nep-mon New Economics Papers
on Monetary Economics
Issue of 2009‒11‒14
twenty-two papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. A New World Monetary System: Keynes' view revisited By Mohammed, Shehu Tijjani
  2. Announcement effect and intraday volatility patterns of euro-dollar exchange rate : monetary policy news arrivals and short-run dynamic response. By Mokhtar Darmoul; Mokhtar Kouki
  3. Heeding Daedalus: Optimal inflation and the zero lower bound By John C. Williams
  4. “On the ‘Hot Potato Effect’ of Inflation: Intensive versus Extensive Margins” By Lucy Qian Liu; Liang Wang; Randall Wright
  5. Exchange Rate Regimes in the Asia-Pacific Region and the Global Financial Crisis By McKibbin, Warwick J.; Chanthapun, Waranya Pim
  6. A Tale of Two Policies: Prudential Regulation and Monetary Policy with Fragile Banks By Ignazio Angeloni; Ester Faia
  7. The Suspension of the Gold Standard as Sustainable Monetary Policy By Elisa Newby
  8. Inflation Volatility and Forecast Accuracy By Jamie Hall; Jarkko Jääskelä
  9. Nominal Rigidities, Monetary Policy and Pigou Cycles By Stéphane Auray; Paul Gomme; Shen Guo
  10. Liquidity and the Dynamic Pattern of Asset Price Adjustment: A Global View By Ansgar Belke; Walter Orth; Ralph Setzer
  11. Monetary and Fiscal Policy under Deep Habits By Campbell Leith; Ioana Moldovan; Raffaele Rossi
  12. On the GCC Currency Union By Weshah Razzak
  13. The Interest Rate — Exchange Rate Nexus: Exchange Rate Regimes and Policy Equilibria By Christoph Himmels; Tatiana Kirsanova
  14. The Effectiveness of Monetary Policy Reconsidered By John Weeks
  15. Setting an Agenda for Monetary Reform By Jane D'Arista
  16. The Dynamic Properties of Alternative Assumptions on Price Adjustment in New Keynesian Models By Olivier Musy; Mohamed Safouane Ben Aïssa
  17. A Preferred-Habitat Model of the Term Structure of Interest Rates By Jean-Luc Vila; Dimitri Vayanos
  18. Designing monetary and Fiscal policy rules in a New Keynesian model with rule-of-thumb consumers By Raffaele Rossi
  19. Thirty Years of Currency Crises in Argentina: External Shocks or Domestic Fragility? By Graciela Kaminsky; Amine Mati; Nada Choueiri
  20. Output Persistence from Monetary Shocks with Staggered Prices or Wages under a Taylor Rule By Sebastiano Daros; Neil Rankin
  21. Forecasting Inflation Using Dynamic Model Averaging By Gary Koop; Dimitris Korobilis
  22. OCA cubed: Mundell in 3D By Michaela Krčílková; Jan Zápal

  1. By: Mohammed, Shehu Tijjani
    Abstract: This essay critically examines the view of Keynes on the reform of the international monetary system. We then apply modern monetary and banking theory, where money is redefined as a pure numerical vehicle in contrast to money being defined as a net asset, to appraise those elements that are required for a functioning and efficient international monetary system. It is suggested that Keynes’ view are still very much relevant today if the world is to move from the present non-system of international monetary arrangements to a system where currencies would no longer be perceived as net assets and countries would no longer be grouped as key and non-key currency countries.
    Keywords: Monetary System; Bank Money; Absolute Exchange Rate
    JEL: F33
    Date: 2009–11–07
  2. By: Mokhtar Darmoul (Centre d'Economie de la Sorbonne); Mokhtar Kouki (LEGI-Ecole Polytechnique de Tunis)
    Abstract: In this article, we examine the announcement effect of news relating to the monetary policies of the ECB and the FED and resulting from the official meetings of the Council of the governors and the FOMC on intraday volatility of the foreign exchange rate euro-dollar at five minutes of intervals. The results show that the news of the monetary policy of the ECB relative to its Target interest rates are more significant and more influential on the level of intraday volatility than those of the monetary policy of the FED relative to its federal funds rate. In spite of the reduced number of these news, their effect appears statistically significant during the years of the sample of foreign exchange rate euro-dollar selected. We also introduced a polynomial structure which enables us to take into account the short-run response patterns and to highlight a possible dissymmetry in the effect of each variable of signal on the volatility of foreign exchange rate euro-dollar.
    Keywords: Announcement effect, forex, news, exchange rate.
    JEL: C15 E44 F31 G14
    Date: 2009–08
  3. By: John C. Williams
    Abstract: This paper reexamines the implications of the zero lower bound on interest rates for monetary policy and the optimal choice of steady-state inflation in light of the experience of the recent global recession. There are two main findings. First, the zero lower bound did not materially contribute to the sharp declines in output in the United States and many other economies through the end of 2008, but it is a significant factor slowing recovery. Model simulations imply that an additional 4 percentage points of rate cuts would have kept the unemployment rate from rising as much as it has and would bring the unemployment and inflation rates more quickly to steady-state values, but the zero bound precludes these actions. This inability to lower interest rates comes at the cost of $1.7 trillion of foregone output over four years. Second, if recent events are a harbinger of a significantly more adverse macroeconomic climate than experienced over the preceding two decades, then a 2 percent steady-state inflation rate may provide an inadequate buffer to keep the zero bound from having noticeable deleterious effects on the macroeconomy assuming the central bank follows the standard Taylor Rule. In such an adverse environment, stronger systematic countercyclical fiscal policy and/or alternative monetary policy strategies can mitigate the harmful effects of the zero bound with a 2 percent inflation target. However, even with such policies, an inflation target of 1 percent or lower could entail significant costs in terms of macroeconomic volatility.
    Keywords: Monetary policy ; Fiscal policy ; Liquidity (Economics)
    Date: 2009
  4. By: Lucy Qian Liu (International Monetary Fund, Wash D.C.); Liang Wang (Department of Economics, University of Pennsylvania); Randall Wright (Department of Economics, University of Wisconsin-Madison)
    Abstract: Conventional wisdom is that inflation makes people spend money faster, trying to get rid of it like a “hot potato,” and this is a channel through which inflation affects velocity and welfare. Monetary theory with endoge- nous search intensity seems ideal for studying this. However, in standard models, inflation is a tax that lowers the surplus from monetary exchange and hence reduces search effort. We replace search intensity with a free entry (participation) decision for buyers - i.e., we focus on the extensive rather than intensive margin - and prove buyers always spend their money faster when inflation increases. We also discuss welfare.
    Keywords: Search, Money, Inflation, Velocity, Free Entry
    JEL: E40 E50 E31
    Date: 2009–11–04
  5. By: McKibbin, Warwick J. (Australian National University); Chanthapun, Waranya Pim (Australian National University)
    Abstract: Rising economic integration in Asia and periodic volatility in global and national financial markets raise the issue of the optimal degree and form of monetary cooperation among Asian economies. There is a large literature on the benefits and costs of monetary cooperation, however, less can be found with a specific focus on Asia. A number of studies have explored whether Asia might form an optimal currency area, although these have focused on the nature of shocks, in particular business cycle correlations, as well as the extent of trade linkages among economies. Less has been done on the impact of portfolio shifts and financial shocks, and how these shocks impact on financial cooperation. <p> This paper has two goals. The first is to explore the impacts of the current global financial crisis on Asian economies under existing monetary and exchange rate arrangements. The second is to explore how alternative forms of cooperation and exchange rate regimes might change the economic outcomes in Asia. In particular, the paper explores the impact of current regimes compared to one of three hypothetical regimes: (i) all countries peg to the US dollar, (ii) all Asian economies are in an Asian Currency Union with an Asian Central Bank setting policy, or (iii) floating exchange rates with each central bank in Asia independently choosing optimal time-consistent, close-loop policy rules to target a loss function consisting of deviation in inflation and output growth from desired levels.
    Keywords: Monetary cooperation; exchange rates; financial crisis
    JEL: E27 E42 E44 E52 E58 F41 F42
    Date: 2009–10–01
  6. By: Ignazio Angeloni; Ester Faia
    Abstract: We introduce banks, modeled as in Diamond and Rajan (JoF 2000 or JPE 2001), into a standard DSGE model and use this framework to study the role of banks in the transmission of shocks, the effects of monetary policy when banks are exposed to runs, and the interplay between monetary policy and Basel-like capital ratios. In equilibrium, bank leverage depends positively on the uncertainty of projects and on the bank’s "relationship lender" skills, and negatively on short term interest rates. A monetary restriction reduces leverage, while a productivity or asset price boom increases it. Procyclical capital ratios are destabilising; monetary policy can only partly offset this effect. The best policy combination includes mildly anticyclical capital ratios and a response of monetary policy to asset prices or leverage
    Keywords: capital requirements, leverage, bank runs, combination policy, market liquidity
    Date: 2009–10
  7. By: Elisa Newby
    Abstract: This paper models the gold standard as a state contingent commitment technology that is only feasible during peace. Monetary policy during war, when the gold convertibility rule suspended, can still be credible, if the policy maker’s plan is to resume the gold standard in the future. The DGE model developed in this paper suggests that the resumption of the gold standard was a sustainable plan, which replaced the gold standard as a commitment technology and made monetary policy time consistent. Trigger strategies support the equilibrium: private agents retaliate if a policy maker defaults its plan to resume the gold standard.
    Keywords: Time Consistency, Monetary Policy, Monetary Regimes.
    JEL: C61 E31 E4 E5 N13
    Date: 2009–06
  8. By: Jamie Hall (Reserve Bank of Australia); Jarkko Jääskelä (Reserve Bank of Australia)
    Abstract: This paper examines the statistical properties of inflation in a sample of inflation-targeting and non-inflation-targeting countries. First, it analyses the time-varying volatility of a measure of the persistent component of inflation. Based on this measure, inflation-targeting countries (Australia, Canada, New Zealand, Sweden and the United Kingdom) have experienced a relatively more pronounced fall in the volatility of inflation than non-inflation-targeting countries (Austria, France, Germany, Japan and the United States). But it is hard to say whether inflation is more volatile in inflation-targeting or non-inflation-targeting countries. Second, it analyses whether inflation became easier to forecast after the introduction of inflation targeting. It finds that inflation became easier to forecast in both inflation-targeting and non-inflation-targeting countries; the improvement was greater for the former group but forecast errors remain smaller for the latter group.
    Keywords: inflation; time series econometrics
    JEL: C53 E37
    Date: 2009–10
  9. By: Stéphane Auray (Université Lille 3 (GREMARS), Université de Sherbrooke (GREDI) and CIRPÉE); Paul Gomme (Concordia University, CIREQ); Shen Guo (China Academy of Public Finance and Public Policy, Central University of Finance and Economics, Beijing, China)
    Abstract: A chief goal of the Pigou cycle literature is to generate a boom in response to news of a future increase in productivity, and a bust if this improvement does not in fact take place. We nd that monetary policy can generate Pigou cycles in a two sector model with durables and non-durables, and nominal price rigidities { even when the Ramsey-optimal policy displays no such cycles. Estimated interest rate rules are a good t to data simulated under the Ramsey policy, implying that policymakers could come close to replicating the Ramsey-optimal policy.
    Keywords: Pigou cycles; monetary policy
    JEL: E3 E4 E5
    Date: 2009–09–01
  10. By: Ansgar Belke; Walter Orth; Ralph Setzer
    Abstract: Global liquidity expansion has been very dynamic since 2001. Contrary to conventional wisdom, high money growth rates have not coincided with a concurrent rise in goods prices. At the same time, however, asset prices have increased sharply, significantly outpacing the subdued development in consumer prices. We investigate the interactions between money and goods and asset prices at the global level. Using aggregated data for major OECD countries, our VAR results support the view that different price elasticities on asset and goods markets explain the observed relative price change between asset classes and consumer goods.
    Keywords: Global liquidity, inflation control, monetary policy transmission, asset prices
    JEL: E31 E52 F01 F42
    Date: 2009
  11. By: Campbell Leith; Ioana Moldovan; Raffaele Rossi
    Abstract: Recent work on optimal policy in sticky price models suggests that demand management through fiscal policy adds little to optimal monetary policy. We explore this consensus assignment in an economy subject to ‘deep’ habits at the level of individual goods where the counter-cyclicality of mark-ups this implies can result in government spending crowding-in private consumption in the short run. We explore the robustness of this mechanism to the existence of price discrimination in the supply of goods to the public and private sectors. We then describe optimal monetary and fiscal policy in our New Keynesian economy subject to the additional externality of deep habits and explore the ability of simple (but potentially non¬linear) policy rules to mimic fully optimal policy.
    Keywords: Monetary Policy, Fiscal Policy, Deep Habits, New Keynesian.
    JEL: E21 E63 E61
    Date: 2009–09
  12. By: Weshah Razzak
    Abstract: Essentially, the impact of the currency union on member countries depends on whether the common currency area is optimal in the sense that the effect of the asymmetric shocks is small, Mundell (1961). Typically, researchers use VAR of different types to analyze the data. For robustness, we use different methodologies. First, we use different estimators to estimate a small textbook model for the panel of the Gulf Cooperation Council countries (GCC) from 1970 to 2006, where the short-run equilibrium real output and the real exchange rate are determined by the intersection of the assets and goods markets equilibrium schedules. And the central bank fixes the exchange rate by keeping the money supply at a level where the domestic interest rate is equal to the foreign interest rate. Then we test for symmetry using the nonparametric Triples test, Randles et al. (1980). Third, we introduce a nonparametric multivariate statistic to test whether the variances of the shocks (the conditional variance) are equal across countries.
    Keywords: Optimum Currency Area, asymmetrical shocks and conditional variance
    JEL: F31 P28 C13 C33
    Date: 2009–02–11
  13. By: Christoph Himmels; Tatiana Kirsanova
    Abstract: We study a credible Markov-perfect monetary policy in an open New Keynesian economy with incomplete finacial markets. We demonstrate the existence of two discretionary equilibria. Following a shock the economy can be stabilised either 'quickly' or 'slow', both dynamic paths satisfy conditions of optimality and time-consistency. The model can help us to understand sudden change of the interest rate and exchange rate volatility in 'tranquil' and 'volatile' regimes even under a fully credible 'soft peg' of the nominal exchange rate in developing countries.
    Keywords: Small Open Economy, Incomplete Financial Markets, Discretionary Monetary Policy, Multiple Equilibria.
    JEL: E31 E52 E58 E61 C61 F4
    Date: 2009–08
  14. By: John Weeks
    Abstract: <p>In this PERI Working Paper, John Weeks inspects the standard policy rule that under a flexible exchange rate regime with perfectly elastic capital flows, monetary policy is effective, and fiscal policy is not. The logical validity of the statement requires that the effect of an exchange rate change on the domestic price level be ignored. The price level effect is noted in some textbooks, but not formally analyzed. When it is subjected to a rigorous analysis, the interaction between changes in the exchange rate and the domestic price level significantly alters the standard policy rule.</p> According to Weeks, the more accurate statement would be: under a flexible exchange rate regime with perfectly elastic capital flows <i>the effectiveness of monetary policy depends on the values of the import share and the sum of the trade elasticities.</i> Inspection of data from developing countries indicates the effectiveness of monetary policy under flexible exchange rates can be quite low, even if capital flows are perfectly elastic.   
    Date: 2009
  15. By: Jane D'Arista
    Abstract: The monetary policy that culminated in the current crisis and the failure of the Federal Reserve’s efforts to end the credit freeze in 2008 are critical components of the analysis needed as a backdrop for reform. This working paper argues that the link between excess liquidity, the buildup in debt, the asset bubbles that debt created and the financial crisis that followed are outcomes of monetary as well as regulatory policy failures; that they reflect a substantial weakening in the Fed’s ability to implement countercyclical initiatives. D'Arista argues that the effectiveness of monetary policy can, and must, be restored. She proposes a new system of reserve management that assesses reserves against assets rather than deposits and applies reserve requirements to all segments of the financial sector. She concludes that a change in the current system for implementing monetary policy is needed to end the credit crunch, address the impact of the current crisis on the financial sector and the economy and ensure the success of any fiscal stimulus that will be undertaken.
    Keywords: Federal Reserve System, monetary policy, reserve requirements, financial crisis.
    Date: 2009
  16. By: Olivier Musy; Mohamed Safouane Ben Aïssa
    Abstract: This paper presents a classification of the different new Phillips curves existing in the literature as a set of choices based on three assumptions: the choice of the structure of price adjustments (Calvo or Taylor), the presence of backward indexation, and the type of price contracts (fixed prices or predetermined prices). The paper suggests study of the dynamic properties of each specification, following different monetary shocks on the growth rate of the money stock. We develop the analytical form of the price dynamics, and we display graphics for the responses of prices, output, and inflation. We show that the choice made for each of the three assumptions has a strong influence on the dynamic properties. Notably, the choice of the price structure, while often considered as unimportant, is indeed the most influential choice concerning the dynamic responses of output and inflation.
    Keywords: New Keynesian Phillips Curves, Taylor Price Rule, Calvo Price Rule, Fixed Prices, Predetermined Prices, Disinflation policy.
    JEL: E31 E52
    Date: 2009
  17. By: Jean-Luc Vila; Dimitri Vayanos
    Abstract: We model the term structure of interest rates as resulting from the interaction between investor clienteles with preferences for specific maturities and risk-averse arbitrageurs. Because arbitrageurs are risk averse, shocks to clienteles’ demand for bonds affect the term structure and constitute an additional determinant of bond prices to current and expected future short rates. At the same time, because arbitrageurs render the term structure arbitrage-free, demand effects satisfy no-arbitrage restrictions and can be quite different from the underlying shocks. We show that the preferred-habitat view of the term structure generates a rich set of implications for bond risk premia, the effects of demand shocks and of shocks to short-rate expectations, the economic role of carry trades, and the transmission of monetary policy.
    Date: 2009–11
  18. By: Raffaele Rossi
    Abstract: This paper develops a small New Keynesian model augmented with a steady state level of public debt and a share of rule-of-thumb consumers (ROTC henceforth) as in Gali' et al. (2004; 2007). The paper focuses on the consequences for the design of monetary and fiscal rules, of the bifurcation generated by the presence of ROTC on the demand side of the economy, in the absence of Ricardian equivalence. We find that, when fiscal policy follows a balanced budget rule, the amount of ROTC determines whether an active and/or a passive monetary policy in the sense of Leeper (1991) guarantees determinacy. When short run public debt assets are introduced, the amount of ROTC determines whether equilibrium determinacy requires a mix of active (passive) monetary policy and a passive (active) fiscal policy or a mix where policies are both active or passive. This set of equilibria has the potential to explain the empirical evidence on the U.S. postwar data on monetary and fiscal policy interactions.
    Keywords: Rule-of-thumb consumers, monetary-?scal iteractions, balanced budget rule, Taylor principle, active-passive policy mix
    JEL: E32 E62 H30
    Date: 2009–11
  19. By: Graciela Kaminsky; Amine Mati; Nada Choueiri
    Abstract: This paper examines Argentina’s currency crises from 1970 to 2001, with particular attention to the role of domestic and external factors. Using VAR estimations, we find that deteriorating domestic fundamentals matter. For example, at the core of the late 1980s crises was excessively loose monetary policy while a sharp output contration triggered the collapse of the currency board in January 2002. In contrast, adverse external shocks were at the heart of the 1995 crisis, with spillovers from the Mexican crisis and high world interest rates being key sources of financial distress.
    JEL: F3 F30 F32 F34
    Date: 2009–11
  20. By: Sebastiano Daros; Neil Rankin
    Abstract: We analytically examine output persistence from monetary shocks in a DSGE model with staggered prices or wages under a Taylor Rule for monetary policy. The best known such model assumes Calvo-style staggering of prices and flexible wages and is known to yield no persistence under a Taylor Rule. Switching to Taylor-style staggering introduces lagged output into the model’s ‘New Keynesian Phillips Curve’ equation. Despite this, we show it generates no persistence, whether staggering is in wages or prices. Surprisingly, however, Calvo-style staggering of wages does generate persistence, if there are decreasing returns to labour.
    Keywords: Output Persistence, Staggered Prices/Wages, Taylor Rule.
    JEL: E32 E52
    Date: 2009–05
  21. By: Gary Koop (Department of Economics, University of Strathclyde and RCEA); Dimitris Korobilis (Department of Economics, University of Strathclyde and RCEA)
    Abstract: There is a large literature on forecasting inflation using the generalized Phillips curve (i.e. using forecasting models where inflation depends on past inflation, the unemployment rate and other predictors). The present paper extends this literature through the use of econometric methods which incorporate dynamic model averaging. These not only allow for coefficients to change over time (i.e. the marginal effect of a predictor for inflation can change), but also allows for the entire forecasting model to change over time (i.e. different sets of predictors can be relevant at different points in time). In an empirical exercise involving quarterly US inflation, we fi…nd that dynamic model averaging leads to substantial forecasting improvements over simple benchmark approaches (e.g. random walk or recursive OLS forecasts) and more sophisticated approaches such as those using time varying coefficient models.
    Keywords: Option Pricing; Modular Neural Networks; Non-parametric Methods
    JEL: E31 E37 C11 C53
    Date: 2009–01
  22. By: Michaela Krčílková (Czech University of Life Sciences Prague,Faculty of Economics and Management); Jan Zápal (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic; London School of Economics and Political Science)
    Abstract: This paper intends to fill two gaps in the Optimal Currency Area literature. First of all, Mundell's original idea has very little formalmodel theoretical underpinning. Second, it almost exclusively views countries contemplating monetary unification as single economies. We question this view and expand the model to incorporate the division of an economy into three sectors. In the empirical part of the paper, we follow recent OCA empirici literature and investigate the correlation of shocks between the individual new EU member countries and the `EU-core'. Treating the whole economy as one sector this is a standard exercise. However, since the three-sector version of our model provides a natural metric on which to assess the appropriateness of unification, we are able to repeat the exercise treating each country's economy as a collection of three distinct sectors. In the paper we test for the different reactions of stock markets to the current financial crisis. We focus on Central European stock markets, namely the Czech, Polish and Hungarian ones, and compare them to the German and U.S. benchmark stock markets. Using wavelet analysis, we decompose a time series into frequency components called scales and measure their energy contribution. The energy of a scale is proportional to its wavelet variance. The decompositions of the tested stock markets show changes in the energies on the scales during the current financial crisis. The results indicate that each of the tested stock markets reacted differently to the current financial crisis. More important, Central European stock markets seem to have strongly different behaviour during the crisis.
    Keywords: OCA, supply and demand shocks, VAR decomposition, new EU member states
    JEL: E32 F15 F40
    Date: 2009–10

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