nep-mon New Economics Papers
on Monetary Economics
Issue of 2010‒06‒18
fourteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. The Monetary Pillar and the Great Financial Crisis By Jordi Galí
  2. Price Bargaining, the Persistence Puzzle, and Monetary Policy By Dennis Wesselbaum
  3. On the Sources of Euro Area Money Demand Stability. A Time-Varying Cointegration Analysis By Matteo Barigozzi; Antonio Conti
  4. Monetary and Fiscal Policies in Bulgaria: Lessons from the Historical Record By Kalina Dimitrova
  5. Financial Stress, Monetary Policy, and Economic Activity By Fuchun Li; Pierre St-Amant
  6. Money growth and inflation: a regime switching approach By Gianni Amisano; Gabriel Fagan
  7. Reverse causality in global current accounts By Gunther Schnabl; Stephan Freitag
  8. Choice of exchange rate regimes for African countries: Fixed or Flexible Exchange rate regimes? By Simwaka, Kisu
  9. Has the Euro changed the Business Cycle? By Zeno Enders; Philip Jung; Gernot J. Mueller
  10. Exchange Rate Regimes and Macroeconomic Performance in South Asia By Ashima Goyal
  11. Towards a robust monetary policy rule for the euro area By Tobias S. Blattner; Emil Margaritov
  12. Trend inflation, endogenous mark-ups and the non-vertical Phillips curve By Giovanni Di Bartolomeo; Patrizio Tirelli; Nicola Acocella
  13. Money in a Model of Prior Production and Imperfectly Directed Search By Adrian Masters
  14. Epstein-Zin preferences and their use in macro-finance models: implications for optimal monetary policy By Matthieu Darracq Pariès; Alexis Loublier

  1. By: Jordi Galí
    Abstract: Since its inception, a most distinctive (and controversial) feature of the ECB monetary policy strategy has been its emphasis on money and monetary analysis, which constitute the basis of the so-called monetary pillar. The present paper examines the performance of the monetary pillar around the recent financial crisis episode, and discusses its prospects in light of the renewed emphasis on financial stability and the need for enhanced macro-prudential policies.
    Keywords: monetary policy strategy, two pillar strategy, monetarism, financial stability.
    JEL: E52 E58
    Date: 2010–06
  2. By: Dennis Wesselbaum
    Abstract: In the recent New Keynesian literature a standard assumption is that the price for which an intermediate good is sold to the final good firm is equal to the marginal costs of the intermediate good firm. However, there is empirical evidence that this need not to hold. This paper introduces price bargaining into an otherwise standard New Keynesian DSGE model and show that this model performs reasonably well in replicating the observed persistence values. We further discuss the role of those product market imperfections for monetary policy and find a trade-off between stabilizing intermediate or final good inflation. In addition, the Ramsey optimal monetary policy can be approximated reasonably well with a Taylor-type interest rate rule with weights on both inflation rates and output
    Keywords: Inflation and Output Persistence, Monetary Policy, Price Bargaining
    JEL: E31 E52 L10
    Date: 2010–06
  3. By: Matteo Barigozzi; Antonio Conti
    Abstract: We adopt a time-varying cointegration test to discriminate among different empirical studies claiming to find a stable Euro Area money demand equation. A time invariant relation explaining real balances is rejected by data, even when accounting for housing, financial and labour markets. Conversely, an international portfolio allocation approach provides stabilization. In particular, international financial markets, rather than monetary policy, are the key determinant of the observed diverging path of money growth. In terms of policy, we provide empirical support for a New Two Pillars Strategy aimed to achieve financial stability through money and credit and price stability through interest rates.
    Keywords: Euro Area Money Demand; Time-Varying Vector Error Correction Model; International Portfolio Allocation; Financial Stability
    JEL: E41 E44 C32
    Date: 2010
  4. By: Kalina Dimitrova
    Abstract: There are two aspects through which an economic policy can influence the economic situation – monetary and fiscal. Monetary and fiscal policies have different and sometimes controversial goals to achieve by means of specific instruments. While the mission of central banks is generally price stability, governments usually set their goals in the realm of economic growth and employment. Fiscal institutions , however, often use inflation in order to derive revenues (seigniorage) and finance budget deficits. Hence, inflation is viewed as a public finance phenomenon (Barro, 1979; Mankiw, 1987; Grilli, 1989). The purpose of this paper is to present a historical perspective on the behaviour of the monetary and fiscal policies pursued in Bulgaria from 1879, when the Bulgarian National Bank was established (soon after the liberation from the Ottoman Empire). Furthermore, historical time series of monetary and fiscal indicators give us the chance to study the link between government budget problems, fluctuations of monetary variables and inflation dynamics in different monetary episodes.
    Keywords: monetary and fiscal policy, inflation, exchange rate.
    JEL: E31 E63
    Date: 2010–06
  5. By: Fuchun Li; Pierre St-Amant
    Abstract: This paper examines empirically the impact of financial stress on the transmission of monetary policy shocks in Canada. The model used is a threshold vector autoregression in which a regime change occurs if financial stress conditions cross a critical threshold. Using the financial stress index developed by Illing and Liu (2006) as a measure of the Canadian financial stress conditions, the authors examine questions such as: Do contractionary and expansionary monetary policy shocks have symmetric effects? Do financial stress conditions play a role as a nonlinear propagator of monetary policy shocks? Does monetary policy have the same effect on the real economy in the low financial stress regime and in the high financial stress regime? Suppose that the economy is currently in a given financial stress regime, do monetary policy shocks have a substantial effect on the transition probability of moving from the given regime to the other? The empirical findings reveal that (i) contractionary monetary shocks typically have a larger effect on output than expansionary monetary shocks; (ii) the effects of large and small shocks are approximately proportional; (iii) expansionary monetary shocks have larger effects on output in the high financial stress regime than in the low financial stress regime; (iv) large expansionary monetary shocks increase the likelihood of moving to, or remaining in, the low financial stress regime; (v) typically, high financial stress regime has been characterized by weaker output growth, higher inflation, and higher interest rates.
    Keywords: Financial stability; Monetary policy and uncertainty
    JEL: E50 C01
    Date: 2010
  6. By: Gianni Amisano (European Central Bank, DG Research, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Gabriel Fagan (European Central Bank, DG Research, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: We develop a time-varying transition probabilities Markov Switching model in which inflation is characterised by two regimes (high and low inflation). Using Bayesian techniques, we apply the model to the euro area, Germany, the US, the UK and Canada for data from the 1960s up to the present. Our estimates suggest that a smoothed measure of broad money growth, corrected for real-time estimates of trend velocity and potential output growth, has important leading indicator properties for switches between inflation regimes. Thus money growth provides an important early warning indicator for risks to price stability. JEL Classification: C11, C53, E31.
    Keywords: money growth, inflation regimes, early warning, time varying transition probabilities, Markov Switching model, Bayesian inference.
    Date: 2010–06
  7. By: Gunther Schnabl (Leipzig University, Grimmaische Straße 12, 04109 Leipzig, Germany.); Stephan Freitag (Leipzig University, Grimmaische Straße 12, 04109 Leipzig, Germany.)
    Abstract: The paper discusses global imbalances under the aspect of an asymmetric world monetary system. It identifies the US and Germany as center countries with rising / high current account deficits (US) and surpluses (Germany). These are matched by current account surpluses of countries stabilizing their exchange rates against the dollar (dollar periphery) and current account deficits of countries stabilizing their exchange rate against the euro (euro periphery). Meanwhile, the aggregate current account balance of the euro area has been by and large balanced. The paper finds that changes of world current account positions are affected by the macroeconomic policy decisions both in the centers and peripheries, albeit the centers – due to structural characteristics related to size – are argued to have a higher degree of freedom in macroeconomic policy making. In specific, expansionary monetary policy in the US as well as exchange rate stabilization and sterilization policies in the dollar periphery are found to have contributed to global current account imbalances. Given that the sample period for the analysis extends from 1981-2008, the results for Germany mostly capture the situation before the euro was created. JEL Classification: F31, F32.
    Keywords: Global Imbalances, Asymmetric World Monetary System, Twin Deficit, Twin Surplus, International Currency, Sterilization, Granger Causality Tests.
    Date: 2010–06
  8. By: Simwaka, Kisu
    Abstract: The choice of an appropriate exchange rate regime has been a subject of ongoing debate in international economics. The majority of African countries are small open economies and thus where the choice of the exchange rate regime is an important policy issue. Aside from factors such as interest rates and inflation, the exchange rate is one of the most important determinants of a country’s relative level of economic health. For this reason, exchange rates are among the most watched analyzed and governmentally manipulated economic variables. This paper revisits the debate on the choice of an appropriate exchange-rate regime for African countries. It starts by reviewing literature on the debate of appropriate exchange rate regimes. It then discusses relevant considerations for the choice of the exchange rate regimes for African countries. The debate revolves around the effect of exchange rate on macroeconomic management, particularly inflation and export competitiveness. The paper recommends the conventional peg arrangement as a viable option for the majority of low-income African countries. But this is contingent on a number of important pre-conditions. For middle-income African economies, with relatively developed financial markets and linkages to modern global capital markets, floating arrangements, including the managed floating exchange rate regime, look more promising. In conclusion, the paper cautions that no single exchange rate regime is right for all countries or at all times.
    Keywords: Exchange rate options; sub-Saharan African countries
    JEL: F30 F31 F33
    Date: 2010–03–15
  9. By: Zeno Enders (University of Bonn); Philip Jung (University of Mannheim); Gernot J. Mueller (University of Bonn)
    Abstract: In this paper we analyze European business cycles before and under EMU. Across the two periods we find 1) a significant decline in real exchange rate volatility, 2) significant changes in cross-country correlations, and 3) the volatility of macroeconomic fundamentals largely unchanged. We develop a two-country business cycle model and show that the calibrated model is able to replicate key features of the data prior to and under EMU. We find that the euro has a strong bearing on the transmission mechanism as cross-country spillovers increase substantially under EMU. As a result, foreign shocks become more and domestic shocks less important in accounting for the (unchanged) volatility of macroeconomic fundamentals.
    Keywords: European business cycles, Euro, Optimum Currency Area, EMU, Monetary Policy, Exchange rate regime, Cross-country spillovers
    JEL: F41 F42 E32
    Date: 2010–05–31
  10. By: Ashima Goyal
    Abstract: Stylized facts for South Asia show the dominance of supply shocks, amplified by macroeconomic policies and procyclical current accounts. Interest and exchange rate volatility rose initially on liberalization, but fell as markets deepened. A gradual middling through approach to openness and market development are helping the region absorb shocks without reducing growth. Diverse sources of demand, flexible exchange rates, robust domestic savings, and changing political preferences are contributing. Countercyclical policy more suited to structure, and removal of distortions raising costs, would allow better coordination of monetary and fiscal polices to further support the process.[WP-2010-005]
    Keywords: South Asia, supply shocks, flexible exchange rates, diversity, distortions
    Date: 2010
  11. By: Tobias S. Blattner (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Emil Margaritov (Goethe University, Department of Money and Macroeconomics, House of Finance, Grueneburgplatz 1, 60323 Frankfurt am Main, Germany.)
    Abstract: Estimations of simple monetary policy rules are often very rigid. Standard practice requires that a decision is made as to which indicators the central bank is assumed to respond to, ignoring the data-rich environment in which policy-makers typically form their decisions. However, the choice of the feedback variables in the estimations of simple rules bears non-trivial implications for the prescriptions borne from these rules. This paper addresses this issue for the euro area using a new comprehensive real-time database for the euro area and examines the ECB’s past interest-rate setting behaviour in two complementary ways that are designed to deal with both model and data uncertainty. In a first step we follow the “thick-modelling” approach suggested byGranger and Jeon (2004) and estimate a series of 3,330 policy rules. In a second step we employ a factor-model approach similar to Bernanke and Boivin (2003) for the US Fed, but with structurally interpretable factors à la Belviso and Milani (2006). Taken together, we find a strong justification for the need of adopting robust approaches to describe the historical evolution of euro area monetary policy. We also find that the ECB is neither purely backward nor forward-looking, but reacts to a synthesis of the available information on the current and future state of the economy. JEL Classification: C50, E52, E58.
    Keywords: Taylor rules, Monetary policy, Real-time data.
    Date: 2010–06
  12. By: Giovanni Di Bartolomeo; Patrizio Tirelli; Nicola Acocella
    Abstract: Recent developments in macroeconomics resurrect the view that wel- fare costs of inflation arise because the latter acts as a tax on money balances. Empirical contributions show that wage re-negotiations take place while expiring contracts are still in place. Bringing these seemingly unrelated aspects together in a stylized general equilibrium model, we ?nd a disciplining e¤ect of a positive inflation target on the wage markup and identify a long-term trade-off between in?ation and output.
    Keywords: trend inflation, long-run Phillips curve, in?ation targeting, real money balances.
    JEL: E52 E58 J51 E24
    Date: 2010–05
  13. By: Adrian Masters
    Abstract: This paper considers the effect of monetary policy and inflation on retail markets. It analyzes a model in which: goods are dated and produced prior to being retailed, buyers direct their search on the basis of price and general quality and, buyers' match specific tastes are their private information. Sellers set the same price for all buyers but some do not value the good highly enough to purchase it. The market economy is typically inefficient as a social planner would have the good consumed. The Friedman rule represents optimal policy as long as there is free-entry of sellers. When the upper bound on the number of participating sellers binds sufficiently, moderate levels of inflation can be welfare improving.
    Date: 2010
  14. By: Matthieu Darracq Pariès (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Alexis Loublier
    Abstract: Epstein-Zin preferences have attracted significant attention within the macro-finance literature based on DSGE models as they allow to substantially increase risk aversion, and consequently generate non-trivial risk premia, without compromising the ability of standard models to achieve satisfactory macroeconomic data coherence. Such appealing features certainly hold for structural modelling frameworks where monetary policy is set according to Taylor-type rules or seeks to minimize an ad hoc loss function under commitment. However, Epstein-Zin preferences may have significant quantitative implications for both asset pricing and macroeconomic allocation under a welfare-based monetary policy conduct. Against this background, the paper focuses on the impact of such preferences on the Ramsey approach to monetary policy within a medium-scale model based on Smets and Wouters (2007) including a wide range of nominal and real frictions that have proven to be relevant for quantitative business cycle analysis. After setting an empirical benchmark that generates a mean value of 100 bp for the ten-year term premium, we show that Epstein-Zin preferences significantly affect the macroeconomic outcome when optimal policy is considered. The level and the dynamic pattern of risk premia are also markedly altered. We show that the effect of Epstein-Zin preferences is extremely sensitive to the presence of real rigidities in the form of quasi-kinked demands. We also analyse how this effect can be linked to a combined effect of capital accumulation and wage rigidities. JEL Classification: E44, E52, E61, G12.
    Keywords: Optimal monetary policy, macroeconometric equivalence, non time-separable preferences, term premium.
    Date: 2010–06

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