nep-mon New Economics Papers
on Monetary Economics
Issue of 2009‒12‒11
twenty-one papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Monetary Policy in a Currency Union with Heterogeneous Limited Asset Markets Participation By Fabian Eser
  2. The evolving role and definition of the federal funds rate in the conduct of U.S. monetary policy By Belongia, Michael; Hinich, Melvin
  3. Evaluating Monetary Policy By Svensson, Lars E.O.
  4. Do Central Bank Independence Reforms Matter for Inflation Performance? By Landström, Mats
  5. Monetary policy, inflation expectations and the price puzzle By Castelnuovo, Efrem; Surico, Paolo
  6. The role of income in money demand during hyper-inflation: the case of Yugoslavia By Zorica Mladenovic; Bent Nielsen
  7. Quantitative Easing: A Rationale and Some Evidence from Japan By Volker Wieland
  8. The quality of monetary policy and inflation performance: globalization and its aftermath By Bohl , Martin T; Mayes , David G; Siklos, Pierre L
  9. Nonlinearities in the Real Exchange Rate and Monetary Policy: Interest Rate Rules Reconsidered By Konstantinos D. Mavromatis
  10. DEVOLUTION OF THE FISHER EQUATION: Rational Appreciation to Money Illusion By James R. Rhodes
  11. Does inflation targeting really matter? Another look at the OECD economies By Brito, Ricardo D.
  12. Advantages of Fixed Exchange Rate Regime from a General Equilibrium Perspective By Viktors Ajevskis; Kristine Vitola
  13. Reforming the Fed: what would real change look like? By Belongia, Michael
  14. Two Essays on Central Bank Independence Reforms By Landström, Mats
  15. Why the Publication of Socially Harmful Information May Be Socially Desirable By Volker Hahn
  16. ‘History of the Official Currency and the Central Bank of Cyprus’ Preliminary Conclusions for the Period 1960-2007 By Sophocles Michaelides
  17. Coping With Uncertainty: Historical and Real-Time Estimates Of The Natural Unemployment Rate and The Uk Monetary Policy By George Chouliarakis
  18. "The Euro and Its Guardian of Stability--The Fiction and Reality of the 10th Anniversary Blast" By Joerg Bibow
  19. Provision of Liquidity through the Primary Credit Facility during the Financial Crisis: A Structural Analysis By Erhan Artuç; Selva Demiralp
  20. A Banking Explanation of the US Velocity of Money: 1919-2004 By Szilard Benk; Max Gillman; Michal Kejak
  21. The Difficulties of the Chinese and Indian Exchange Rate Regimes By Ila Patnaik

  1. By: Fabian Eser (Nuffield College, Oxford University, Oxford.)
    Abstract: This paper examines monetary policy in a currency union whose member countries exhibit heterogeneous rates of limited asset markets participation (LAMP). As a result risk sharing among member countries is imperfect and the monetary transmission mechanism can differ across countries. In the limit the elasticity of output to the union-wide nominal interest rate can be of opposite sign in different countries. I develop a tractable model in which the dispersion of asset markets participation (AMP) becomes a key parameter. While monetary policy can guarantee determinacy by following an active or passive rule depending on the sign of the interest-elasticity of output, ignoring dispersion can lead to incorrect computation of the sign and the size of the latter. Taking the heterogeneity into account is thus central for sound policy Furthermore, due to the failure of risk sharing, determinacy for union-aggregates does not guarantee determinacy in every member country. However, the more open a country is in trade terms, the greater the rate of LAMP for which the country still displays equilibrium determinacy. For complete openness, determinacy is guaranteed. This underlines the importance of risk sharing and trade integration for the functioning of a currency union. Considering the optimal union-wide targeting rule, a higher mean and dispersion of LAMP increase the desired inflation volatility and decrease the desired output volatility. The implied optimal Taylor rule shows that subject to the Taylor principle, the higher are mean and dispersion of LAMP, the softer should be the response of the nominal interest rate to expected inflation.
    Keywords: Monetary Union, Limited Asset Markets Participation, Heterogeneity, (Optimal) Monetary Policy, Real (In)determinacy, Sticky Prices
    JEL: E52 F41 E44
    Date: 2009–11–19
  2. By: Belongia, Michael; Hinich, Melvin
    Abstract: Over the past twenty years, the federal funds rate has evolved from being an intermediate target or indicator variable in discussions of monetary policy to the Federal Reserve’s (exogenous) policy instrument. How the funds rate is characterized has important implications for modeling, particularly in settings such as the popular Taylor Rule. Crucially, however, little investigation has been done to examine whether the funds rate meets the conditions one would require for an instrument of policy. This paper offers empirical evidence on the relationships among the federal funds rate, variables that might influence its behavior and variables of interest to monetary policy.
    Keywords: federal funds rate; monetary policy; causality tests; reserves
    JEL: E43 E58 E52
    Date: 2009–04
  3. By: Svensson, Lars E.O. (Executive Board)
    Abstract: Evaluating inflation-targeting monetary policy is more complicated than checking whether inflation has been on target, because inflation control is imperfect and flexible inflation targeting means that deviations from target may be deliberate in order to stabilize the real economy. A modified Taylor curve, the forecast Taylor curve, showing the tradeoff between the variability of the inflation-gap and output-gap forecasts can be used to evaluate policy ex ante, that is, taking into account the information available at the time of the policy decisions, and even evaluate policy in real time. In particular, by plotting mean squared gaps of inflation and output-gap forecasts for alternative policy rate paths, it may be examined whether policy has achieved an efficient stabilization of both inflation and the real economy and what relative weight on the stability of inflation and the real economy has effectively been applied. Ex ante evaluation may be more relevant than evaluation ex post, after the fact. Publication of the interest-rate path also allows the evaluation of its credibility and the effectiveness of the implementation of monetary policy.
    Keywords: Monetary policy evaluation; forecast Taylor curve; mean squared gaps
    JEL: E52 E58
    Date: 2009–10–01
  4. By: Landström, Mats (Department of Economics, Umeå University)
    Abstract: A difference-in-difference approach was used to investigate whether Central Bank Indepencence (CBI) reforms matter for inflation, based on a novel data set including the possible occurence of such reforms in 132 countries during the period 1980-2003. CBI-reforms are found to have contributed to bringing down high inflation rates where those existed, but they seem unrelated to performance in low-inflation countries.
    Keywords: Monetary policy; institutional reforms; central banking; price stability; political economy; delegation
    JEL: E52 E58
    Date: 2009–11–27
  5. By: Castelnuovo, Efrem (University of Padua); Surico, Paolo (London Business School)
    Abstract: This paper re-examines the VAR evidence on the price puzzle and proposes a new theoretical interpretation. Using actual data and two identification strategies based on zero restrictions and model-consistent sign restrictions, we find that the positive response of prices to a monetary policy shock is historically limited to the sub-samples that are typically associated with a weak interest rate response to inflation. Using pseudo data generated by a sticky price model of the US economy, we then show that the structural VARs are capable of reproducing the price puzzle only when monetary policy is passive. The omission in the VARs of a variable capturing expected inflation is found to account for the price puzzle observed in simulated and actual data.
    Keywords: SVARs; price puzzle; sticky price model; Taylor principle; passive policy
    JEL: E30 E52
    Date: 2009–11–08
  6. By: Zorica Mladenovic (Faculty of Economics, University of Belgrade); Bent Nielsen (Department of Economics, University of Oxford)
    Abstract: During extreme hyper-inflations productivity tends to fall dramatically. Yet, in models of money demand in hyper-inflation variables such as real income has been given a somewhat passive role, either assuming it exogenous or to have a negligible role. In this paper we use an empirical methodology based on cointegrated vector autoregressions to analyse data from the extreme Yugoslavian episode to investigate the role of income. The analysis suggests that even in extreme hyper-inflation the monetary variables and real income are simultaneously determined. The methodology enables a description of the short term adjustment of the variables considered.
    Keywords: Cointegration, hyper-inflation, income, money-demand
    Date: 2009–03–27
  7. By: Volker Wieland
    Abstract: This paper reviews the rationale for quantitative easing when central bank policy rates reach near zero levels in light of recent announcements regarding direct asset purchases by the Bank of England, the Bank of Japan, the U.S. Federal Reserve and the European Central Bank. Empirical evidence from the previous period of quantitative easing in Japan between 2001 and 2006 is presented. During this earlier period the Bank of Japan was able to expand the monetary base very quickly and significantly. Quantitative easing translated into a greater and more lasting expansion of M1 relative to nominal GDP. Deflation subsided by 2005. As soon as inflation appeared to stabilize near a rate of zero, the Bank of Japan rapidly reduced the monetary base as a share of nominal income as it had announced in 2001. The Bank was able to exit from extensive quantitative easing within less than a year. Some implications for the current situation in Europe and the United States are discussed.
    JEL: E31 E52 E58 E61
    Date: 2009–12
  8. By: Bohl , Martin T (Westfälische-Wilhelms Universität); Mayes , David G (University of Auckland); Siklos, Pierre L (Wilfrid Laurier University, Viessmann European Research Centre, Waterloo, ON, Canada. Freie Universität, Berlin, Germany. Centre for International Governance Innovation (CIGI))
    Abstract: With a few unfortunate exceptions the last three decades have seen reductions in inflation around the world to the point that many would argue that further improvements in price stability would offer only limited welfare gains. This experience is the result of many factors, some of which are country-specific. In this paper we seek to isolate one of the factors, namely, the improvement in the quality of monetary policy. There are two novel aspects to the study. Firstly, we essentially estimate a gravity-like model. Secondly, we propose generally a more exhaustive analysis of the potential role of a large number of institutional factors than has been done before. Briefly, we find that institutional factors play a role in explaining inflation relative to the US experience, which is used as the benchmark. Nevertheless, any reduction in inflation stemming from greater central bank autonomy is a feature of the 1980s and early 1990s. Thereafter, central banks in the OECD look very much alike.
    Keywords: globalization; inflation differentials; monetary policy strategy; institutional change
    JEL: C33 E42 E58
    Date: 2009–11–09
  9. By: Konstantinos D. Mavromatis (University of Warwick)
    Abstract: Empirical research during the last ten years has found significant evidence in favour of a nonlinear-threshold type behaviour of the real exchange rate. Interest rate rules which include the exchange rate appear to have either an insignificant effect on or generate small coefficients for the real exchange rate. However, the empirical studies do not take into account the nonlinear behaviour of the exchange rate. The inclusion of nonlinearities in the real exchange rate could imply nonlinear behaviour in the interest rate rule, whenever the exchange rate is included. We use a two-country sticky price model to show that nonlinear Taylor-type rules where the exchange rate is included lead to lower variation in output and inflation.
    Keywords: Taylor rules, real exchange rate, nonlinearities
    JEL: E52 F41 F42
    Date: 2009–10
  10. By: James R. Rhodes (National Graduate Institute for Policy Studies)
    Abstract: In Appreciation and Interest Irving Fisher (1896) derived an equation connecting interest rates in any two standards of value. The original Fisher equation (OFE) was expressed in terms of the expected appreciation of money [percent change in E(1/P)] whereas the ubiquitous conventional Fisher equation (CFE) uses expected goods inflation [percent change in E(P)]. Since Jensen?s inequality implies the non-equivalence of the two equations, the OFE is not subject to standard criticisms of non-rationality leveled against the CFE. The puzzling substitution of inflation for expected money appreciation in Fisher (1930) is resolved by taking into account Fisher's theory of “money illusion.”
    Keywords: Fisher equation, Fisher hypothesis, Fisher effect, money illusion, nominal interest rate, purchasing power of money, value of money.
    JEL: E40 B00 B31
    Date: 2006–06
  11. By: Brito, Ricardo D.
    Date: 2009–10
  12. By: Viktors Ajevskis; Kristine Vitola
    Abstract: In this paper we estimate a small open economy DSGE model for Latvia following Lubik and Schorfheide (2007) using Bayesian methods. The estimates of the structural parameters fall within plausible ranges. Simulation results suggest that under inflation targeting inflation turns out to be more volatile than under the peg in the case of Latvia. Additional concern for output stabilisation accounts for lower inflation variability while it is still higher than under existing exchange rate regime with ±1% fluctuation bands. The model results therefore support the existing exchange rate policy.
    Keywords: DSGE, small open economy, exchange rate policy, Bayesian estimation
    JEL: C11 C3 C51 D58 E58 F41
    Date: 2009–11–25
  13. By: Belongia, Michael
    Abstract: The Federal Reserve has responsibilities in three functional areas: Bank supervision and regulation, monetary policy, and services to the payments system. Although much has changed in each of these areas since the Fed was founded nearly one hundred years ago, the Federal Reserve System has changed relatively little. This paper reviews the Fed's operations and structure and suggests reforms that are coherent with its mission and the current state of the financial system.
    Keywords: Federal Reserve; monetary policy;
    JEL: E58 E50
    Date: 2009–11
  14. By: Landström, Mats (Department of Economics, Umeå University)
    Abstract: This thesis consists of two empirically oriented papers on Central Bank Independence (CBI) Reforms. Paper [1] is an investigation of why politicians around the world have chosen to give up power to independent central banks, thereby reducing their ability to control the economy. A new data-set covering 132 countries, of which 89 had implemented CBI reforms during 1980-2005, was collected. Politicians in non-OECD countries were more likely to delegate power to independent central banks if their country had been characterized by high variability in inflation and if they faced a high probability of being replaced. No such effects were found for OECD countries. Paper [2], using a difference-in-difference approach, studies whether CBI reform matters for inflation performance. The analysis is based on a dataset including the possible occurence of CBI reforms in 132 countries during the period 1980-2005. CBI reform is found to have contributed to bringing down inflation in high-inflation countries, but it seems unrelated to inflation performance in low-inflation countries.
    Keywords: Monetary policy; institutional reform; central banking; price stability; political economy; delegation; institutional economics; inflation; time-inconsistency; accountability
    JEL: E52 E58 P48
    Date: 2009–11–27
  15. By: Volker Hahn (CER-ETH - Center of Economic Research at ETH Zurich, Switzerland)
    Abstract: We propose a signaling model in which the central bank and firms receive information on cost-push shocks independently from each other. If the firms’ signals are rather unlikely to be informative, central banks should remain silent about their own private signals. If, however, firms are sufficiently likely to be informed, it is socially desirable for the central bank to reveal its private information. By doing so, the central bank eliminates the distortions stemming from the signaling incentives under opacity. Our model may also explain the recent trend towards more transparency in monetary policy.
    Keywords: signaling games, transparency, monetary policy, central banks, communication
    JEL: D82 D83 E58
    Date: 2009–11
  16. By: Sophocles Michaelides (Central Bank of Cyprus)
    Abstract: The period 1960 to 2007 – when the Cyprus pound was legal tender – is examined with a view to relating the major turning points of exchange, fiscal and monetary policies to their likely causes and consequences. Assumptions are made and conclusions are drawn regarding: the four periods of exchange rate policy (1960-1972, 1972-1992, 1992-1999, 1999-2007); the three phases of bank claims on the government sector (1960-1966, 1966-1975, 1975-2007); the five swings of bank credit to the private sector (1960-1965, 1965-1975, 1975-1984, 1984-2007); the five oscillations of the banking system’s foreign assets (1960-1971, 1971-1980, 1980-1989, 1989-1998, 1998-2007); the parallel tracks of GDP, CPI and the average annual salary during the 47 years under review. The above methodology is applied to the analysis and synthesis of the monetary and credit history of Cyprus between 1878 and 2007.
    Keywords: Economic history, business cycle, exchange rate, fiscal policy, private credit, price index, wage adjustment
    JEL: E3 E4 E5 N1
    Date: 2009–09
  17. By: George Chouliarakis
    Abstract: The paper derives and compares historical and real-time estimates of the UK natural unemployment rate and shows that real-time estimates are fraught with noise and should be treated with scepticism. A counterfactual exercise shows that, for most of the 1990s, the Bank of England tracked changes in the natural rate relatively successfully, albeit with some recognition lag which, at times, might have led to excessively cautious policy. A careful scrutiny of the minutes of the monetary policy committee meetings reveals that such ‘cautiousness’ should be taken as evidence of awareness of the real-time informational limitations that monetary policy is facing.
    Date: 2009
  18. By: Joerg Bibow
    Abstract: This paper investigates why Europe fared particularly poorly in the global economic crisis that began in August 2007. It questions the self-portrait of Europe as the victim of external shocks, pushed off track by reckless policies pursued elsewhere. It argues instead that Europe had not only contributed handsomely to the buildup of global imbalances since the 1990s and experienced their implosive unwinding as an internal crisis from the beginning, but that it had also nourished its own homemade intra-Euroland and intra-EU imbalances, the simultaneous implosion of which has further aggravated Europe's predicament. To keep its own house in order in the future, Euroland must shun the outdated "stability oriented" policy wisdom inherited from Germany's mercantilist past and Bundesbank mythology. Steps toward a fiscal union to back the euro are also warranted.
    Keywords: Economic and Monetary Union; Euro; European Central Bank; Global Imbalances; Global Crisis; Intra-area Imbalances; Competitiveness Positions; Policy Coordination; Tax-push Inflation; Financial Supervision; Mercantilism
    JEL: E30 E42 E52 E58 E61 E63 E65 F36
    Date: 2009–12
  19. By: Erhan Artuç (Koc University); Selva Demiralp
    Abstract: Over the course of the recent liquidity crisis, the Federal Reserve made several changes to its primary credit lending facility such as narrowing the spread between the primary credit rate and the target funds rate and increasing the term of the borrowing. In this paper, we use the model developed by Artuç and Demiralp (2008) to provide a structural assessment of the effectiveness of these changes. Our results suggest that these changes were effective in stabilizing the federal funds market.
    Keywords: Discount Window, Primary Credit, Federal Funds Market
    JEL: E40 E58
    Date: 2009–12
  20. By: Szilard Benk (Hungarian Central Bank); Max Gillman (Institute of Economics - Hungarian Academy of Sciences); Michal Kejak (The Center for Economic Research and Graduate Education of Charles University (CERGE EI))
    Abstract: The paper shows that US GDP velocity of M1 money has exhibited long cycles around a 1.25% per year upward trend, during the 1919-2004 period. It explains the velocity cycles through shocks constructed from a DSGE model and annual time series data (Ingram et al., 1994). Model velocity is stable along the balanced growth path, which features endogenous growth and decentralized banking that produces exchange credit. Positive shocks to credit productivity and money supply increase velocity, as money demand falls, while a positive goods productivity shock raises temporary output and velocity. The paper explains such velocity volatility at both business cycle and long run frequencies. With filtered velocity turning negative, starting during the 1930s and the 1987 crashes, and again around 2003, results suggest that the money and credit shocks appear to be more important for velocity during less stable times and the goods productivity shock more important during stable times.
    Keywords: business cycle, credit shocks, velocity and volatility
    JEL: E13 E32 E44
    Date: 2009–11
  21. By: Ila Patnaik
    Abstract: China and India have both attempted distorting the exchange rate in order to foster exports-led growth. This is described as the Bretton Woods II framework, where developing countries buy bonds in the US and keep undervalued exchange rates, in order to foster export-led growth. The costs and benefits of this approach need to factor in the extent to which monetary policy is distorted by the pursuit of exchange rate policy. In this paper, dates of structural change are identified, and the characteristics of the de facto exchange rate regime, for both countries are examined. These results utilise recent developments in the econometrics of structural change. Business cycle conditions and the short-term rate (expressed in real terms) in both India and China are also examined. [NIPFP WP No 2009-62].
    Keywords: GDP, RBI, indian, exports, china, India, exchange rte, bretton woods, US, monetary policy, developing countries, de facto, business cycle,
    Date: 2009

This nep-mon issue is ©2009 by Bernd Hayo. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.