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

  1. Euro Area Monetary Policy in Uncharted Waters By Emil Stavrev; Martin Cihák; Thomas Harjes
  2. Requirements for Using Interest Rates as an Operating Target for Monetary Policy:The Case of Tunisia By Alexandre Chailloux; Alain Durré; Bernard Laurens
  3. Monetary Policy and the Central Bank in Jordan By Samar Maziad
  4. Measures of Underlying Inflation in Sri Lanka By Magnus Saxegaard; Souvik Gupta
  5. The Gambia: Demand for Broad Money and Implications for Monetary Policy Conduct By Subramanian S. Sriram
  6. Forecasting Inflation in Sudan By Kenji Moriyama; Abdul Naseer
  7. Broad Money Demand and Asset Substitution in China By Ge Wu
  8. The Instability in the Monetary Policy Reaction Function and the Estimation of Monetary Policy Shocks By Kishor, N. Kundan; Newiak, Monique
  9. In Search of Successful Inflation Targeting: Evidence from an Inflation Targeting Index By Yanliang Miao
  10. The Role of Transparency in the Conduct of Monetary Policy By Makoto Minegishi; Boris Cournède
  11. What Drives China's Interbank Market? By Nathaniel John Porter; TengTeng Xu
  12. Monetary Model of Exchange Rate for Thailand: Long-run Relationship and Monetary Restrictions By Liew, Venus Khim-Sen; Baharumshah, Ahmad Zubaidi; Puah, Chin-Hong
  13. Balance of Payments Anti-Crises By Michael Kumhof; Isabel K. Yan
  14. Panacea, Curse, or Nonevent? Unconventional Monetary Policy in the United Kingdom By André Meier
  15. "What Should Inflation Targeting Countries Do When Oil Prices Rise and Drop Fast?" By Nicoletta Batini; Eugen Tereanu
  16. Stability of East Asian Currencies during the Global Financial Crisis By Junko Shimizu; Eiji Ogawa
  17. Monetary Policy Trade-Offs in an Estimated Open-Economy DSGE Model By Adolfson, Malin; Laseén, Stefan; Lindé, Jesper; Svensson, Lars E.O.
  18. Country Experiences with the Introduction and Implementation of Inflation Targeting By Inci Ötker; Charles Freedman
  19. Current Accounts in a Currency Union By Emil Stavrev; Jörg Decressin
  20. Monetary Policy and Asset Prices in a Small Open Economy: A Factor-Augmented VAR Analysis for Singapore By Hwee Kwan Chow; Keen Meng Choy
  21. Deteriorating Public Finances and Rising Government Debt: Implications for Monetary Policy By Lillian Cheung; Chi-Sang Tam; Jessica Szeto
  22. Interest Rate Liberalization in China By Nathaniel John Porter; Elöd Takáts; Tarhan Feyzioglu
  23. The Federal Reserve System Balance Sheet-What Happened and Why it Matters By Peter Stella
  24. Introducing the Euro as Legal Tender - Benefits and Costs of Eurorization for Cape Verde By Patrick A. Imam
  25. Establishing Conversion Values for New Currency Unions: Method and Application to the planned Gulf Cooperation Council (GCC) Currency Union By Bassem Kamar; Jean-Etienne Carlotti; Russell C. Krueger
  26. Macroeconomic Responses to Terms-of-Trade Shocks: A Framework for Policy Analysis for the Argentine Economy By Pelin Berkmen
  27. Optimal Monetary and Fiscal Policy with Limited Asset Market Participation By Sven Jari Stehn
  28. One Money, One Market - A Revised Benchmark By Theo S. Eicher; Christian Henn
  29. The Macroeconomic Performance of the Inflation Targeting Policy: An Approach Based on the Evolutionary Co-spectral Analysis By Zied Ftiti
  30. The Role of Demographics in Precipitating Crises in Financial Institutions By Macunovich, Diane
  31. Are Hard Pegs Ever Credible in Emerging Markets? Evidence from the Classical Gold Standard By Kris James Mitchener; Marc D. Weidenmier
  32. Monetary Policy and Real Wage Cyclicality By Chandarath Amarasekara; George Bratsiotis
  33. Is the East African Community an Optimum Currency Area? By Kishor, N. Kundan; Ssozi, John
  34. UK Macroeconomic Forecasting with Many Predictors: Which Models Forecast Best and When Do They Do So? By Gary Koop; Dimitris Korobilis

  1. By: Emil Stavrev; Martin Cihák; Thomas Harjes
    Abstract: We analyze the European Central Bank's (ECB's) response to the global financial crisis. Our results suggest that even during the crisis, the core part of ECB's monetary policy transmission-from policy rates to market rates-has continued to operate, but at a decreased efficiency. We also find some evidence that the ECB's non-standard measures, namely the lengthening of the maturity of monetary policy operations and the provision of funds at the fixed rate, reduced money market term spreads, facilitating the pass-through from policy to market rates. Furthermore, the results imply that the substantial increase in the ECB's balance sheet may have contributed to a reduction in government bond term spreads.
    Keywords: Central bank policy , Deflation , Economic models , European Monetary System , European Union , Financial crisis , Inflation , Liquidity controls , Monetary policy , Monetary transmission mechanism ,
    Date: 2009–08–31
  2. By: Alexandre Chailloux; Alain Durré; Bernard Laurens
    Abstract: This paper discusses the use of interest rates as the operating target for monetary policy in Tunisia and the roadmap for establishing the other building blocks of an inflation targeting framework. It argues that strengthening the effectiveness of the current monetary policy framework will facilitate the adoption of inflation targeting over time.
    Keywords: Economic models , Economic reforms , Financial sector , Inflation targeting , Interest rates , Liquidity management , Monetary operations , Monetary policy , Money markets , Tunisia ,
    Date: 2009–07–16
  3. By: Samar Maziad
    Abstract: The Central Bank of Jordan (CBJ) and its operational independence changed over time in line with the evolution of the monetary policy framework and as a result of the currency crisis in the late 1980s. The paper examines the developments of the CBJ, its independence in conducting monetary policy and the various instruments at its disposal, with special focus on the certificates of deposit (CDs) market, the main monetary policy instrument, and the treasury bill market. The paper also examines the issue of the autonomy of monetary policy in Jordan given the influence of world interest rates. Although, Jordan operates an exchange rate peg, which has been fixed to the USD since 1995, there is some room for flexibility in operating monetary policy in the short-run, where the CBJ has some autonomy in determining the spread between domestic and US interest rates. VAR and VECM results suggest that the response of the policy rate in Jordan to innovations in the US Federal Fund's rate is less than one-for-one. In the short-run, the CBJ appears to conduct monetary policy in response to domestic inflation and a measure of the domestic output gap.
    Keywords: Central bank autonomy , Central bank role , Central banks , Economic models , Exchange rate regimes , Jordan , Monetary policy , Monetary policy instruments ,
    Date: 2009–09–09
  4. By: Magnus Saxegaard; Souvik Gupta
    Abstract: During the first half of 2008, Sri Lanka witnessed significantly higher inflation than most other emerging Asian countries. Inflation has since declined amid declining world commodity prices and tight monetary policy. Given the sensitivity to global commodity prices, a core inflation measure could be useful for monetary policy. The purpose of this paper is to compare the performance of Sri Lanka's existing official measure of core inflation against alternative measures. Our findings suggest that the existing measure does contain information about the future path of headline information, but may be inadequate as a communication tool for the Central Bank.
    Keywords: Central bank policy , Consumer price indexes , Economic models , Inflation , Monetary policy , Performance indicators , Price structures , Sri Lanka ,
    Date: 2009–08–10
  5. By: Subramanian S. Sriram
    Abstract: This paper evaluates the demand for broad money (M2) in The Gambia for January 1988-June 2007. There appears to be a long-run relationship for demand for real M2, but the relationship is not stable. Exogenous output shocks, financial innovation, changes in income velocity, and inadequate data quality contribute to the instability. The authorities may need to apply the monetary targeting regime flexibly in the overall objective of preserving price stability. A possible option for The Gambia is to become an inflation targeter lite.
    Keywords: Central bank policy , Commercial banks , Demand for money , Economic growth , Economic models , Financial sector , Gambia, The , Inflation targeting , Interest rates on deposits , Liquidity , Monetary policy , Price stabilization , Sub-Saharan Africa , Time series ,
    Date: 2009–09–10
  6. By: Kenji Moriyama; Abdul Naseer
    Abstract: This paper forecasts inflation in Sudan following two methodologies: the Autoregressive Moving Average (ARMA) model and by looking at the leading indicators of inflation. The estimated ARMA model remarkably tracks the actual inflation during the sample period. The Granger causality test suggests that private sector credit and world wheat prices are the leading indicators explaining inflation in Sudan. Inflation forecasts based on both approaches suggest that inflationary pressures for 2009 and 2010 will be modest and that inflation will remain in single-digits, assuming that prudent macroeconomic policies are maintained.
    Keywords: Central banks , Commodity price fluctuations , Credit expansion , Data analysis , External shocks , Forecasting models , Inflation , Inflation targeting , Monetary policy , Money supply , Private sector , Sudan , Wheat ,
    Date: 2009–06–24
  7. By: Ge Wu
    Abstract: Recent changes to China's financial system, in particular ongoing interest rate liberalization, gradual movement toward a more flexible exchange rate regime, and rapid development of capital markets, have changed substantially the environment in which monetary policy operates. In light of these changes, we estimate an error correction model using a General-to-Specific methodology and confirm that a stable broad money demand function exists taking proper account of asset substitution, with an income elasticity of less than unity. Current inflation is found to have a significant negative impact on the real money demand. However, money demand does not appear very sensitive to interest rates, possibly reflecting their partial liberalization. Changes in the exchange rate also do not affect money demand significantly, but expectations of a further renminbi appreciation since 2005 appears to induce more money demand. Stock prices are statistically insignificant despite recent investors' interest in equity markets.
    Keywords: Capital markets , Central bank policy , China, People's Republic of , Demand for money , Economic models , Exchange rate regimes , Exchange rates , Financial assets , Financial systems , Interest rates , Monetary policy , Private investment ,
    Date: 2009–06–23
  8. By: Kishor, N. Kundan; Newiak, Monique
    Abstract: This paper uses the conventional wisdom about the shift in the monetary policy stance in 1979 to compute monetary policy shocks by estimating different monetary policy reaction functions for the pre-1979 and post-1979 time periods. We use the information from the internal forecasts of the Federal Reserve to derive monetary policy shocks. The results in this paper show that a monetary policy shock in the pre-1979 period affects output and prices much more strongly and quickly than what has been reported in the literature for the full sample. Our findings suggest that the dynamic response of output and prices to a monetary policy shock declined significantly between 1980-2001. We argue that this diminished response to the monetary policy shock is the result of a successful monetary policy that has led to a less volatile economy.
    Keywords: Monetary Policy Shocks; Greenbook data; Reaction Function
    JEL: E32 E58 E52
    Date: 2009–06–18
  9. By: Yanliang Miao
    Abstract: In a first attempt to treat inflation targeting (IT) as a continuous variable, we construct IT subindices for 21 full-fledged ITers on three dimensions: flexibility, transparency, and explicitness. Comparing flexibility and transparency we find that (1) the impact of flexibility on both the mean and variation of inflation is more quadratic than that of transparency; (2) after adding the transparency index, the impact of flexibility is no longer significant. The significant and negative association between transparency and the level and variation of inflation is confirmed when we check for robustness by controlling for disinflation stage, subsampling, instrumental variable estimation, and principal component analysis (PCA).
    Keywords: Cross country analysis , Economic models , Inflation , Inflation rates , Inflation targeting , Monetary policy , Transparency ,
    Date: 2009–07–16
  10. By: Makoto Minegishi; Boris Cournède
    Abstract: In contrast to the once prevailing norm of secrecy and opaqueness, transparency has now become one of the main features characterising the conduct of monetary policy. Detailed analysis of eleven OECD central banks shows that communication practices have converged markedly in the direction of ever greater transparency. Empirical evidence is consistent with the hypothesis that transparency contributes to the successful conduct of monetary policy: higher transparency is a typical element of monetary frameworks that are associated with better anchored inflation expectations and more stable inflation outcomes. Despite this general trend toward increased transparency, however, central banks differ in actual communication practices. There is a particular divergence with respect to transparency in the decision-making process and communication regarding future policy inclination. Although the appropriate degree of transparency in these areas is an unsettled issue, the fact that financial dislocation is impairing conventional monetary transmission makes these two areas critical for policy implementation.<BR>À rebours des habitudes de secrets et d’opacité qui ont pu prévaloir par le passé, la transparence constitue désormais un moyen essentiel de mise en œuvre de la politique monétaire. Une étude approfondie des pratiques de onze banques centrales de la zone OCDE confirme la convergence vers toujours plus de transparence. Les résultats empiriques sont cohérents avec l’hypothèse selon laquelle la transparence contribue à l’efficacité de la politique monétaire : en moyenne, les cadres de politique monétaire qui fournissent un meilleur ancrage des anticipations d’inflation et une inflation plus stable s’appuient sur un niveau plus élevé de transparence. Malgré une tendance générale vers davantage de transparence, les pratiques de communication diffèrent encore sensiblement d’une banque centrale à l’autre. Les divergences sont particulièrement marquées s’agissant de la transparence à propos des procédures de décision et de l’orientation future de la politique monétaire. Bien que le degré optimal de transparence sur ces deux sujets demeure un objet de débat, le fait que les troubles financiers actuels obèrent les canaux traditionnels de transmission de la politique monétaire donne à ces deux questions une importance toute particulière.
    Keywords: transparency, transparence, monetary policy, politique monétaire, inflation expectation, anticipation d'inflation, communication, communication
    JEL: E31 E50 E52 E58
    Date: 2009–09–25
  11. By: Nathaniel John Porter; TengTeng Xu
    Abstract: Interest rates in China comprise a mix of both market determined interest rates (interbank rates and bond yields), and regulated interest rates (lending and deposit rates), reflecting China's gradual process of interest rate liberalization. We argue, using a theoretical model and empirical analysis, that the regulation of key retail interest rates diminishes the ability of the market determined rates to act as independent price signals, or as benchmarks for use in asset pricing and monetary policy. Further interest rate liberalization should, therefore, strengthen the information conveyed by movements in interest rates, allowing for the better pricing of risk and capital.
    Keywords: Asset prices , Bank regulations , Banking sector , Bond markets , Capital markets , Central bank policy , China, People's Republic of , Economic models , Interest rates , Interest rates on deposits , Interest rates on loans , Liquidity , Monetary policy , Pricing policy ,
    Date: 2009–09–08
  12. By: Liew, Venus Khim-Sen; Baharumshah, Ahmad Zubaidi; Puah, Chin-Hong
    Abstract: This paper examines the long-run relationship between exchange rate and its determinants based on the flexible-price monetary model. Multivariate cointegration approach (Johansan 1988, 1989 and Johansen-Juselius 1990) is adopted to attain our objective of study. The empirical results provide evidence favoring the monetary approach to exchange rate for a small and open emerging economy, namely Thailand. In addition, the validity of the underlying assumptions of the monetary approach to the determination of exchange rate is established. The above findings suggest that exchange rate players may effectively monitor and forecast the exchange rate movement via the money supplies, incomes, and interest rates variables of both Thailand and Japan. Besides, one has to follow the economic development of Thailand’s major trading partner, Japan, to understanding the movement of exchange rate for Thailand. Moreover, our findings add new insights to accompaniment previous studies that documented the important influence of US in the emerging Asian economies.
    Keywords: Exchange rate; monetary model; Thailand; cointegration
    JEL: C52 F31 C01
    Date: 2009
  13. By: Michael Kumhof; Isabel K. Yan
    Abstract: Several emerging economies have, until recently, experienced large government surpluses and accelerating foreign exchange reserve accumulation. This has been accompanied by economic booms, exchange rate appreciations and in some cases increases in domestic inflation. We show that one way to understand these episodes is as manifestations of balance of payments anti-crises, as reflecting the perception that the government intends to discontinue its accumulation of reserves in the near future. The end-phase of such crises is characterized by nominal interest rates approaching their zero lower bound in accelerating fashion and, if the government targets CPI inflation, by fast increasing domestic inflation.
    Keywords: Balance of payments , Current account surpluses , Data analysis , Economic models , Emerging markets , Exchange rate appreciation , Fiscal policy , Foreign exchange reserves , Inflation , Monetary policy , Reserves accumulation ,
    Date: 2009–07–06
  14. By: André Meier
    Abstract: The Bank of England's current "quantitative easing" strategy has given rise to a controversial debate about the effects and risks of unconventional monetary policy. The present paper makes two contributions to this debate. First, it provides a systematic overview of unconventional policy options, drawing from existing theoretical and empirical studies. Against this backdrop, it then analyzes the BoE's specific policies, discussing their effectiveness so far and putting them into a cross-country context. Tentative evidence on the BoE's quantitative easing is moderately encouraging, although the strategy is neither guaranteed to succeed nor as perilous as some of its detractors claim.
    Keywords: Asset management , Bonds , Capital markets , Central bank policy , Credit controls , Credit risk , Cross country analysis , Financial risk , Inflation , Interest rate policy , Liquidity management , Monetary policy , Risk management , United Kingdom ,
    Date: 2009–08–05
  15. By: Nicoletta Batini; Eugen Tereanu
    Abstract: After a long period of global price stability, in 2008 inflation increased sharply following unprecedented increases in the price of oil and other commodities, notably food. Although inflation remained lower and growth higher in inflation targeting countries than elsewhere, almost everywhere price stability seemed in jeopardy as consumer prices kept surging and central banks struggled to maintain expectations anchored. The rapid drop in energy and food prices that later accompanied the world slowdown helped avert the worse, but inflation stayed high in many inflation targeting countries. This paper uses a small open-economy DSGE model to design the correct monetary policy response to a protracted supply shock of the kind observed today, and explains how to choose optimal policy horizons under such shock. Using a version of the model with Kalman learning, the paper also evaluates the implications of a loss of target credibility, showing how rules must be adjusted when the authorities' commitment to low inflation has been eroded. The appropriate response to future evolutions of the price of oil, including to a large downward correction as recently observed, is also evaluated.
    Keywords: Agricultural commodities , Agricultural prices , Central banks , Commodity price fluctuations , Consumer prices , Demand , Economic models , External shocks , Inflation , Inflation targeting , Monetary policy , Oil prices , Price stabilization ,
    Date: 2009–05–28
  16. By: Junko Shimizu; Eiji Ogawa
    Abstract: In this study, we investigate the movements of the nominal effective exchange rates (NEER) of East Asian currencies and the Asian Monetary Unit (AMU), which is the weighted average of East Asian currencies, during the course of the global financial crisis. We found that the NEER were more stable in countries that adopted the currency basket system even during the financial crisis. Comparisons made between the NEER and a combination of the AMU and AMU Deviation Indicators show intra-regional exchange rates among the East Asian currencies, and that there have been strong relationships between them before and after the global financial crisis. Accordingly, monitoring both the AMU and the AMU Deviation Indicators is effective in stabilizing the NEER of East Asian currencies. In this respect, our findings indicate that the AMU Deviation Indicators as well as the AMU will play a very important role in the surveillance of the stability of intra-regional exchange rates.
    Keywords: currency basket system, effective exchange rate, global financial crisis, East Asian currencies
    JEL: F31 F36
    Date: 2009–09
  17. By: Adolfson, Malin (Monetary Policy Department, Central Bank of Sweden); Laseén, Stefan (Monetary Policy Department, Central Bank of Sweden); Lindé, Jesper (Division of International Finance); Svensson, Lars E.O. (Executive Board)
    Abstract: This paper studies the transmission of shocks and the trade-offs between stabilizing CPI inflation and alternative measures of the output gap in Ramses, the Riksbank’s empirical dynamic stochastic general equilibrium (DSGE) model of a small open economy. The main results are, first, that the transmission of shocks depends substantially on the conduct of monetary policy, and second, that the trade-off between stabilizing CPI inflation and the output gap strongly depends on which concept of potential output in the output gap between output and potential output is used in the loss function. If potential output is defined as a smooth trend this trade-off is much more pronounced compared to the case when potential output is defined as the output level that would prevail if prices and wages were flexible.
    Keywords: Optimal monetary policy; instrument rules; open-economy DSGE models; propagation of shocks; impulse responses; output gap; potential output
    JEL: E52 E58
    Date: 2009–08–01
  18. By: Inci Ötker; Charles Freedman
    Abstract: This is the tenth chapter of a forthcoming monograph entitled, "On Implementing Full- Fledged Inflation-Targeting Regimes: Saying What You Do and Doing What You Say." It describes the experiences of a number of countries with the introduction and implementation of inflation targeting regimes. It discusses their motivation for introducing IT; how they fared in meeting the various conditions that some have argued are needed in advance of introducing IT; how they transitioned to a full-fledged IT framework and coordinated their preparations with other economic policies and reforms; the benefits they gained by adopting IT; the challenges they faced in implementation; and the lessons from their experiences.
    Keywords: Cross country analysis , Economic policy , Economic reforms , Inflation , Inflation targeting , Monetary policy ,
    Date: 2009–07–30
  19. By: Emil Stavrev; Jörg Decressin
    Abstract: A fear about EMU was that in the absence of national currencies, country-specific shocks would result in greater current account divergences between member states. This paper finds that divergences across euro-area countries are smaller and have not risen relative to those across 13 other advanced economies with more flexible exchange rates. Also, the size of country-specific current account shocks in EMU countries is smaller and their persistence is greater than in the other advanced economies. However, these differences in current account dynamics do not appear related to different exchange rate dynamics.
    Keywords: Cross country analysis , Current account , Economic models , European Economic and Monetary Union , External shocks , Monetary unions , Real effective exchange rates , Regional shocks ,
    Date: 2009–06–17
  20. By: Hwee Kwan Chow (School of Economics, Singapore Management University); Keen Meng Choy (School of Humanities and Social Sciences, Nanyang Technological University)
    Abstract: The ongoing global financial turmoil has revived the question of whether central bankers ought to tighten monetary policy preemptively in order to head off asset price misalignments before a sudden crash triggers financial instability. This study explores the issue of the appropriate monetary policy response to asset price swings in the small open economy of Singapore. Empirical analysis of monetary policy based on standard VAR models, unfortunately, is often hindered by the use of sparse information sets. To better reflect the extensive information monitored by Singapore’s central bank, including global economic indicators, we augment a monetary VAR model with common factors extracted from a large panel dataset spanning 122 economic time series and the period 1980q1 to 2008q2. The resulting FAVAR model is used to assess the impact of monetary policy shocks on residential property and stock prices. Impulse response functions and variance decompositions suggest that monetary policy can potentially be used to lean against asset price booms in Singapore.
    Keywords: Monetary Policy; Asset Prices; Dynamic Factors; Vector Autoregression
    JEL: C33 E52
    Date: 2009–10
  21. By: Lillian Cheung (Research Department, Hong Kong Monetary Authority); Chi-Sang Tam (Research Department, Hong Kong Monetary Authority); Jessica Szeto (Research Department, Hong Kong Monetary Authority)
    Abstract: The sharp rise in government debt in many major economies following the introduction of large fiscal stimulus measures during the global financial crisis of 2008-09 has triggered concerns over its impact on long-term interest rates and the potential negative consequences for future growth and inflation. This paper uses an error-correction model to assess the effect of growing government debt on long-term real interest rates by drawing on empirical evidence from the US. The results show that in the long run, a one-percentage-point increase in the federal debt-to-GDP ratio raises the equilibrium 10-year real US Treasury yield by about six basis points. We also discuss the economic consequences of a rise in the world long-term interest rates, and draw implications for longer-term growth and the conduct of monetary policy in the Asian economies.
    Keywords: Public debt, fiscal policy, monetary policy, long term interest rate, real interest rate, error-correction model
    JEL: E43 E47 E52 E62 H63
    Date: 2009–08
  22. By: Nathaniel John Porter; Elöd Takáts; Tarhan Feyzioglu
    Abstract: What might interest rate liberalization do to intermediation and the cost of capital in China? China's most binding interest rate control is a ceiling on the deposit rate, although lending rates are also regulated. Through case studies and model-based simulations, we find that liberalization will likely result in higher interest rates, discourage marginal investment, improve the effectiveness of intermediation and monetary transmission, and enhance the financial access of underserved sectors. This can occur without any major disruption. International experience suggests, however, that achieving these benefits without unnecessary instability, requires vigilant supervision, governance, and monetary policy, and a flexible policy toolkit.
    Keywords: Banking , Banking sector , Banks , Capital markets , China, People's Republic of , Credit controls , Credit demand , Cross country analysis , Economic models , Financial intermediation , Interest rates , Loans , Monetary policy ,
    Date: 2009–08–12
  23. By: Peter Stella
    Abstract: The recent expansion of the balance sheet of the consolidated Federal Reserve Banks (FRB) is analyzed in an historical context. The analysis reveals that the nature of Fed involvement in U.S. financial markets has changed dramatically and its expansion is several orders of magnitude beyond what is usually reported. The associated fiscal risks and potential exit strategies are then considered. Although risks are considerable in certain unlikely scenarios, FRB capital, earnings capacity, and reserves are more than ample to preserve their financial independence. Nevertheless, the occurrence of losses or a significant drop in FRB profit might lead to an eventual curtailment of Fed operational independence. The paper concludes by considering options to enhance FRB risk management and to assign responsibilities for monetary, financial stability and fiscal policies once the current crisis is overcome.
    Keywords: Capital markets , Central bank policy , Central banks , Commercial banks , Credit risk , Financial risk , Financial systems , Liquidity management , Monetary policy , Monetary reserves , Risk management , United States ,
    Date: 2009–06–01
  24. By: Patrick A. Imam
    Abstract: In recent years, recommendations for countries to unilaterally dollarize/eurorize have become common, particularly when the countries lack economic credibility. After exploring the characteristics of dollarizing/eurorizing economies, we look at the merits and costs of unilateral eurorization for Cape Verde, a highly tourism based economy that has become increasingly integrated into the euro-zone area and that has a strong macroeconomic track record. We illustrate that neither the benefits nor the costs of unilateral eurorization are large and conclude that there is no compelling case to change the current exchange rate arrangement at this point in time. Econometrically, we assess the characteristics of dollarized economies and demonstrate that few of them apply to Cape Verde, further confirming that Cape Verde does not fit the pattern of most dollarizing countries.
    Keywords: Benefits , Cape Verde , Cross country analysis , Currency pegs , Currency substitution , Dollarization , Exchange rate regimes , Fiscal policy , Monetary systems ,
    Date: 2009–07–14
  25. By: Bassem Kamar; Jean-Etienne Carlotti; Russell C. Krueger
    Abstract: A key issue in creating a new currency union is setting the rates to convert national currencies into the new union currency. Planned unions in the Gulf region and Africa are seeking methods to set the conversion rates when their new currencies are created. We propose a forward-looking econometric methodology to determine conversion rates by calculating the degree of misalignment in the real exchange rate, and apply it to the GCC currency union. For each GCC currency, we identify the year at which the economy is the closest to its internal and external equilibrium, and then estimate the degree of misalignment in the bilateral real exchange rate vis-à-vis the U.S. dollar based on WEO forecasts until 2013. Application of the methodology to other regions is also considered.
    Keywords: Convertibility , Convertible currencies , Currencies , East Africa , Economic models , Exchange rate determination , Exchange rates , Monetary unions , Real effective exchange rates , West Africa ,
    Date: 2009–08–31
  26. By: Pelin Berkmen
    Abstract: This paper presents a version of the global integrated monetary fiscal (GIMF) model adapted and calibrated to the Argentine economy. The model replicates the effect of the strong improvement in Argentina's terms of trade stemming from higher world commodity prices as well as other key economic trends in Argentina during the period 2003-2007. The model can be used to assess the potential impact of different combinations of monetary and fiscal policies on output, inflation, and the external trade.
    Keywords: Argentina , Commodity prices , Demand , Economic models , External shocks , Fiscal policy , Inflation , International trade , Monetary policy , Price increases , Revenues , Terms of trade , Time series ,
    Date: 2009–05–29
  27. By: Sven Jari Stehn
    Abstract: This paper characterises the jointly optimal monetary and fiscal stabilisation policy in a new Keynesian model that allows for consumers who lacking access to asset markets consume their disposable income each period. With full asset market participation, the optimal policy relies entirely on the interest rate to stabilise cost-push shocks and government expenditure is not changed. When asset market participation is limited, there is a case for fiscal stabilisation policy. Active use of public spending raises aggregate welfare because it enables a more balanced distribution of the stabilisation burden across asset-holding and non-asset-holding consumers. The optimal response of government expenditure is sensitive to the financing scheme and whether the policymaker has access to a targeted transfer that can directly redistribute resources between consumers.
    Keywords: Capital markets , Economic models , Financial assets , Fiscal policy , Government expenditures , Monetary policy , Stabilization measures ,
    Date: 2009–07–08
  28. By: Theo S. Eicher; Christian Henn
    Abstract: The introduction of the euro generated substantial interest in measuring the impact of currency unions (CUs) on trade flows. Rose's (2000) initial estimates suggested a tripling of trade and created a literature in search of "more reasonable" CU effects. A recent meta-analysis of this literature shows that subsequent papers quantify CU trade impacts at 30-90 percent. However, most recent studies use shorter time series and fewer countries than Rose in his original work. We revisit Rose's original benchmark, extend the dataset, and address Baldwin's (2006) critiques regarding the proper specification of gravity models in large panels by simultaneously accounting for multilateral resistance and unobserved bilateral heterogeneity. This produces a robust average CU trade effect of 45 percent. Yet, the trade impacts of individual CUs vary substantially and are generally lower than those of preferential trade agreements (PTAs). Our revised benchmark can be used as a yardstick for future studies to delineate how estimates differ due to new data or differences in econometric specifications.
    Keywords: Bilateral trade , Economic models , Markets , Monetary systems , Monetary unions , Trade integration , Trade relations ,
    Date: 2009–09–02
  29. By: Zied Ftiti (GATE-CNRS/ENS LSH, University of Lyon, France)
    Abstract: This paper proposes a new methodology to check the economic performance of a monetary policy and in particular the inflation targeting policy (ITP). The main idea of this work is to consider the ITP as economically efficient when it generates a stable monetary environment. The latter is considered as stable when a long-run equilibrium exists to which the paths of economic variables (inflation rate, interest rate and GDP growth) converge. The convergence of the variables’ paths implies that these variables are more predictable and implies a lower degree of uncertainty in the economic environment. To measure the degree of convergence between economic variables, we propose, in this paper, a dynamic time-varying variable presented in the frequency approach named cohesion. This variable is estimated from the evolutionary co-spectral theory as deï¬ned by Priestley and Tong (1973) and Priestley (1988-1996). We apply this theory to the measure of cohesion presented by Croux et al (2001) to obtain a dynamic time-varying measure. In the last step of the study, we apply the Bai and Perron test (1998-2003b) to determine the change in the cohesion path. The results show that the implementation of the ITP generates a high degree of convergence between economic series that implies less uncertainty into the monetary environment. We conclude that the inflation targeting generates a stable monetary environment. This result allows us to conclude that the ITP is relevant in the case of industrialized countries.
    Keywords: segregation, Inflation Targeting, Co-Spectral Analysis, Cohesion, Stability Environment, Economic Performance and Structural Change
    JEL: C16 E52 E63
    Date: 2009
  30. By: Macunovich, Diane (University of Redlands)
    Abstract: There are significant effects of changing demographics on economic indicators: growth in GDP especially, but also the current account balance and gross capital formation. The 15-24 age group appears to be one of the key age groups in these effects, with increases in that age group exerting strong positive effects on GDP growth, and negative effects on the CAB and GCF. There have been major shifts in the share of the population aged 15-24 during the past half century or more, many of which correspond closely to periods of institutional turmoil. The hypothesis presented in this paper is that increases in the share of the 15-24 age group lead producers to ratchet up their production expectations and take out loans to expand production capacity; but then reductions in that share – or even declining rates of increase – confound these expectations and precipitate a downward spiral of missed loan payments and even defaults and bankruptcies, putting pressure on central banks and causing foreign investors to withdraw funds and speculators to unload the local currency. This appears to have been the pattern not only during the 1996-98 crisis with the Asian Tigers, but also during the "Tequila" crisis of the early 1990s, the crises that occurred in the early 1980s among developed as well as developing nations, and the economic problems Japan has experienced since about 1990. The effect appears to be even more pronounced for the current 2008-2009 period.
    Keywords: age structure, currency crisis, demographic change, financial crisis
    JEL: J1 E3 F3 F4
    Date: 2009–09
  31. By: Kris James Mitchener; Marc D. Weidenmier
    Abstract: Using a new database of weekly sovereign debt prices of paper currency and pound sterling (or gold) denominated debt, we identify the currency-risk component of sovereign yield spreads for nine of the largest emerging market borrowers for the period 1870-1913. Five years after a country joined the gold standard, paper currency bonds traded at significantly higher interest rates (more than 400 basis points on average) than a country’s foreign currency debt denominated in pound sterling. Investors also expected exchange rates to fall by roughly 20 percent even after emerging market borrowers had joined the gold standard. The presence of persistent positive currency risk premiums long after gold standard adoption suggests that hard pegs for emerging market borrowers may never be fully credible.
    JEL: F2 F33 F36 F41 N10 N20
    Date: 2009–10
  32. By: Chandarath Amarasekara; George Bratsiotis
    Abstract: Several recent studies highlight the potential bias that may arise in measuring real wage cyclicality. This paper points to the important role of monetary policy in determining the latter. Using a simple model that diverts its focus from relative nominal price and wage rigidities, we show that other things kept equal, the degree and direction of real wage cyclicality is determined by the interaction of (i) the returns to scale in production, (ii) the nature of aggregate shocks, and (iii) monetary policy. Given that production technology is fairly constant in the short run, we suggest that variations in the real wage-output covariance depend largely on the latter two. Empirical evidence from eight major OECD countries appears to be consistent with this claim.
    Date: 2009
  33. By: Kishor, N. Kundan; Ssozi, John
    Abstract: This paper investigates whether the East African Community (EAC) constitutes an optimum currency area (OCA) by estimating the degree and evolution of business cycle synchronization between the EAC countries. We also investigate whether the degree of business cycle synchronization has improved after signing of the EAC treaty in 1999. The degree of business cycle synchronization is estimated using an unobserved components model of structural shocks obtained from a structural VAR model. We then use a time-varying parameter model to estimate the evolution of business cycle synchronization. Our results indicate that the proportion of shocks that is common across different countries is small, implying weak synchronization. However, we also find that the degree of synchronization has improved after signing of the EAC treaty in 1999.
    Keywords: East African Community; Optimum Currency Area; Business Cycle Synchronization; Structural VAR; State-Space Model
    JEL: F15 E42 F33
    Date: 2009–10–03
  34. By: Gary Koop (Department of Economics, University of Strathclyde); Dimitris Korobilis (Department of Economics, University of Strathclyde)
    Abstract: Block factor methods offer an attractive approach to forecasting with many predictors. These extract the information in these predictors into factors reflecting different blocks of variables (e.g. a price block, a housing block, a financial block, etc.). However, a forecasting model which simply includes all blocks as predictors risks being over-parameterized. Thus, it is desirable to use a methodology which allows for different parsimonious forecasting models to hold at different points in time. In this paper, we use dynamic model averaging and dynamic model selection to achieve this goal. These methods automatically alter the weights attached to different forecasting models as evidence comes in about which has forecast well in the recent past. In an empirical study involving forecasting output growth and inflation using 139 UK monthly time series variables, we find that the set of predictors changes substantially over time. Furthermore, our results show that dynamic model averaging and model selection can greatly improve forecast performance relative to traditional forecasting methods.
    Keywords: Bayesian, state space model, factor model, dynamic model averaging
    JEL: E31 E37 C11 C53
    Date: 2009–08

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