nep-mon New Economics Papers
on Monetary Economics
Issue of 2010‒07‒03
twenty-one papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Bank of Canada Communication, Media Coverage, and Financial Market Reactions By Bernd Hayo; Matthias Neuenkirch
  2. Is Monetary Policy Effective in Developing Countries? Evidence from Ghana By Mustapha Ibn Boamah; Robert Ackrill; Juan Carlos Cuestas
  3. Financial Stability and Monetary Policy By Martin, Christopher; Milas, C
  4. Bi-currency versus Single-Currency Targeting: Lessons from the Russian Experience By Sokolov, Vladimir
  5. Implementation of Monetary Policy: How Do Central Banks Set Interest Rates? By Benjamin Friedman; Kenneth Kuttner
  6. The Federal Funds Rate and the Conduction of the International Orchestra By Antonio Ribba
  7. Optimal simple monetary policy rules and welfare in a DSGE Model for Hungary By Zoltán M. Jakab; Henrik Kucsera; Katalin Szilágyi; Balázs Világi
  8. Calvo vs. Rotemberg in a Trend Inflation World: An Empirical Investigation By Guido Ascari; Efrem Castelnuovo; Lorenza Rossi
  9. Sectoral money demand and the great disinflation in the US By Alessandro Calza; Andrea Zaghini
  10. Central bank co-operation and international liquidity in the financial crisis of 2008-9 By William Allen; Richhild Moessner
  11. How Endogenous Is Money? Evidence from a New Microeconomic Estimate By David Cuberes; William R. Dougan
  12. Exchange rate regimes and macroeconomic performance in South Asia By Ashima Goyal
  13. Regional Monetary Coordination in Asia after the Global Financial Crisis: Comparison in Regional Monetary Stability between ASEAN+3 and ASEAN+3+3 By Eiji Ogawa
  14. The role of financial market structure and the trade elasticity for monetary policy in open economies By Katrin Rabitsch
  15. Exchange Rate Dynamics In Brazil By Holland, Márcio; Vilela Vieira, Flávio
  16. Inflation asymmetry, menu costs and aggregation bias – A further case for state dependent pricing By Péter Karádi; Ádám Reiff
  17. Monetary Policy, Term Structure and Asset Return: Comparing REIT, Housing and Stock By Chang, Kuang-Liang; Chen, Nan-Kuang; Leung, Charles Ka Yui
  18. Perception is Always Right: The CNB’s Monetary Policy in the Media By Jiri Bohm; Petr Kral; Branislav Saxa
  19. Consumer Price Behavior in Mexico Under Inflation Targeting: A Microdata Approach By Carla Ysusi
  20. Sveriges Riksbank's Inflation Interval Forecasts 1999-2005 By Lundholm, Michael
  21. Inflation and Unemployment in Competitive Search Equilibrium By Mei Dong

  1. By: Bernd Hayo (Philipps-University Marburg); Matthias Neuenkirch (Philipps-University Marburg)
    Abstract: We examine the impact of Bank of Canada communications and media reporting on them on Canadian (short- and medium-term) bond and stock market returns using a GARCH model. Communications are rather uniformly distributed over the sample period (1998–2006); however, media coverage is particularly high during phases of increased uncertainty about the future course and timing of Canadian monetary policy. Official communications exert a larger influence on the bond market, whereas media coverage is more relevant for the stock market. In general, media filtering does not play a prominent role.
    Keywords: Bank of Canada, Central Bank Communication, Financial Markets, Media Coverage, Monetary Policy
    JEL: E52 G14 G15
    Date: 2010
  2. By: Mustapha Ibn Boamah; Robert Ackrill; Juan Carlos Cuestas
    Abstract: The central bank of Ghana officially adopted an explicit inflating targeting monetary policy in May 2007 following its operational independence in March 2002. This paper explores monetary policy rules and conduct in Ghana. The paper uses time series estimations of Taylor-type reactions functions to characterise monetary policy conduct. The long-run interest rate response to inflation, output gap, and other inflation precursors from estimated reaction functions is compared with Taylor’s reference values. We conclude monetary policy was largely ineffective in controlling inflation. The paper suggests possible reasons for the non effectiveness of monetary policy and offers policy recommendations for long-term inflation control.
    Keywords: Central bank, Ghana, Inflation targeting, Monetary Policy
    JEL: E52 E58 E61
    Date: 2010–06
  3. By: Martin, Christopher; Milas, C
    Abstract: We argue that although UK monetary policy can be described using a Taylor rule in 1992- 2007, this rule fails during the recent financial crisis. We interpret this as reflecting a change in policymakers’ preferences to give priority to stabilising the financial system. Developing a model of optimal monetary policy with preference shifts, we show this provides a superior empirical model over crisis and pre-crisis periods. We find no response of interest rates to inflation during the financial crisis, possibly implying that the UK abandoned inflation targeting during the financial crisis.
    Keywords: monetary policy; financial crisis
    Date: 2010–03–31
  4. By: Sokolov, Vladimir (BOFIT)
    Abstract: This paper examines the impacts of the 2005 shift in Russian exchange rate policies from single-currency to bi-currency basket targeting on domestic interest rates and sovereign risk premium dynamics. The policy shift disconnected domestic interest rates from US dollar-denominated interest rates, replacing them with a growing positive relationship with the dual-currency basket (USD-EUR) adopted by the Central Bank of Russia, as well as a synthetic interest rate composed of the US dollar LIBOR and the euro LIBOR. The paper also considers the insulating properties of Russian basket targeting policies during the recent global liquidity crisis. I present evidence that the Russian MosIBOR rate was negatively related to the US dollar LIBOR rate and positively related to the synthetic USD-EUR rate during the "decoupling" stage of the crisis. Even with the steep quantitative easing of the US Fed during this period, the finding suggests the Russian money market was more in sync with the monetary policies of the euro area. The central conclusion here is that, in conditions of managed floating exchange rate policies and liberalized capital accounts, the relationship between a country's domestic interest rates and their foreign counterparts depends on the de facto operating target of the central bank of this country, whether it is a single currency or a basket.
    Keywords: exchange rate policy; basket targeting; sovereign CDS; decoupling
    JEL: F31 F33
    Date: 2010–06–15
  5. By: Benjamin Friedman (Harvard University); Kenneth Kuttner (Williams College)
    Abstract: Central banks no longer set the short-term interest rates that they use for monetary policy purposes by manipulating the supply of banking system reserves, as in conventional economics textbooks; today this process involves little or no variation in the supply of central bank liabilities. In effect, the announcement effect has displaced the liquidity effect as the fulcrum of monetary policy implementation. The chapter begins with an exposition of the traditional view of the implementation of monetary policy, and an assessment of the relationship between the quantity of reserves, appropriately defined, and the level of short-term interest rates. Event studies show no relationship between the two for the United States, the Euro-system, or Japan. Structural estimates of banks’ reserve demand, at a frequency corresponding to the required reserve maintenance period, show no interest elasticity for the U.S. or the Euro-system (but some elasticity for Japan). The chapter next develops a model of the overnight interest rate setting process incorporating several key features of current monetary policy practice, including in particular reserve averaging procedures and a commitment, either explicit or implicit, by the central bank to lend or absorb reserves in response to differences between the policy interest rate and the corresponding target. A key implication is that if reserve demand depends on the difference between current and expected future interest rates, but not on the current level per se, then the central bank can alter the market-clearing interest rate with no change in reserve supply. This implication is borne out in structural estimates of daily reserve demand and supply in the U.S.: expected future interest rates shift banks’ reserve demand, while changes in the interest rate target are associated with no discernable change in reserve supply. The chapter concludes with a discussion of the implementation of monetary policy during the recent financial crisis, and the conditions under which the interest rate and the size of the central bank’s balance sheet could function as two independent policy instruments.
    Keywords: Reserve supply, reserve demand, liquidity effect, announcement effect
    JEL: E52 E58 E43
    Date: 2010–06
  6. By: Antonio Ribba
    Abstract: In the first ten years of EMU, monetary policy choices of the European Central Bank (ECB) in setting the short-term interest rate have followed, systematically, monetary policy decisions made by the Federal Reserve System (Fed). For, despite the presence of variable lags with respect to Fed decisions, turning points of European short-term interest rates have been largely anticipated by movements in the federal funds rate. In this paper we show that, in the context of a bivariate cointegrated system, a clear long-run US dominance emerges. Moreover, the structural analysis reveals that a permanent increase in the federal funds rate causes a permanent one-for-one movement in the eonia rate.
    Keywords: Monetary policy; Identification; Structural Cointegrated VARs
    JEL: C32 E5
    Date: 2010–06
  7. By: Zoltán M. Jakab (Office of Fiscal Council); Henrik Kucsera (Magyar Nemzeti Bank); Katalin Szilágyi (Magyar Nemzeti Bank); Balázs Világi (Magyar Nemzeti Bank)
    Abstract: We explore the properties of welfare-maximizing monetary policy in a medium-scale DSGE model for Hungary. In order to make our results operational from a policymaker’s perspective, we approximate the optimal policy rule with a set of simple rules reacting only to observable variables. Our results suggest that “science of monetary policy” that is found robust in simple models, holds in this medium-scaled setting as well. That is, the welfare-maximizing policy that aims to eliminate distortions associated with nominal rigidities can be approximated by a simple inflation targeting rule. Adding exchange rate into the feedback rule only marginally improves the stabilization properties of the policy rule. However, a rule reacting to wage inflation can be significantly welfare-improving. These results may suggest that in our medium-sized model the distortions associated with sticky wage setting have at least as important welfare implications as those related to the price stickiness in product markets.
    Keywords: monetary policy, central banking, policy design.
    JEL: E52 E58 E61
    Date: 2010
  8. By: Guido Ascari (Università di Pavia); Efrem Castelnuovo (Università di Padova); Lorenza Rossi (Università di Pavia)
    Abstract: This paper estimates and compares New-Keynesian DSGE monetary models of the business cycle derived under two different pricing schemes - Calvo (1983) and Rotemberg (1982) - under a positive trend inflation rate. Our empirical findings (i) support trend inflation as an empirically relevant feature of the U.S. great moderation; (ii) provide evidence in favor of the statistical superiority of the Calvo setting; (iii) support the absence of price indexation under the Calvo mechanism only. The superiority of the Calvo model (against Rotemberg) is due to the restrictions imposed by such a pricing scheme on the aggregate demand equation. The determinacy regions implied by the two estimated models indicate relevant differences in the implementable simple policy rules.
    Keywords: Calvo, Rotemberg, trend inflation, Bayesian estimations.
    JEL: L40 L62 L52
    Date: 2010–02
  9. By: Alessandro Calza (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Andrea Zaghini (Banca d’Italia, Research Department, Via Nazionale 91, I-00184 Rome, Italy.)
    Abstract: Estimates of the welfare costs of inflation based on Bailey (1956) are typically computed using aggregate money demand models. Yet, the behavior of money demand may vary across sectors. Thus, the impact on welfare of inflation regime shifts may differ between households and …firms. We speci…cally investigate the sectoral welfare implications of the shift from the Great Inflation to the present regime of low and stable inflation. For this purpose, we estimate different functional speci…fications of money demand for US households and non-…financial …firms using flow-of-fund data covering four decades. We fi…nd that the bene…fits were signi…cant for both sectors. JEL Classification: E31, E41.
    Keywords: welfare cost of inflation, flow of funds data, demand for money.
    Date: 2010–06
  10. By: William Allen; Richhild Moessner
    Abstract: The financial crisis that began in August 2007 has blurred the sharp distinction between monetary and financial stability. It has also led to a revival of practical central bank co-operation. This paper explains how things have changed. The main innovation in central bank cooperation during this crisis was the emergency provision of international liquidity through bilateral central bank swap facilities, which have evolved to form interconnected swap networks. We discuss the reasons for establishing swap facilities, relate the probability of a country receiving a swap line in a currency to a measure of currency-specific liquidity shortages based on the BIS international banking statistics, and find a significant relationship in the case of the US dollar, the euro, the yen and the Swiss franc. We also discuss the role and effectiveness of swap lines in relieving currency-specific liquidity shortages, the risks that central banks run in extending swap lines and the limitations to their utility in relieving liquidity pressures. We conclude that the credit crisis is likely to have a lasting effect on the international liquidity policies of governments and central banks.
    Keywords: Central bank cooperation, central bank swap lines, FX swaps, international liquidity, lender of last resort
    Date: 2010–06
  11. By: David Cuberes (Dpto. Fundamentos del Análisis Económico); William R. Dougan (Clemson University)
    Abstract: This paper uses microeconomic data on firms' money demand and investment in physical capital for the period 1983-2006 to estimate the extent to which variation in the U.S. money supply is an endogenous response to variation in firms' demand for liquidity. We estimate a simple model in which each firm's desired money balances in any period depend on that firm's current transactions, current investment, and its planned future investment, as well as aggregate variables such as interest rates and common policy forecasts. Calculations based on our estimates suggest that only a very small fraction of the variability in the aggregate stock of money represents an endogenous response to autonomous changes in firms' investment plans.
    Keywords: Money demand, money supply, endogenous money, monetary neutrality
    JEL: E41 E51
    Date: 2010–03
  12. By: Ashima Goyal (Indira Gandhi Institute of Development Research)
    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.
    Keywords: South Asia, supply shocks, flexible exchange rates, diversity, distortions
    JEL: E3 E63 O11
    Date: 2010–06
  13. By: Eiji Ogawa
    Abstract: This paper analyzes how much deviation we have among Asian currencies, which include the Indian rupee, the Australian dollar, and the New Zealand dollar, given that we are discussing East Asian Community based on ASEAN+3 (Japan, China, and South Korea)+3 (India, Australia, and New Zealand). We investigate whether the instability or deviation of intra-regional exchange rates would increase when the additional three countries (India, Australia, and New Zealand) join the ASEAN+3. Contribution of each currency to the weighted average of AMU-wide Deviation Indicators shows that movements in the Japanese yen have contributed to those in the weighted average of the AMU-wide Deviation Indicators over time during the sample period from January 2000 to January 2010. Moreover, we use concepts of β and σ convergences in the context of economic growth to statistically analyze convergence or divergence for the ASEAN+3+3 currencies. The addition of the Indian rupee into the ASEAN+3 currencies makes the regional currencies unstable before and during the global financial crisis. Moreover, comparison between ASEAN+3+3 and ASEAN+3+Indian currencies shows that the addition of only the Indian rupee is relatively more stable than the addition of the Australian dollar and the New Zealand dollar as well as the Indian rupee since September 2008. It is worthy to consider that India will join the Chiang Mai Initiative to manage currency crises while the monetary authorities will conduct surveillance over stability of the intra-regional exchange rates in the near future.
    Date: 2010–06
  14. By: Katrin Rabitsch (Central European University, Magyar Nemzeti Bank)
    Abstract: The degree of international risk sharing matters for how monetary policy should optimally be conducted in an open economy. This is because risk sharing affects the way in which monetary policy is affected by terms of trade considerations. In a standard two-country model with monopolistic competition and nominal rigidities I consider different assumptions on international financial markets – complete markets, financial autarky and a bond economy – and a large region for the crucial parameter of the trade elasticity. There are three main results: one, the prescription of (producer) price stability as the optimal policy is obtained only as a special case, while in general it is optimal to deviate from a strictly zero inflation rate. Two, while gains from international policy coordination are generally small, they become potentially substantial when international risk sharing is poor and wealth effects from shocks across countries are large. And, three, when international financial markets are incomplete, there are also (sometimes considerable) gains over the flexible price allocation achievable.
    Keywords: monetary policy, risk sharing, price stability, policy coordination, financial market structure, trade elasticity.
    JEL: E52 E58 F42
    Date: 2010
  15. By: Holland, Márcio; Vilela Vieira, Flávio
    Abstract: The paper aims to investigate on empirical and theoretical grounds the Brazilian exchange rate dynamics under floatingexchange rates. The empirical analysis examines the short and long term behavior of the exchange rate, interest rate(domestic and foreign) and country risk using econometric techniques such as variance decomposition, Grangercausality, cointegration tests, error correction models, and a GARCH model to estimate the exchange rate volatility. Theempirical findings suggest that one can argue in favor of a certain degree of endogeneity of the exchange rate and thatflexible rates have not been able to insulate the Brazilian economy in the same patterns predicted by literature due to itsown specificities (managed floating with the use of international reserves and domestic interest rates set according toinflation target) and to externally determined variables such as the country risk. Another important outcome is the lackof a closer association of domestic and foreign interest rates since the new exchange regime has been adopted. That is,from January 1999 to May 2004, the US monetary policy has no significant impact on the Brazilian exchange ratedynamics, which has been essentially endogenous primarily when we consider the fiscal dominance expressed by theprobability of default.
    Date: 2010–06–16
  16. By: Péter Karádi (Magyar Nemzeti Bank); Ádám Reiff (Magyar Nemzeti Bank)
    Abstract: Asymmetric inflation response to aggregate shocks is an identifying macro-prediction of state dependent pricing models with trend inflation (Ball and Mankiw, 1994). The paper uses the natural experiment of symmetric value-added tax (VAT) changes in Hungary with highly asymmetric inflation responses to provide further evidence for state-dependent pricing and for the Ball-Mankiw conjecture. The paper shows, furthermore, that while a standard menu cost model like that of Golosov and Lucas (2007) underestimates the observed asymmetry, a model of multi-product firms that takes sectoral heterogeneity explicitly into consideration can quantitatively account for the inflation asymmetry observed in the data. This aggregation bias of the standard model is the result of the strong interaction term between trend inflation and menu costs in determining asymmetry in the model, and the positive correlation between sectoral inflation rates and menu costs in the data. The paper implies that the real effects of negative monetary shocks can be substantial even in the standard Golosov and Lucas (2007) model if these additional factors are taken into consideration.
    Keywords: aggregation bias, inflation asymmetry, menu cost, sectoral heterogeneity, value-added tax.
    JEL: E30
    Date: 2010
  17. By: Chang, Kuang-Liang; Chen, Nan-Kuang; Leung, Charles Ka Yui
    Abstract: This paper confirms that a regime-switching model out-performs a linear VAR model in terms of understanding the system dynamics of asset returns. Impulse responses of REIT returns to either the federal funds rate or the interest rate spread are much larger initially but less persistent. Furthermore, the term structure acts as an amplifier of the impulse response for REIT return, a stabilizer for the housing counterpart under some regime, and, perhaps surprisingly, almost no role for the stock return. In contrast, GDP growth has very marginal effect in the impulse response for all assets.
    Keywords: monetary policy; yield curve; REITs; house prices; Markov Regime Switching
    JEL: R21 E40 G10 R33
    Date: 2009–09
  18. By: Jiri Bohm; Petr Kral; Branislav Saxa
    Abstract: In this paper we analyze the favorableness and extent of the media coverage of the CNB’s monetary policy decisions in the period of 2002–2007. We identify the factors explaining the variance in these two dimensions using an extensive set of articles published in the four most relevant Czech daily broadsheets immediately after monetary policy meetings. We take account of parameters of the CNB’s actual monetary policy decisions and related communication as well as variables characterizing the general economic environment that prevailed at the times of the individual meetings. The most appealing results are that those CNB’s decisions that surprise financial markets are − if needed − not negatively perceived by the media and that the media welcomes interest rate changes. Therefore, from the media coverage point of view, there is no need for too much smoothing. Simultaneously, our analyses shed some light on how the media tends to report on (economic) events in general.
    Keywords: Communication, media, monetary policy, newspapers.
    JEL: E52 E58
    Date: 2009–12
  19. By: Carla Ysusi
    Abstract: In this paper we do a statistical analysis of the Mexican Consumer Price Index microdata set to characterize the rigidities of the price setting process in the different sectors of the Mexican economy. The microdata set goes from July 2002 to December 2009. Broadly, results show that there exists a considerable heterogeneity in the price setting behavior across different sectors and over time. Evidence was found that when big shocks affect inflation, there is a strong co-movement of the fraction of the firms that change prices with the level of inflation.
    Keywords: Consumer Price Index, price setting process, frequencies and magnitudes of price changes.
    JEL: C19 E31
    Date: 2010–06
  20. By: Lundholm, Michael (Dept. of Economics, Stockholm University)
    Abstract: Are Sveriges Riksbank's inflation (CPI and KPIX) interval forecasts calibrated in the sense that the intervals cover realised inflation with the stated ex ante coverage probabilities 50, 75 and 90 percent? In total 150 interval forecast 1999:Q2-2005:Q2 are assessed for CPI and KPIX. The main result is that the forecast uncertainty is understated, but there are substantial differences between individual forecast origins and inflation measures.
    Keywords: Inflation; forecast; interval forecast; forecast uncertainty
    JEL: C53 E31 E37
    Date: 2010–06–23
  21. By: Mei Dong
    Abstract: Using a monetary search model, Rocheteau, Rupert and Wright (2007) show that the relationship between inflation and unemployment can be positive or negative depending on the primitives of the model. The key features are indivisible labor, nonseparable preferences and bargaining. Their results are derived only for a special case of the bargaining solution, take-it-or-leave-it offer by buyers. Instead of bargaining, this paper considers competitive search (price posting with directed search). I show that the results in Rocheteau, Rupert and Wright (2007) can be generalized in an environment where both buyers and sellers have nonseparable preferences. In addition, the relationship between inflation and unemployment is robust to allowing free entry by sellers, which cannot be studied in Rocheteau, Rupert and Wright (2007).
    Keywords: Inflation: costs and benefits
    JEL: E40 E52 E12 E13
    Date: 2010

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