefore, to obtain more reliable information in monitoring general price movements we suggest use of asymmetric trimmed means estimators which allows trimming different percentages from each tail of the distribution.
    Keywords: Infation, Prices, Distribution, Robust Skewness, Robust, Kurtosis.
    JEL: C43 E31 E52
    Date: 2009–09
  20. By: David Andolfatto; Fernando M. Martin
    Abstract: Conventional theory suggests that fiat money will have value in capital-poor economies. We demonstrate that fiat money may also have value in capital-rich economies, if the price of capital is excessively volatile. Excess asset-price volatility is generated by news; information that has no social value, but is privately useful in forming forecasts over the short-run return to capital. One advantage of fiat money is that its expected return is not linked directly to news concerning the prospects of an underlying asset. When money and capital compete as media of exchange, excess volatility in the short-term returns of liquid asset portfolios is mitigated and welfare is improved. A legal restriction that prohibits the use of capital as a payment instrument renders the expected return to money perfectly stable and, as a consequence, may generate an additional welfare benefit.
    Keywords: Money theory ; Capital
    Date: 2009
  21. By: Jan Libich
    Abstract: Empirical literature provided convincing evidence that explicit (ie legislated) inflation targets anchor expectations. We propose a novel game theoretic framework with generalized timing that allows us to formally capture this beneficial anchoring effect. Using the framework we identify several factors that influence whether and how strongly expectations are anchored, namely: (i) the public’s cost of decision-making, (ii) the public’s inflation aversion, (iii) the slope of the Phillips curve, (iv) the magnitude of supply shocks, (v) the degree of central bank conservatism, and under many (but not all) circumstances, (vi) the explicitness of the inflation target.
    JEL: E61 E63
    Date: 2009–08
  22. By: Aleksander Berentsen; Mariana Rojas Breu; Shouyong Shi
    Abstract: Many countries simultaneously suffer from high rates of inflation, low growth rates of per capita income and poorly developed financial sectors. In this paper, we integrate a microfounded model of money and finance into a model of endogenous growth to examine the effects of inflation and financial development. A novel feature of the model is that the market for innovation goods is decentralized. Financial intermediaries arise endogenously to provide liquid funds to the innovation sector. We calibrate the model to address two quantitative issues. One is the effects of an exogenous improvement in the productivity of the financial sector on welfare and per capita growth. The other is the effects of inflation on welfare and growth. Consistent with the data but in contrast to previous work, reducing inflation generates large gains in the growth rate of per capita income as well as in welfare. Relative to reducing inflation, improving the efficiency of the financial market increases growth and welfare by much smaller amounts.
    Keywords: Money, Credit, Innovation, Growth
    Date: 2009–09
  23. By: Andreas M. Fischer
    Abstract: Do immigrants have a higher demand for large denominated banknotes than natives? This study examines whether cash orders for CHF 1000 notes, a banknote not used for daily transactions, is concentrated in Swiss cities with a high foreign-to-native ratio. Controlling for a range of socio-economic indicators across 250 Swiss cities, European immigrants in Switzerland are found to hoard less CHF 1000 banknotes than natives. A 1 percent increase in the immigrant-to-native ratio leads to a reduction in currency orders by CHF 4000. This negative correlation between immigrant-to-native ratio and currency orders for CHF 1000 notes holds irrespective of the European immigrants' country of origin. Hoarding of large denominated banknotes by natives is attributed tax avoidance.
    Keywords: Money ; Immigrants ; Bank notes ; Monetary policy
    Date: 2009
  24. By: Miguel Rocha de Sousa (Department of Economics, University of Évora; NICPRI-UE)
    Abstract: We show the Portuguese transition to the euro, in the framework of political economics, by constructing a bivariate confidence index, based upon Rocha de Sousa (1998, 1999a,b, 2001). Besides we try to understand if the euro functioned as an instrument of politico-economic integration. The article has the following structure: section 1 shows the process of monetary European construction, section two illustrates the need for budget consolidation before the euro, section three illustrates the notion of monetary credibility and the construction of a bivariate politico-economic index, section four illustrates the role of ECB and of the SECB, section 5 assesses the study of euro impact on Portugal and, section 6 evaluates EMU after 10 years based upon EC (2008) and, finnally, section 7 concludes.
    Keywords: Credibility, Euro, Europe, ECB, European Integration, EMU, Pair Minister of Finance / Governor, Portugal.
    Date: 2009
  25. By: A. N. Sekar Iyengar
    Abstract: We have presented a novel technique of detecting intermittencies in a financial time series of the foreign exchange rate data of U.S.- Euro dollar(US/EUR) using a combination of both statistical and spectral techniques. This has been possible due to Continuous Wavelet Transform (CWT) analysis which has been popularly applied to fluctuating data in various fields science and engineering and is also being tried out in finance and economics. We have been able to qualitatively identify the presence of nonlinearity and chaos in the time series of the foreign exchange rates for US/EURO (United States dollar to Euro Dollar) and US/UK (United States dollar to United Kingdom Pound) currencies. Interestingly we find that for the US-INDIA(United States dollar to Indian Rupee) foreign exchange rates, no such chaotic dynamics is observed. This could be a result of the government control over the foreign exchange rates, instead of the market controlling them.
    Date: 2009–10
  26. By: Muchlinski, Elke
    Keywords: Central banks and their policies,institutions,communication,language and meaning
    JEL: A12 B25 E42 E52 E58 F33 Z13
    Date: 2009

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