nep-mon New Economics Papers
on Monetary Economics
Issue of 2009‒10‒24
twenty papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Exchange Rate Pass-through and Monetary Policy: How Strong is the Link? By Stephen Murchison
  2. A Note on the Volatilities of the Interest Rate and the Exchange Rate Under Different Monetary Policy Instruments: Mexico 1998-2008. By Guillermo Benavides; Carlos Capistrán
  3. Monetary Asset Substitution in the Euro Area By Zagaglia, Paolo
  4. Timeless perspective vs discretionary policymaking when the degree of inflation persistence is unknown By Juan Paez-Farrell
  5. The welfare effect of foreign monetary conservatism with non-atomistic wage setters By Vincenzo Cuciniello
  6. Estimating the implicit inflation target in the Euro area By Fève, P.; Matheron, J.; Sahuc, J-G.
  7. International monetary policy cooperation revisited: conservatism and non-atomistic wage setting By Vincenzo Cuciniello
  8. Evaluating Exclusion-from-Core Measures of Inflation using Real-Time Data By Tierney, Heather L.R.
  9. Optimal Monetary and Fiscal Policy in the EMU: Does Fiscal Policy Coordination matter? By Chiara Forlati
  10. Inflation targeting and private sector forecasts By Stephen G. Cecchetti; Craig Hakkio
  11. Optimal Exchange-Rate Targeting with Large Labor Unions By Vincenzo Cuciniello; Luisa Lambertini
  12. Monetary-Labor Interactions, International Monetary Regimes, and Central Bank Conservatism By Vincenzo Cuciniello
  13. Political institutions and central bank independence revisited By Davide Ferrari; Barbara Pistoresi; Francesco Salsano
  14. Overconfidence, Monetary Policy Committees and Chairman Dominance By Carl Andreas Claussen; Egil Matsen; Øistein Røisland; Ragnar Torvik
  15. A defence of the FOMC By Martin Ellison; Thomas J. Sargent
  16. Real-Time Inflation Forecasting in a Changing World By Jan J. J. Groen; Richard Paap; Francesco Ravazzolo
  18. Estonia and Euro Adoption: Small Country Challenges of Joining EMU By Zuzana Brixiova; Margaret Morgan; Andreas Wörgötter
  19. The US dollar shortage in global banking and the international policy response By Goetz von Peter; Patrick McGuire
  20. Central Bank Economic Research: Output, Demand, Productivity, and Relevance By Miguel sarmiento

  1. By: Stephen Murchison
    Abstract: Several authors have presented reduced-form evidence suggesting that the degree of exchange rate pass-through to the consumer price index has declined in Canada since the early 1980s and is currently close to zero. Taylor (2000) suggests that this phenomenon, which has been observed for several other countries, may be due to a change in the behaviour of inflation. Specifically, moving from a high to a low-inflation environment has reduced the expected persistence of cost changes and, by consequence, the degree of pass-through to prices. This paper extends his argument, suggesting that this change in persistence is due to a change in the parameters of the central bank's policy rule. Evidence is presented for Canada indicating that policy has responded more aggressively to inflation deviations over the low pass-through period relative to the high pass-through period. We test the quantitative importance of this change in policy for exchange rate pass-through by varying the parameters of a simple monetary policy rule embedded in an open economy, dynamic stochastic general equilibrium model. Results suggest that increases in the aggressiveness of policy consistent with that observed for Canada are sufficient to effectively eliminate measured pass-through. However, this conclusion depends critically on the inclusion of price-mark-up shocks in the model. When these are excluded, a more modest decline to pass-through is predicted.
    Keywords: Exchange rates; Transmission of monetary policy
    JEL: F31 F41 E52
    Date: 2009
  2. By: Guillermo Benavides; Carlos Capistrán
    Abstract: To advance our understanding of the mechanisms through which monetary policy affect the economy, in this note we analyze the volatilities of the Mexican short-term interest rate and of the peso-Dollar exchange rate under two monetary policy instruments: a non-borrowed reserves requirement target (the "Corto") and an interest rate target. Using tests for multiple structural changes, we document that both volatilities decreased around the time Banco de México started the transition from the former to the latter. With respect to the volatility transmission from interest rates to exchange rates and vice versa, we find, using a bivariate GARCH model and causality-in-variance tests, bi-causality during the period of the Corto, but no causal relation after the transition started.
    Keywords: Corto, granger causality, multiple structural breaks, multivariate volatility.
    JEL: C22 E43 E52 F31
    Date: 2009–10
  3. By: Zagaglia, Paolo
    Abstract: I estimate time-varying elasticities of substitution between monetary assets for the Euro area using the semi-nonparametric method of Gallant (1981). The estimated elasticities suggest are consistent with the assumption of imperfect substitution between asset. Furthermore, the elasticities provide little evidence for the presence of structural breaks in money demand in the period 2001-2003 suggested by the ECB (2003).
    Keywords: money demand; asset substitution; nonparametric methods
    JEL: C63 C14 E41
    Date: 2009–10–14
  4. By: Juan Paez-Farrell (Dept of Economics, Loughborough University)
    Abstract: It is often assumed that monetary policy in forward looking models yields higher welfare, measured in terms of the unconditional loss, when it operates under the timeless perspective than under discretion. This paper consider the robustness of such a result in a New Keynesian model when the degree of intrinsic inflation persistence is misperceived by the policymaker. It finds that for reasonable parameter values discretion can be superior to the timeless perspective. The reason for this stems from the fact that the timeless perspective policy varies more with the degree of inflation persistence than does the discretionary policy.
    Keywords: discretion, timeless perspective, inflation persistence, uncertainty
    JEL: E52 E58
    Date: 2009–09
  5. By: Vincenzo Cuciniello (Chair of International Finance, Ecole Polytechnique Federale de Lausanne (EPFL), Switzerland)
    Abstract: This paper sheds light on the real effects of foreign central bank’s degree of inflation aversion in presence of non-atomistic wage setters. It extends the Lippi’s (2003) framework to an open economy and identifies the key strategic mechanisms between monetary policy and wage-setting decisions so as to assess the real effects of domestic and foreign policy makers’ aversion to inflation. A main finding is that foreign central bank’s aversion to inflation always increases employment. The impact of domestic central bank’s aversion to inflation instead depends on the combination of three strategic effects.
    Keywords: Foreign central bank conservatism, centralized wage setting, open-economy macro
    JEL: E58 F41 J51
    Date: 2009–04
  6. By: Fève, P.; Matheron, J.; Sahuc, J-G.
    Abstract: Euro area countries as a whole have experienced a marked downward trend over the 1980s. Over this period, the unemployment rate has increased and economic activity has been sluggish. Changes in the implicit inflation target, viewed as low frequency movements of inflation, might possibly explain these developments. To highlight this issue, the present study estimates the dynamics of the implicit inflation target in the euro zone over the period 1970Q1-2004Q4. Based on a small macroeconometric model, the implicit target, not known by the econometrician, is identified through a minimal set of theoretical restrictions: (i) the inflation target is a non stationary process, (ii) inflation is a monetary phenomenon in the long-run, and (iii) changes in the implicit target have no long-run effects whatsoever on real variables. The model is estimated so as to match output growth, changes in inflation and the ex post real interest rate. Our main results are: (i) inflation target shocks account for the bulk of nominal fluctuations; (ii) due to monetary policy inertia and nominal stickiness, changes in the target generate large swings in the real interest rate translating into substantial short-run effects on real variables; (ii) in spite of this inflation target shocks moderately impact on output dynamics.
    Keywords: Implicit inflation target, Macroeconometric modelling, Euro area.
    JEL: E31 E32 E52
    Date: 2009
  7. By: Vincenzo Cuciniello (Chair of International Finance, Ecole Polytechnique Federale de Lausanne (EPFL), Switzerland)
    Abstract: This paper presents a simple model of policy coordination in line with the New Open Economy Macroeconomics literature. I extent the analysis on non-cooperative toward cooperative solutions by incorporating a collective wage bargaining system and conservative central banks. It turns out that previous results on international monetary policy cooperation are modified such that cooperation is welfare improving. The finding in the model relies on wage setters’ perceptions about affecting monetary policy. It is shown that under cooperation wage setters perceive a tighter monetary policy, thereby inducing wage restraints.
    Keywords: Monetary policy games , International policy coordination , Central bank conservatism, Monopoly unions
    JEL: E58 F41 F42 J51
    Date: 2009–06
  8. By: Tierney, Heather L.R.
    Abstract: Using parametric and nonparametric methods, inflation persistence is examined through the relationship between the exclusions-from-core measure of inflation and total inflation for two sample periods and five in-sample forecast horizons ranging from one to twelve quarters over fifty vintages of real-time data in two measures of inflation: personal consumption expenditure and the consumer price index. This paper finds that core inflation is only able to capture the overall trend of total inflation for the twelve-quarter in-sample forecast horizon using the consumer price index in both the parametric and nonparametric models in the longer sample period. The nonparametric model outperforms the parametric model for both data samples and for all five in-sample forecast horizons.
    Keywords: Inflation Persistence; Real-Time Data; Monetary Policy; Nonparametrics; In-Sample Forecasting
    JEL: C53 C14 E52
    Date: 2009–08
  9. By: Chiara Forlati (Chair of International Finance, Ecole Polytechnique Federale de Lausanne (EPFL), Switzerland)
    Abstract: I develop and analyze a DSGE model of a currency union to revise the question of how to conduct monetary and fiscal policy in countries that share the same currency. In contrast with the previous literature which assumes coordination, this paper analyzes the case where coordination lacks among fiscal authorities as well as between fiscal and monetary authorities. I show that the normative prescriptions emphasized by former analyses are not valid any more once policymakers are not coordinated. Indeed, in that case the common central bank does not stabilize the average union in ation as if it were in a closed economy because it has to take into account the distortions caused by the lack of coordination among fiscal policymakers. At the same time, if there is not a common agreement to coordinate fiscal policies, autonomous governments should use government expenditure as a stabilization tool even if shocks are symmetric.
    Keywords: Monetary and Fiscal Policy, Policy Coordination
    JEL: E52 E58 E62 F42
    Date: 2006–08
  10. By: Stephen G. Cecchetti; Craig Hakkio
    Abstract: Transparency is one of the biggest innovations in central bank policy of the past quarter century. Modern central bankers believe that they should be as clear about their objectives and actions as possible. However, is greater transparency always beneficial? Recent work suggests that when private agents have diverse sources of information, public information can cause them to overreact to the signals from the central bank, leading the economy to be too sensitive to common forecast errors. Greater transparency could be destabilizing. While this theoretical result has clear intuitive appeal, it turns on a combination of assumptions and conditions, so it remains to be established that it is of empirical relevance. In this paper we study the degree to which increased information about monetary policy might lead to individuals coordinating their forecasts. Specifically, we estimate a series of simple models to measure the impact of inflation targeting on the dispersion of private sector forecasts of inflation. Using a panel data set that includes 15 countries over 20 years we find no convincing evidence that adopting an inflation targeting regime leads to a reduction in the dispersion of private sector forecasts of inflation. While for some specifications adoption of inflation target does seem to reduce the standard deviation of inflation forecasts, the impact is rarely precise and always small.
    JEL: E31 E42 E52 E58
    Date: 2009–10
  11. By: Vincenzo Cuciniello (Chair of International Finance, Ecole Polytechnique Federale de Lausanne (EPFL), Switzerland); Luisa Lambertini (Chair of International Finance, Ecole Polytechnique Federale de Lausanne (EPFL), Switzerland)
    Abstract: We study whether monetary policy should target the exchange rate in a two-country model with non-atomistic wage setters, non-traded goods and different degrees of exchange-rate pass through. Commitment to an exchange rate target reduces the labor market distortion. Large labor unions anticipate that higher wages depreciate the exchange rate, which triggers an increase in the interest rate and restrain wage demands. However, reduced exchange rate flexibility worsens the distortion stemming from preset pricing. Targeting the nominal exchange rate will be optimal when the labor market distortion is larger than the preset-pricing one. This result arises with cooperation both under producer and local currency pricing, even though the optimal degree of exchange-rate targeting is higher under local currency pricing. In the Nash equilibrium, the terms-of-trade effect raises optimal wage mark-ups thereby reducing the optimal weight on the exchange rate target. The terms-of-trade effect is stronger as openness and substitutability among Home and Foreign goods increase.
    Keywords: Monetary policy, International Finance, Open-Economy Macroeconomics
    JEL: F3 F41 E52
    Date: 2009–05
  12. By: Vincenzo Cuciniello (Chair of International Finance, Ecole Polytechnique Federale de Lausanne (EPFL), Switzerland)
    Abstract: A two-country general equilibrium model with large wage setters and conservative monetary authorities is employed to investigate the welfare implications of three international monetary regimes: i) non-cooperative, ii) cooperative, and iii) monetary union. The analysis shows that the unions’ wage claims depend on three strategic effects which are substantially different between the international policy arrangements. In contrast with recent studies, a switch from non-cooperation to monetary union is welfare improving with a sufficiently conservative central bank because unions perceive wage hikes as delivering lower terms-of-trade gains; while a switch from non-cooperation to cooperation is always beneficial because wage hikes do not yield any terms-of-trade gain. Finally, the paper qualifies Lippi’s (2003) findings.
    Keywords: Central bank conservatism, non-atomistic wage setting, open-economy macro, monetary regime
    JEL: E42 E58 F33 F41 J5
    Date: 2009–02
  13. By: Davide Ferrari; Barbara Pistoresi; Francesco Salsano
    Abstract: We build on earlier studies regarding Central Bank independence (CBI) by relating it to political, institutional and economic variables. The data suggest that CBI is positively related to the presence of federalism, the features of the electoral system and parties, the correlation between the shocks to the level of economic activity in the countries included in the sample and, for a sub-sample of economies, the convergence criteria to join the European Monetary Union (EMU).
    Keywords: ICentral Bank independence; institutional systems; variable selection
    JEL: E5
    Date: 2009–07
  14. By: Carl Andreas Claussen (Sveriges Riksbank and Norges Bank (Central Bank of Norway)); Egil Matsen (Norwegian University of Science and Technology and Norges Bank); Øistein Røisland (Norges Bank (Central Bank of Norway)); Ragnar Torvik (Norwegian University of Science and Technology and Norges Bank)
    Abstract: We suggest that overconfidence among policymakers explains why formal decision power over monetary policy is given to committees, while much of the real power to set policy remains with central bank chairmen. Overconfidence implies that the chairman underweights advice from his staff, increasing policy risk if he alone decides. A committee with decision power reduces this risk, because it induces moderation from the chairman. Overconfidence also yields disagreement and dissent in the committee, consistent with evidence from monetary policy committees. As the chairman is on average better informed, through his wider access to the staff, this would give him a suboptimal influence if policy is set through simple majority voting. Giving the chairman extra decision power, through e.g. agenda-setting rights, restores his influence. A monetary policy committee with a strong chairman balances the risks and influence distortions that occur if policymakers are overconfident.
    Keywords: Central Bank Governance, Monetary Policy Committees, Overcon?dence, Agenda-setting
    JEL: D02 D71 E58
    Date: 2009–10–13
  15. By: Martin Ellison; Thomas J. Sargent
    Abstract: We defend the forecasting performance of the FOMC from the recent criticism of Christina and David Romer. Our argument is that the FOMC forecasts a worst-case scenario that it uses to design decisions that will work well enough (are robust) despite possible misspecification of its model. Because these FOMC forecasts are not predictions of what the FOMC expects to occur under its model, it is inappropriate to compare their performance in a horse race against other forecasts. Our interpretation of the FOMC as a robust policymaker can explain all the findings of the Romers and rationalises differences between FOMC forecasts and forecasts published in the Greenbook by the staff of the Federal Reserve System.
    Keywords: Forecasting, Monetary policy, Robustness
    JEL: C53 E52 E58
    Date: 2009
  16. By: Jan J. J. Groen (Federal Reserve Bank of New York); Richard Paap; Francesco Ravazzolo (Norges Bank (Central Bank of Norway))
    Abstract: This paper revisits ination forecasting using reduced form Phillips curve forecasts, i.e., inflation forecasts using 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 of the individual specifications 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 certainty that unavoidably affects Phillips curve forecasts. We use this framework to describe PCE deflator and GDP deflator inflation rates for the United States across the post-WWII period. Over the full 1960-2008 sample the framework indicates several structural breaks across different combinations of activity measures. These breaks often coincide with, amongst others, policy regime changes and oil price shocks. In contrast to many previous studies, we find less evidence for 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 and one-year ahead forecasts for quarterly inflation relative to a whole range of forecasting models that are typically used in the literature.
    Keywords: Inflation forecasting, Phillips correlations, real-time data, structural breaks, model uncertainty, Bayesian model averaging.
    JEL: C11 C22 C53 E31
    Date: 2009–08–01
  17. By: Max Bruche (CEMFI, Centro de Estudios Monetarios y Financieros); Javier Suarez (CEMFI, Centro de Estudios Monetarios y Financieros)
    Abstract: This paper develops a tractable general equilibrium model in which money markets provide structural funding to some banks. When bank default risk becomes significant, retail deposit insurance creates an asymmetry between banks that operate in savingsrich regions, which can remain financed at cheap risk-free rates, and in savings-poor regions, which have to pay either large spreads in money markets or high rates for the scarce regional savings. We show that this asymmetry can cause a severe distortion of the aggregate allocation of credit. When interdependencies across borrowers are large (e.g., via demand externalities), output and welfare losses are also large and can be dramatically reduced by an aggressive subsidization of money market borrowing. The analysis offers some insights on the rationale for responding to a money markets freeze with full-allotment fixed-rate lending policies by central banks or the extension of government guarantees on non-deposit liabilities.
    Date: 2009–06
  18. By: Zuzana Brixiova; Margaret Morgan; Andreas Wörgötter
    Abstract: Estonia gave up the exchange rate and monetary policy tools of macroeconomic management when it introduced its currency board in 1992. While the currency board arrangement served the country well during transition in the 1990s, it offers limited flexibility to implement policies that would ease the EU convergence as well as mitigate the global financial and economic crisis. The ongoing financial crisis has made euro adoption more attractive than ever and put it on the top of the country’s policy agenda. However, shocks affecting Estonia are only weakly synchronized with those of the euro area, and the structure of its economy also notably differs from the euro zone. To benefit fully from joining the EMU, Estonia must strengthen other adjustment mechanisms to shocks, including flexibility of the labour market, further improving its environment to do business and a framework, which allows for anti-cyclical fiscal policies.<P>L’Estonie et l’adoption de l’euro : Les problèmes que pose à un petit pays l’adhésion à l’UEM<BR>En mettant en place un régime de caisse d’émission en 1992, l’Estonie a renoncé pour sa gestion macroéconomique aux instruments que constituent la politique de taux de change et la politique monétaire. Tout en ayant été très utile pour le pays durant la période de transition des années 1990, le régime de caisse d’émission n’offre qu’une souplesse limitée pour mettre en œuvre les mesures qui faciliteraient la convergence par rapport à l’UE et qui atténueraient aussi la crise financière et économique mondiale. Du fait de la crise financière actuelle, l’adoption de l’euro est plus attrayante que jamais et est une des priorités du pays. Malgré tout, les chocs que subit l’Estonie ne sont que faiblement synchronisés avec ceux que connaît la zone euro et la structure de l’économie estonienne est également assez différente de celle de l’économie de la zone euro. Pour bénéficier pleinement de la participation à l’UEM, l’Estonie devra renforcer d’autres mécanismes d’ajustement aux chocs économiques ; il lui faudra un marché du travail plus flexible, un environnement plus propice aux activités industrielles et commerciales et un cadre qui lui permette de mener des actions budgétaires anticycliques.
    Keywords: EMU, UME, Estonia, Estonie, business cycle synchronization, synchronisation du cycle conjoncturel, structural VAR, VAR structurelle
    JEL: C53 E32 E42
    Date: 2009–10–13
  19. By: Goetz von Peter; Patrick McGuire
    Abstract: Among the policy responses to the global financial crisis, the international provision of US dollars via central bank swap lines stands out. This paper studies the build-up of stresses on banks' balance sheets that led to this coordinated policy response. Using the BIS international banking statistics, we reconstruct the worldwide consolidated balance sheets of the major national banking systems. This allows us to investigate the structure of banks' global operations across their offices in various countries, shedding light on how their international asset positions are funded across currencies and counterparties. The analysis first highlights why a country's "national balance sheet", a residency-based measure, can be a misleading guide to where the vulnerabilities faced by that country's national banking system (or residents) lie. It then focuses on banking systems' consolidated balance sheets, and shows how the growth (since 2000) in European and Japanese banks' US dollar assets produced structural US dollar funding requirements, setting the stage for the dollar shortage when interbank and swap markets became impaired.
    Keywords: international banking, financial crises, funding risk, US dollar shortage, central bank swap lines
    Date: 2009–10
  20. By: Miguel sarmiento
    Abstract: The economic research of 30 central banks in OECD and Latin America countries from 2000 to 2007 is evaluated in this study. An international comparison based on four indexes that measure central bank research output, demand, productivity and relevance is included. From this view, the European Central Bank, the United States Federal Reserve Bank-Board of Governors- and the Bank of Canada showed the best results. The Central Bank of Colombia achieves an important position among the central banks selected for the study and holds that position in most of the indexes. Three aspects of research were examined in depth: i) focus of the research agenda, ii) the way research is organized, and iii) strategies for its development for six leading central banks in the sample, based on the results of the measure, including the Central Bank of Colombia. The study shows a tendency of central banks to develop studies with academic institutions. This practice allows them to broad the range of their analysis, by having an outside perspective, while getting expertise with recent techniques and theories for better economic analysis, which contributes to policy design.
    Date: 2009–10–12

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