nep-mon New Economics Papers
on Monetary Economics
Issue of 2011‒08‒22
twenty papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Inflation Aversion By Heng-fu Zou; Liutang Gong; Xinsheng Zeng
  2. Exchange Rate Pass-Through and Monetary Integration in the Euro Area By Ayako Saiki
  3. Inflation persistence: Implication for a monetary union in the Caribbean By Juan Carlos Cuestas; Carlyn Dobson
  4. Inflation Aversion and the Optimal Inflation Tax By Gaowang Wang; Heng-fu Zou
  5. On the implementation of Markov-perfect monetary policy By Michael Dotsey; Andreas Hornstein
  6. Optimal monetary policy in a model of money and credit By Pedro Gomis-Porqueras; Daniel R. Sanches
  7. Bank concentration and the interest rate pass-through in Sub-Saharan African countries By T. Mangwengwende; Z. Chinzara; H. Nel
  8. Money, interest rates and the real activity By Hong, Hao
  9. Central banks and macroprudential policy. Some reflections from the Spanish experience By Enrique Alberola; Carlos Trucharte; Juan Luis Vega
  10. "The Continental Dollar: Initial Design, Ideal Performance, and the Credibility of Congressional Commitment" By Farley Grubb
  11. Working Paper 134 - Inflation Targeting, Exchange Rate Shocks and Output: Evidence from South Africa By AfDB
  12. Inflation Inertia in Egypt and its Policy Implications By Kenji Moriyama
  13. Exchange Rate Dynamics and Fundamental Equilibrium Exchange Rates By Jamel Saadaoui
  14. Inefficient Provision of Liquidity By Hart, Oliver; Zingales, Luigi
  15. Foreign Exchange Intervention: A Shield Against Appreciation Winds? By Gustavo Adler; Camilo E Tovar Mora
  16. A Framework to Analyze the Impact of Exchange Rate: Uncertainty on Output Decisions By Gonzalo Varela
  17. Determinants of Interest Rate Pass-Through: Do Macroeconomic Conditions and Financial Market Structure Matter? By Nikoloz Gigineishvili
  18. Exchange Rate Misalignments and World Imbalances: a FEER Approach for Emerging Countries By Nabil Aflouk; Se-Eun Jeong; Jacques Mazier; Jamel Saadaoui
  19. How much you know matters: A note on the exchange rate disconnect puzzle By Onur, Esen
  20. Individual and Aggregate Money Demands By André C. Silva

  1. By: Heng-fu Zou (Central University of Finance and Economics; Shenzhen University; Wuhan University; Peking University); Liutang Gong (Guanghua School of Management, Peking University); Xinsheng Zeng (Wuhan University)
    Abstract: With inflation aversion, an increase in the monetary growth rate decreases the steady-state value of capital stock, consumption, and real balance holding.
    Keywords: Inflation aversion, Capital accumulation, Money
    JEL: D91 E63 O23
    Date: 2011
  2. By: Ayako Saiki
    Abstract: The purpose of this study is to examine how monetary integration affects the exchange rate pass-through, by testing whether monetary policy convergence in the euro area led to a convergence in terms of exchange rate pass-through. We conduct a comparative study between the “experiment group” (the euro area) and the “control group” (non-euro industrial countries). We find evidence for stronger convergence of exchange rate pass-through for the euro area economies as a group, especially around the 1980s. The group of non-euro industrial countries also had conditional convergence (convergence with permanent cross-sectional heterogeneity) in exchange rate pass-through, but its cross-sectional dispersion remains substantially larger compared to the euro area. This indicates that monetary integration affects the exchange rate pass-through. This has an important policy implication for the euro area, especially for the new member countries, as their exchange rate pass-through would not remain constant or purely exogenous; it should also converge to the euro area average as they work to achieve the Maastricht Criteria.
    Keywords: Monetary Policy; Central Banks and Their Policies; International Monetary Arrangements and Institutions
    JEL: E52 E58 F33
    Date: 2011–08
  3. By: Juan Carlos Cuestas (Department of Economics, The University of Sheffield); Carlyn Dobson (Division of Economics, Nottingham trent University)
    Abstract: In this paper we aim to shed some light on the potential for creating a monetary union in the Caribbean. We analyse the inflation rates for twelve countries using various time series methods. The results show that the inflation rates are mean reverting processes and that there is evidence of a convergence club in inflation rates within the area, which contradicts previous studies. Our contribution implies good news for the creation of a common central bank in the Caribbean.
    Keywords: Caribbean, inflation persistence, monetary union and unit roots
    JEL: C32 F15
    Date: 2011–08
  4. By: Gaowang Wang (School of Economics and Management, Wuhan University); Heng-fu Zou (CEMA, Central University of Finance and Economics; China School of Advanced Study (SAS), Shenzhen University; IAS, Wuhan University; GSM, Peking University)
    Abstract: The optimal inflation tax is reexamined in the framework of dynamic second best economy populated by individuals with inflation aversion. A simple formula for the optimal inflation rate is derived. Different from the literature, it is shown that if the marginal excess burden of other distorting taxes approaches zero, Friedman's rule for optimum quantity of money is not optimal, and the optimal inflation tax is negative; if the marginal excess burden of other taxes is nonzero, the optimal inflation rate is indeterminate and relies on the tradeoffs between the impatience effect of inflation and the effects of other economic forces in the monetary economy.
    Keywords: Inflation aversion, Optimal inflation tax, Second best taxation, The friedman rule
    JEL: E31 E41 E52 H21
    Date: 2011
  5. By: Michael Dotsey; Andreas Hornstein
    Abstract: The literature on optimal monetary policy in New Keynesian models under both commitment and discretion usually solves for the optimal allocations that are consistent with a rational expectations market equilibrium, but it does not study whether the policy can be implemented given the available policy instruments. Recently, King and Wolman (2004) have provided an example for which a time-consistent policy cannot be implemented through the control of nominal money balances. In particular, they find that equilibria are not unique under a money stock regime and they attribute the non-uniqueness to strategic complementarities in the price-setting process. The authors clarify how the choice of monetary policy instrument contributes to the emergence of strategic complementarities in the King and Wolman (2004) example. In particular, they show that for an alternative monetary policy instrument, namely, the nominal interest rate, there exists a unique Markov-perfect equilibrium. The authors also discuss how a time-consistent planner can implement the optimal allocation by simply announcing his policy rule in a decentralized setting.
    Keywords: Monetary policy ; Interest rates ; Money supply
    Date: 2011
  6. By: Pedro Gomis-Porqueras; Daniel R. Sanches
    Abstract: The authors investigate the extent to which monetary policy can enhance the functioning of the private credit system. Specifically, they characterize the optimal return on money in the presence of credit arrangements. There is a dual role for credit: It allows buyers to trade without fiat money and also permits them to borrow against future income. However, not all traders have access to credit. As a result, there is a social role for fiat money because it allows agents to self-insure against the risk of not being able to use credit in some transactions. The authors consider a (nonlinear) monetary mechanism that is designed to enhance the credit system. An active monetary policy is sufficient for relaxing credit constraints. Finally, they characterize the optimal monetary policy and show that it necessarily entails a positive inflation rate, which is required to induce cooperation in the credit system.
    Keywords: Monetary policy ; Money ; Credit
    Date: 2011
  7. By: T. Mangwengwende; Z. Chinzara; H. Nel
    Abstract: This study investigates the link between bank concentration and interest rate pass-through (IRPT) in four sub-Saharan countries. It also analyses whether there is asymmetry in IRPT and whether such asymmetry is related to changes in bank concentration. By applying a number of econometric methods including Asymmetric Error Correction Models, Mean Adjustment Lag (MAL) models and Autoregressive Distributed Lag models on monthly data for the period 1994-2007, the study found some evidence of a relationship between bank concentration and IRPT in all four countries. However, the results reveal that bank concentration has a stronger influence on the magnitude of its adjustment rather than its speed. Of particular note in this investigation is the fact that the findings support both the Structure-Conduct-Performance hypothesis and the competing Efficient-Structure hypothesis in the banking industries of the four countries. While there is some evidence supporting the view that bank lending and deposit rates adjust asymmetrically to changes in policy rates, there is very limited evidence that these asymmetries are a result of bank concentration. The key implication of the result for African countries is that increased bank concentration through bank consolidation programmes designed to strengthen banking industries should not be viewed with cynicism in so far as monetary policy transmission is concerned because concentration does not necessarily undermine the effectiveness of monetary policy.
    Keywords: Bank Concentration Monetary Policy Interest Rate Pass-Through Asymmetric Adjustment Sub-Saharan Africa
    JEL: E52 E58 G28
    Date: 2011
  8. By: Hong, Hao (Cardiff Business School)
    Abstract: This paper examines the effectiveness of monetary aggregates through various nominal interest rates by integrating the financial sector into the Cash-in-Advance (CIA) economy. The model assumes that there are two types of representative agents in the financial sector, which are: productive banks and financial intermediates. The productive banks supply a financial service, which is an exchange technology service to households and financial intermediates receive savings fund from savers and offer loans to borrowers. The monetary expansions are increased banking costs through the rate of inflation. It leads households to use more exchange credit relative to cash at the goods market. Since the number of savings funds is equal to the number of exchange credits used at the goods market, money injections are lower the nominal interest rate on saving as the saving fund increases with exchange credit. By assuming that firms are the only borrowers at the capital market from Fuerst (1992), a lower nominal interest rate on the saving fund reduces the marginal cost of labour and increases labour demand. Meanwhile, the increasing marginal cost of money through the expected inflation effect has a negative effect on labour supply. With labour demand dominating labour supply effects, both output and employment increase with monetary expansion. The paper is able to generate a decreasing nominal interest rate with an increasing money supply with an absence of limited participation monetary shocks from Lucas (1990); and by allowing firms to borrow wage bills payment from financial intermediates, it examines the positive response of aggregate output subject to monetary expansion under flexible price framework.
    Keywords: monetary transmission; business cycles; banking sector; interest rates
    JEL: E10 E44 E51
    Date: 2011–07
  9. By: Enrique Alberola (Banco de España); Carlos Trucharte (Banco de España); Juan Luis Vega (Banco de España)
    Abstract: The view that central banks must play a greater role in preserving financial stability has gained considerable ground in the aftermath of the crisis and macroprudential policy has become a central pillar to deal with financial stability. The policy frame of macroprudential policy, its toolbox and interactions with other policies is not completely established yet, though. In this context, Spain’s ten-year experience with its dynamic provision is a key reference. The analysis shows that, during the current financial crisis, dynamic provisions have proved useful to mitigate —to a limited extent— the build-up of risks and, above all, to provide substantial loss absorbency capacity to the financial institutions, suggesting that it could be an important tool for other banking systems. However, it is not the macro-prudential panacea: it needs to be complemented and be consistent with the rest of policies, either within the macro-prudential or in the broader context of macroeconomic management, including monetary policy. While there is a higher awareness of the contribution of monetary policy to financial stability, its role is in practice limited. The case of the euro area is particularly telling in this respect: macro-financial imbalances developed in sectors where financial integration was low and the effects hence were confined to the domestic economies. The asymmetry between a supranational monetary policy plus macroprudential surveillance and domestic implementation of macroprudential policies raises a set of issues which are worth exploring.
    Keywords: Macroprudential policy, Dynamic provision, Central banks
    JEL: E52 E58 G28
    Date: 2011–08
  10. By: Farley Grubb (Department of Economics,University of Delaware)
    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.
    Keywords: American Revolution; war financing; debt retirement; fiat money; bearer bonds; monetary denominations; congressional spending; currency depreciation; U.S. Constitution; founding fathers; Benjamin Franklin; state tax rates.
    JEL: E42 E52 G12 G18 H11 H56 H60 H71 H83 N11 N21 N41
    Date: 2011
  11. By: AfDB
    Date: 2011–08–11
  12. By: Kenji Moriyama
    Abstract: This paper investigates the degree of inflation inertia in Egypt and its determinants using the cross country data consisting of over 100 countries. Medium-unbiased estimator of inflation inertia in Egypt is high compared to other countries, as indicated by its location around the upper quartile among the sample. The cross country analysis indicates that counter-cyclical macroeconomic policy and fiscal consolidation are a key to reduce inflation inertia and the costs of disinflation.
    Keywords: Business cycles , Cross country analysis , Egypt , Fiscal consolidation , Inflation , Monetary policy ,
    Date: 2011–07–11
  13. By: Jamel Saadaoui (CEPN - Centre d'Economie de l'Université Paris Nord - Université Paris-Nord - Paris XIII - CNRS : UMR7234)
    Abstract: The paper investigates if the most popular alternative to the purchasing parity power approach (PPP) to estimate equilibrium exchange rates, the fundamental equilibrium exchange rate (FEER) influences exchange rate dynamics in the long run. For a large panel of industrialized and emerging countries and on the period 1982-2007, we detect the presence of unit roots in the series of real effective exchange rates and in the series of FEERs. We find and estimate a cointegration relationship between real effective exchange rates and FEERs. The results show that the FEER has a positive and significant influence on exchange rate dynamics in the long run.
    Keywords: Fundamental equilibrium exchange rates; Panel unit root tests; Global imbalances; Fully modified ordinary least square; Dynamic ordinary least square; Pooled Mean Group
    Date: 2011–07–06
  14. By: Hart, Oliver; Zingales, Luigi
    Abstract: We study an economy where the lack of a simultaneous double coincidence of wants creates the need for a relatively safe asset (money). We show that, even in the absence of asymmetric information or an agency problem, the private provision of liquidity is inefficient. The reason is that liquidity affects prices and the welfare of others, and creators do not internalize this. This distortion is present even if we introduce lending and government money. To eliminate the inefficiency the government must restrict the creation of liquidity by the private sector.
    Keywords: banking; liquidity; money
    JEL: E41 E51 G21
    Date: 2011–08
  15. By: Gustavo Adler; Camilo E Tovar Mora
    Abstract: This paper examines foreign exchange intervention practices and their effectiveness using a new qualitative and quantitative database for a panel of 15 economies covering 2004 - 10, with special focus on Latin America. Qualitatively, it examines institutional aspects such as declared motives, instruments employed, the use of rules versus discretion, and the degree of transparency. Quantitatively, it assesses the effectiveness of sterilized interventions in influencing the exchange rate using a two-stage IV-panel data approach to overcome endogeneity bias. Results suggest that interventions slow the pace of appreciation, but the effects decrease rapidly with the degree of capital account openness. At the same time, interventions are more effective in the context of already ‘overvalued’ exchange rates.
    Keywords: Central banks , Exchange markets , Exchange rates , Foreign exchange , Intervention , Latin America , Reserves ,
    Date: 2011–07–13
  16. By: Gonzalo Varela (Department of Economics, University of Sussex)
    Abstract: Southern Cone economies exhibit a high record of exchange rate volatility. In this context, rms tend to contract dollar debt, irrespective of their trade orientation, and without available hedging instruments. This exposes them to bankruptcy risk, in the event of large exchange rate movements. This paper provides a framework to analyze the output eect of exchange rate uncertainty in that context, by focusing on the channel uncertainty-output that operates through the nancial strategy of the rm. We nd that increases in exchange rate uncertainty increase the probability of bankruptcy, thus increasing expected marginal bankruptcy costs, and reducing optimal output of a risk-neutral rm. Furthermore, we nd that rms with higher than average liquidity balances will face lower marginal bankruptcy costs, thus producing more than the average rm. The model displays persistence, as any shock to current prots aects future liquidity balances, and so, future output. This framework can easily be extended to explain the response of other rms' decisions to exchange rate uncertainty, such as investment.
    Keywords: Exchange rates, Bankruptcy Costs, Production Under Uncertainty
    JEL: F31 G33 D81
    Date: 2011–08
  17. By: Nikoloz Gigineishvili
    Abstract: Numerous empirical studies have found that the strength of the interest rate pass-through varies markedly across countries and markets. The causes of such heterogeneity have attracted considerably less attention so far. Unlike other studies that mainly focus on small groups of mostly developed and emerging markets in the same region, this paper expands the cross-sectional coverage to 70 countries from all regions, including low income, emerging and developed countries. It uses a wide range of macroeconomic and financial market structure variables to uncover structural determinants of pass-through. The paper finds that per capita GDP and inflation have positive effects on pass-through, while market volatility has a negative effect. Among financial market variables exchange rate flexibility, credit quality, overhead costs, and banking competition were found to strengthen pass-through, whereas excess banking liquidity to impede it.
    Date: 2011–07–27
  18. By: Nabil Aflouk (CEPN - Centre d'économie de l'Université de Paris Nord - CNRS : UMR7115 - Université Paris-Nord - Paris XIII); Se-Eun Jeong (CEPN - Centre d'économie de l'Université de Paris Nord - CNRS : UMR7115 - Université Paris-Nord - Paris XIII); Jacques Mazier (CEPN - Centre d'économie de l'Université de Paris Nord - CNRS : UMR7115 - Université Paris-Nord - Paris XIII); Jamel Saadaoui (CEPN - Centre d'économie de l'Université de Paris Nord - CNRS : UMR7115 - Université Paris-Nord - Paris XIII)
    Abstract: Since the mid-1990s, the world imbalances have increased significantly with a large US current deficit facing Asian surpluses, mainly Chinese. Since 2007, a partial reduction of these imbalances has been obtained, largely thanks to production's decreases, without large exchange rate adjustments. The Asian surpluses have remained important. The objective of this paper is to examine the exchange rate misalignments (ERM) of the main emerging countries in Asia and Latin America since the 1980s, so as to shed light on the 2000s by a long term analysis and compare with the industrialized countries' case. Our results confirm that ERM have been reduced since the mid-2000s at the world level, but the dollar remained overvalued against the East Asian countries, except the yen. Chinese, Indian and Brazilian exchange rate policies have been much contrasted since the 1980s. The Indian rupee has been more often overvalued while a more balance situation prevailed in Brazil only since the 2000s. The Latin American countries have faced wider and more dispersed ERM and current imbalances than East Asian countries. But Argentina, Chile and Uruguay benefits now of undervalued currencies while Mexico is closer to equilibrium.
    Keywords: Equilibrium Exchange Rate, Current Account Balance, Macroeconomic Balance, Emerging Countries
    Date: 2011
  19. By: Onur, Esen
    Abstract: This paper offers a dynamic model of the foreign exchange market where some investors in the market are more informed than others. By adjusting the proportion of informed investors in the market, it is shown that the disconnect between macroeconomic variables and the exchange rate is sensitive to the amount of asymmetric information in the market. A surprising fi…nding is that this disconnect is bigger when the proportion of informed investors in the market is smaller.
    Keywords: Market microstructure; Foreign exchange market; Asymmetric information
    JEL: D82 F31
    Date: 2011
  20. By: André C. Silva
    Abstract: I construct a model in which money and bond holdings are consistent with individual decisions and aggregate variables such as production and interest rates. The agents are infinitely-lived, have constant-elasticity preferences, and receive a fraction of their income in money. Each agent solves a Baumol-Tobin money management problem. Markets are segmented because financial frictions make agents trade bonds for money at different times. Trading frequency, consumption, government decisions and prices are mutually consistent. An increase in inflation, for example, implies higher trading frequency, more bonds sold to account for seigniorage, and lower real balances. JEL codes:E3, E4, E5
    Keywords: money demand, cash management, inventory problem, market segmentation
    Date: 2011

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