nep-mon New Economics Papers
on Monetary Economics
Issue of 2011‒08‒15
seventeen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Preferences of the Central Reserve Bank of Peru and optimal monetary policy rules in the inflation targeting regime. By Cabrera, Nilda; Bejarano, Edilean; Savino Portugal, Marcelo
  2. Evaluation of Wavelet-based Core Inflation Measures: Evidence from Peru By Erick Lahura; Marco Vega
  3. RECONSTRUCTING THE RECENT MONETARY POLICY HISTORY OF COLOMBIA FROM 1990 TO 2010 By Andrés Felipe Giraldo; Martha Misas Arango; Edgar Villa Pérez
  4. "Financial-Sector Shocks in a Credit-View Model" By Burton A. Abrams
  5. China’s new exchange rate regime, optimal basket currency and currency diversification By Zhang, Zhichao; Shi, Nan; Zhang, Xiaoli
  6. The Influence of Irving Fisher on Milton Friedman’s Monetary Economics By Michael D. Bordo; Hugh Rockoff
  8. Exchange rate pass-through and inflation targeting in Peru By Winkelried, Diego
  9. The Role of Monetary Policy in Turkey during the Global Financial Crisis (Kuresel Kriz Doneminde Turkiye'de Para Politikasinin Rolu) By Harun Alp; Selim Elekdag
  11. Monetary-fiscal-trade policy and economic growth in Pakistan: time series empirical investigation By Syed tehseen, jawaid; Faisal sultan, qadri; Nasir, ali
  13. Exchange Rate Equations Based on Interest Rate Rules : In-Sample and Out-of-Sample Performance (Faiz Kurallarina Dayali Doviz Kuru Denklemleri : Orneklem Ici ve Disi Performans) By Mahir Binici; Yin-Wong Cheung
  14. Determinants of Inflation in Nigeria: A Co- Integration Approach By Olatunji, G.B.; Omotesho, O.A.; Ayinde, Opeyemi E.; Ayinde, K.
  15. The Political Economy of Reducing the US Dollar’s Role as a Global Reserve Currency By Yap, Josef T.
  16. The Continental Dollar: Initial Design, Ideal Performance, and the Credibility of Congressional Commitment By Farley Grubb
  17. Volatility, Persistence and Nonlinearity of Simulated DSGE Real Exchange Rates By Yamin Ahmad; Ming Chien Lo; Olena Mykhaylova

  1. By: Cabrera, Nilda (PUC-RJ, Brazil); Bejarano, Edilean (UFPb, Brazil); Savino Portugal, Marcelo (UFRGS, Brazil and CNPq)
    Abstract: This study aims to identify the preferences of the monetary authority in the Peruvian regime of inflation targeting through the derivation of optimal monetary policy rules. To achieve that, we used a calibration strategy based on the choice of values of the parameters of preferences that minimize the square deviation between the true interest rate and interest rate optimal simulation. The results showed that the monetary authority has applied a system of flexible inflation targeting, prioritizing the stabilization of inflation, but without disregarding gradualism in interest rates. On the other hand, concern over output stabilization has been minimal, revealing that the output gap has been important because it contains information about future inflation and not because it is considered a variable goal in itself. Finally, when the smoothing of the nominal exchange rate is considered in the loss function of the monetary authority, the rank order of preferences has been maintained and the smoothing of the exchange rate proved insignificant.
    Keywords: Inflation target; Central Bank preferences, Optimal monetary policy rules, Central Bank of Peru.
    JEL: C61 E52 E58
    Date: 2011–06
  2. By: Erick Lahura (Departamento de Economía - Pontificia Universidad Católica del Perú; Banco Central de la Reserva del Perú); Marco Vega (Departamento de Economía - Pontificia Universidad Católica del Perú; Banco Central de la Reserva del Perú)
    Abstract: Under inflation targeting and other related monetary policy regimes, the identication of non-transitory inflation and forecasts about future inflation constitute key ingredients for monetary policy decisions. In practice, central banks perform these tasks using so-called "core inflation measures". In this paper we construct alternative core inflation measures using wavelet functions and multiresolution analysis (MRA), and then evaluate their relevance for monetary policy. The construction of wavelet-based core inflation measures (WIMs) is relatively new in the literature and their assessment has not been addressed formally, this paper being the first attempt to perform both tasks for the case of Peru. Another main contribution of this paper is that it proposes two alternative criteria for evaluating core inflation measures: (i) a VAR-based long-run criterion, and (ii) forecast-based criteria. Evidence from Peru shows that WIMs are superior in terms of long-run performance, and that they could improve short-term (up-to-6-months) inflation forecasts.
    Keywords: Core inflation, wavelets, forecast, structural VAR
    JEL: C45 E31 E37 E52
    Date: 2011
  3. By: Andrés Felipe Giraldo; Martha Misas Arango; Edgar Villa Pérez
    Abstract: This article reconstructs the history of monetary policy of the central bank of Colombia in the period 1990 to 2010 in which explicit in‡ation targeting was adopted by October of 2000. To do so we developed theoretically a modi…ed Taylor rule with interest rate smoothing for an open and small economy and accordingly estimate a two regime Markov switching model which allows the switching dates to be endogenously determined. We …nd that one regime had explicit in‡ation targeting (from the year 2000 up to 2010) in which the in‡ation rate is a stationary series, given that the central bank enforced a monetary policy that satis…ed the Taylor principle. This in‡ation stabilizing regime did show up in some quarters before the year 2000 but was not the predominant. The other regime was the more prevalent during the 1990s but did not satisfy the Taylor principle allowing a unit root behavior of the in‡ation rate. Moreover we …nd that the central bank reacted aggressively during the 1990s to output ‡uctuations while having an accomodating behavior for this variable during explicit in‡ation targeting from 2000 onwards.
    Date: 2011–05–31
  4. By: Burton A. Abrams (Department of Economics,University of Delaware)
    Abstract: A variation of the Bernanke-Blinder credit-view model reveals that holding constant the money supply following various financial-sector shocks, including an autonomous drop in the money multiplier, is insufficient to prevent aggregate demand from decreasing.
    Keywords: credit-view model, monetary policy, money-supply model
    JEL: F41 E51
    Date: 2011
  5. By: Zhang, Zhichao; Shi, Nan; Zhang, Xiaoli
    Abstract: We build an optimising framework to analyse a class of economies that adopt an ECU-type basket currency while in transition to increased flexibility of the exchange rate regime. Instead of conventional basket pegging, such an economy uses an ECU-type currency index as a benchmark for monitoring and assessing exchange rate movements. This provides an anchoring device for the nation’s exchange rate regime and allows the home currency’s exchange rate to fluctuate. Under the assumption that the central bank is chiefly interested in maintaining stability, the optimal structure of the basket currency is based on its contribution to minimizing the volatility of the country’s external account. A currency invariance index is applied to capture the effect of the country’s exit from exclusive linkage with the US dollar. The approach is illustrated by Chinese exchange rate policy. We find it advisable and viable for China to form a basket currency with a diversified portfolio of currencies. While the portfolio’s weighting scheme could favour the dollar, euro and Japanese yen, we show that the composition of the basket is open to a wide range of possibilities. Moreover, contrary to general fears, there is considerable potential for China to engage in currency diversification, which will not necessarily affect the dollar’s position.
    Keywords: Exchange rate regime; Basket currency; Currency diversification
    JEL: E58 P45 F31
    Date: 2011–08–05
  6. By: Michael D. Bordo; Hugh Rockoff
    Abstract: This paper examines the influence of Irving Fisher’s writings on Milton Friedman’s work in monetary economics. We focus first on Fisher’s influences in monetary theory (the quantity theory of money, the Fisher effect, Gibson’s Paradox, the monetary theory of business cycles, and the Phillips Curve, and empirics, e.g. distributed lags.). Then we discuss Fisher and Friedman's views on monetary policy and various schemes for monetary reform (the k% rule, freezing the monetary base, the compensated dollar, a mandate for price stability, 100% reserve money, and stamped money.) Assessing the influence of an earlier economist's writings on that of later scholars is a challenge. As a science progresses the views of its earlier pioneers are absorbed in the weltanschauung. Fisher's Purchasing Power of Money as well as the work of Pigou and Marshall were the basic building blocks for later students of monetary economics. Thus, the Chicago School of the 1930s absorbed Fisher's approach, and Friedman learned from them. However, in some salient aspects of Friedman's work we can clearly detect a major direct influence of Fisher's writings on Friedman's. Thus, for example with the buildup of inflation in the 1960s Friedman adopted the Fisher effect and Fisher's empirical approach to inflationary expectations into his analysis. Thus, Fisher's influence on Friedman was both indirect through the Chicago School and direct. Regardless of the weight attached to the two influences, Fisher' impact on Friedman was profound.
    JEL: B21 B31 N10
    Date: 2011–08
  7. By: Paul Castillo; Luis Maertens Odria; Gabriel Rodríguez (Departamento de Economía - Pontificia Universidad Católica del Perú)
    Abstract: This paper analyzes whether the exchange rate pass-through into prices changed when the inflation targeting scheme was adopted in Peru. Firstly, a small dynamic stochastic general equilibrium model is simulated, which shows that adopting this scheme induces an increase in exchange rate volatility. Furthermore, applying the theory of the currency denomination of international trade, it is demonstrated that increased exchange rate volatility reduces the share of firms that set their prices in foreign currency (dollars). Given that the pass-though has a direct relationship with this share, it is shown that adopting inflation targeting generates a pass-through contraction. Secondly, we empirically test whether the Peruvian Central Bank’s decision to adopt inflation targeting in January 2002 actually had an effect on the pass-through estimating a time-varying vector autoregressive model which allows for an asymmetrical estimation of the pass-through. It provides parameters for both the pre and post inflation targeting regimes based on the assumption that the transition from one regime to the other is smooth. An analysis of the generalized impulse response functions reveals that the decision to adopt inflation targeting significantly decreased the exchange rate pass-throughs into import, producer, and consumer prices. The results are consistent with economic theory and are robust to the specification of parameters of the model.
    Keywords: Inflation targeting/exchange rate pass-through into prices/ TV-VAR models
    JEL: E52 E58 F31
    Date: 2011
  8. By: Winkelried, Diego (Central Reserve Bank of Peru.)
    Abstract: It has been widely documented that the exchange rate pass-through to domestic inflation has decreased significantly in most of the industralised world. As microeconomic factors cannot completely explain such a widespread phenomenon, a macroeconomic explanation linked to the inflationary environment - that a low and more stable inflation rate leads to a decrease in the pass-through - have gained popularity. Using a structural VAR framework, this paper presents evidence of a similar decline in the pass-through in Peru, a small open economy that gradually reduced inflation to international levels in order to adopt a fully-fledged inflation targeting scheme in 2002. It is argued that the establishment of a credible regime of low inflation has been instrumental in driving the exchange rate pass-through down.
    Keywords: Exchange rate pass-through, inflation targeting,structural VAR.
    JEL: C32 E31 E47 F31
    Date: 2011–07
  9. By: Harun Alp; Selim Elekdag
    Abstract: As an emerging economy, Turkey is an interesting case study because it was one of the hardest hit countries by the crisis, with a year-over-year contraction of 15 percent during the first quarter of 2009. At the same time, anticipating the fallout from the crisis, the Central Bank of the Republic of Turkey (CBRT) decreased policy rates by an astounding 1025 basis points over the November 2008 to November 2009 period. In this context, this paper addresses the following broad question: If an inflation targeting framework underpinned by a flexible exchange rate regime was not adopted, how much deeper would the recent recession have been? Taking the most intense year of the crisis as our baseline, namely 2009, counterfactual simulations indicate that rather than the actual contraction of –4.8 percent, the growth outturn would have been –6.2 percent if the CBRT had not implemented countercyclical and discretionary interest rate cuts. Further, if a fixed exchange rate regime was instead in place, then the counterfactual simulations indicate a growth rate of –8.0 percent in 2009. In other words, the interest rate cuts implemented by the CBRT and exchange rate flexibility both helped substantially soften the impact of the global financial crisis. These counterfactual experiments are based on an estimated structural model which along with standard nominal and real rigidities, include a financial accelerator mechanism in an open-economy framework.
    Keywords: Financial Accelerator, Bayesian Estimation, DSGE Model, Financial Crises, Sudden Stops, Monetary Policy, Turkey, Emerging Economies, Emerging Markets
    JEL: E5 F3 F4 C11
    Date: 2011
  10. By: Alberto Humala; Gabriel Rodríguez (Departamento de Economía - Pontificia Universidad Católica del Perú)
    Abstract: Following the approach of MÈsonnier and Renne (2007), we estimate a Natural Rate of Interest (NRI) using quarterly Peruvian data for the period 1996:3-2008:3. The model has six equations and it is estimated using the Kalman Ölter with output gap and NRI as unobservable variables. Estimation results indicate a more stable NRI in period 2001:3-2008:3 than in period 1996:3-2001:2 and also more stable than the observed real interest rate. Real interest rate gap (di§erence between real and natural rates), which measures monetary policy stance, indicates a restrictive policy for 1996-2001. Results also show a negative interest rate gap onwards, suggesting a less restrictive policy.
    Keywords: Interest Rate / Natural Interest Rate / Kalman Filter / Output Gap / Unobserved Components.
    JEL: C32 E32 E43 E52
    Date: 2011
  11. By: Syed tehseen, jawaid; Faisal sultan, qadri; Nasir, ali
    Abstract: This study empirically examines the effect of monetary, fiscal and trade policy on economic growth in Pakistan using annual time series data from 1981 to 2009. Money supply, government expenditure and trade openness are used as proxies of monetary, fiscal and trade policy respectively. Cointegration and error correction model indicate the existence of positive significant long run and short run relationship of monetary and fiscal policy with economic growth. Result also indicates that monetary policy is more effective than fiscal policy in Pakistan. In contrast, trade policy has insignificant effect on economic growth both in the short run and in the long run. In light of the findings, it is suggested that the policy makers should focus more on monetary policy in order to ensure economic growth in the country. It is also recommended that further research should be conducted to find out such components of exports and imports which lead to the ineffectiveness of trade policy to enhance economic growth in Pakistan.
    Keywords: Monetary; Fiscal; Trade; Economic Growth
    JEL: E62 F13 E42 F43
    Date: 2011–07–21
    Abstract: This study aims to assess the scope for monetary policymakers to aggregate probabilistic interest rate advice. The members of a Shadow Board give probabilistic assessments of the appropriate (target) interest rate for Australia in real time. The pilot project will be running in August, September and October 2011, with the Shadow Board giving advice shortly before each decision by the Reserve Bank of Australia (RBA) Board.
    Date: 2011–08
  13. By: Mahir Binici; Yin-Wong Cheung
    Abstract: Using exchange rate data on five currencies vis-à-vis the US dollar, this paper examines the insample and out-of-sample performance of exchange rate equations derived from alternative empirical and optimal interest rate rules. These rules could have either homogeneous or heterogeneous response coefficients. Our exercise shows that these exchange rate equations do not offer good in-sample explanatory power consistently across currencies and over time. The relative forecasting performance of these exchange rate equations tend to vary across currencies and over time and bears limited relationship with the relative in-sample performance. When the forecast performance is compared with a random walk model, these exchange rate equations offer no better performance under the usual MSFE criterion but are better when the ability of predicting the direction of change is considered.
    Keywords: Taylor Rule, Exchange Rate Determination, Forecast Comparison, Mean Squared Forecast Error, Direction of Change
    JEL: F31 E52 C52
    Date: 2011
  14. By: Olatunji, G.B.; Omotesho, O.A.; Ayinde, Opeyemi E.; Ayinde, K.
    Abstract: Inflation is undeniable one of most leading and dynamics macroeconomics issues confronting almost all economies of the world. Its dynamism has made it an imperative issue to be considered. Hence the study examines the factors affecting inflation in Nigeria. Time series data were employed for the study. The data was sourced from the Central Bank of Nigeria and National Bureau of Statistics. Descriptive statistics and cointegration analysis were the analytical tools used. It was observed that there were variations in the trend pattern of inflation rate. Some of the variables considered were significant in determining inflation in Nigeria. The previous total export was found to have a negative impact on current inflation while the previous total import exerts a positive effect likewise the food price index. It has thus been recommended that policies that will set the interest rate to a level at which it will encourage investment and increase in production level could be institutionalized, importation should be reduced in Nigeria such that it will not encourage change of consumer taste resulting to inflating prices, exchange rate system should be maintained at a level that will not impose threat on the Nigeria economy and the domestic consumption of petroleum product should be focused, not only exportation.
    Keywords: Financial Economics,
    Date: 2010–09
  15. By: Yap, Josef T. (Asian Development Bank Institute)
    Abstract: Many have argued that the major source of the existing global macroeconomic imbalances are the twin deficits of the United States (US). However, there is still a debate about whether the global imbalances indeed pose a significant threat to the world economy. This paper analyzes whether current efforts in East Asia in terms of financial and monetary cooperation and rebalancing of economic growth could significantly mitigate the adverse impacts of a global system that will still be dominated by the US dollar in the foreseeable future. It also explains why the People’s Republic of China is unlikely to make significant unilateral adjustments to reduce global macroeconomic imbalances.
    Keywords: east asia; global macroeconomic imbalances; rebalancing economic growth; financial and monetary cooperation
    JEL: F31 F33
    Date: 2011–08–04
  16. By: Farley Grubb
    Abstract: An alternative history of the Continental Dollar is constructed from the original resolutions passed by Congress. The Continental Dollar was a zero-interest bearer bond, not a fiat currency. The public could redeem it at face value in specie at fixed future dates. Being a zero-interest bearer bond, discounting must be separated from depreciation. Before 1779 there was no depreciation, only discounting. In 1779 and again in 1780 Congress passed ex post facto laws which altered the redemption dates of past Continental Dollars in ways that were not fiscally credible. These laws were the turning point. Depreciation and collapse followed.
    JEL: E42 E52 G12 G18 H11 H56 H6 H71 N11 N21 N41
    Date: 2011–08
  17. By: Yamin Ahmad (Department of Economics, University of Wisconsin - Whitewater); Ming Chien Lo (Department of Economics, St Cloud State University); Olena Mykhaylova (Department of Economics, University of Richmond)
    Abstract: This paper investigates the time series properties of real exchange rates series produced by DSGE models. We simulate a variety of new open economy DSGE models that incorporate features such as local currency pricing, home bias, non-traded goods and incomplete markets. We attempt to ascertain whether the dynamics of the real exchange rate in this class of models are consistent with those found in the time series literature using data from the current floating period. Although none of the basic specifications we consider match the volatility in the raw data, our findings suggest that home bias in consumption and non-traded goods are the key components of DSGE models that are able to generate persistent real exchange rates, comparable to that in the data. Moreover, we find that some of the structural micro-level nonlinearity embedded within DSGE models may be represented as macro-level nonlinearity in the form of a smooth transition autoregressive process, which has previously been found to pprsimoniously characterize the dynamics of real exchange rates in the time series literature.
    Keywords: Real Exchange Rate Dynamics, Nonlinear Dynamics, DSGE Modeling, Smooth Transition Estimation, Simulations
    JEL: F41
    Date: 2011–01

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