nep-mon New Economics Papers
on Monetary Economics
Issue of 2012‒01‒10
nine papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Clarity of Central Bank Communication About Inflation By Ales Bulír; Martin Cihák; David-Jan Jansen
  2. Testing for Explosive Behaviour in Relative Inflation Measures: Implications for Monetary Policy By Vipin Arora; Pedro Gomis-Porqueras; Shuping Shi
  4. Turkey's trilemma trade-offs By Cortuk, Orcan; Singh, Nirvikar
  5. World Technology Shocks and the Real Euro-Dollar Exchange Rate By Lambrias, Kyriacos
  6. Periodic Sequences of Arbitrage: A Tale of Four Currencies By Rod Cross; Victor Kozyakin; Brian O'Callaghan; Alexei Pokrovskii; Alexey Pokrovskiy
  7. Assessing real exchange rate misalignments By Kubota, Megumi
  8. Financial dollarization in Russia: causes and consequences By Ponomarenko, Alexey; Solovyeva, Alexandra; Vasilieva, Elena
  9. Measuring market liquidity: An introductory survey By Alexandros Gabrielsen; Massimiliano Marzo; Paolo Zagaglia

  1. By: Ales Bulír; Martin Cihák; David-Jan Jansen
    Abstract: This paper examines whether the clarity of central bank communication about inflation has changed with the economic environment. We use readability statistics and content analysis to study the clarity of communication on the inflation outlook by seven central banks between 1997 and 2010. Overall, we find no strong indications that central banks were less clear in explaining their policies when faced with higher uncertainty or a less favorable inflation outlook. The global financial crisis, however, did have a negative impact on clarity of central bank communication.
    Keywords: monetary policy; communication; inflation; clarity; transparency
    JEL: E52 E58
    Date: 2011–12
  2. By: Vipin Arora; Pedro Gomis-Porqueras; Shuping Shi
    Abstract: In this paper we test for large deviations in headline measures of the price level relative to core measures using the recently proposed test of Phillips et al. (2011a). We find evidence of explosive behaviour in the headline price index of personal consumption expenditures (PCE) relative to the core PCE (less food and energy prices) on three occasions from 1982-2010. Two of these episodes correspond to energy supply shocks (OPEC price collapse of 1986 and Hurricane Katrina). The third one is during March 2008 through September 2008 which seems to be driven by both food and energy prices as these indices exhibit explosive behaviour. We also find evidence suggesting that inflation expectations behave differently under normal and explosive periods. In particular, unemployment and interest rates also help predict inflation expectations during explosive episodes relative to normal times. Furthermore, explosive episodes in the relative measure between headline and core inflation is found to be more important than the relative volatile periods implied by a Markov-switching model when studying inflation expectations. The findings of this paper suggest that explosive behaviour of headline versus core PCE should be taken into account when conducting monetary policy as it is a key determinant in consumers’ inflation expectations.
    Keywords: Explosive behaviour, core inflation, relative measure, inflation expectations
    JEL: C5 E31
    Date: 2011–12
  3. By: Rangan Gupta (Department of Economics, University of Pretoria)
    Abstract: Empirical evidence on the whether the inflation-targeting South African Reserve Bank (SARB) should also consider responding to exchange rate fluctuations, are contradictory. Against this backdrop of contradictory evidence, we revisit the issue by questioning if the inflation rate is more volatile than it would have been had South Africa not moved to a flexible exchange rate regime in 1995, using the cosine-squared cepstrum. We find that the CPI inflation in South Africa has become more volatile since the second quarter of 1995, post a flexible exchange rate regime, than it would have been had the country continued to pursue a fixed exchange rate policy. Based on this result, we can conclude that the SARB should perhaps respond to exchange rate fluctuations, however, we also warn against the cost of increased volatility in output that is likely to result from targeting exchange rate variability.
    Keywords: Cosine-Squared Cepstrum, Exchange Rate Regime, Inflation Targeting, Inflation Volatility, Output Volatility, Saphe Cracking
    JEL: C65 E42 E52 E64 F31
    Date: 2012–01
  4. By: Cortuk, Orcan; Singh, Nirvikar
    Abstract: In this paper, we study the trilemma configuration of the Turkish economy. The paper starts by empirically testing the Mundell-Fleming theoretical concept of an “impossible trinity” (trilemma) for Turkey, following the Aizenman, Chinn and Ito (ACI) approach. This includes calculating the trilemma indices and investigating their evolution over the period of 1998Q1-2010Q4, which is split into sub-samples according to the Turkey’s macroeconomic policies. We also introduce alternative empirical techniques in order to deal with possible misspecification problems detected in the ACI approach. These techniques include employing additional terms in the regression, Two Stage Least Squares and Kalman filtering. These analyses show how contributions of financial integration and monetary independence have increased from the first period to the last, with corresponding limitations on exchange rate stability. The analysis continues by exploring the implications of changes in the trilemma indices for inflation. Accordingly, it reveals evidence that trilemma indices have impacts on inflation for the period of 2003-2010. Finally, it finds that there is a key role for international reserves as trilemma trade-offs and their effects on inflation can be mitigated with their accumulation. *
    Keywords: Trilemma; exchange rate stability; monetary independence; capital openness; reserve accumulation
    JEL: F15 F32 F41 F31
    Date: 2011–12
  5. By: Lambrias, Kyriacos
    Abstract: We extend the empirical SVAR literature on real exchange rates by extracting a common stochastic trend in productivity, interpreted as a permanent world technology shock. Overall, we find that innovations to world technology constitute an important, albeit not the dominant, source of movements in the real euro-dollar exchange rate. First, the dollar appreciates significantly in response to such an impulse. Second, the world technology shock accounts for approximately one-fifth of the variance of the forecast error in the real euro-dollar rate at business-cycle frequencies. Our results are in line with previous studies who find that demand or nominal shocks are the dominant sources of fluctuations in relative prices and provides limited support to productivity-based models of real exchange rate determination.
    Keywords: Euro-Dollar Real Exchange Rate, World Technology Shocks, Structural VAR
    JEL: C32 F41 E32
    Date: 2011–12–15
  6. By: Rod Cross; Victor Kozyakin; Brian O'Callaghan; Alexei Pokrovskii; Alexey Pokrovskiy
    Abstract: This paper investigates arbitrage chains involving four currencies and four foreign exchange trader-arbitrageurs. In contrast with the three-currency case, we find that arbitrage operations when four currencies are present may appear periodic in nature, and not involve smooth convergence to a "balanced" ensemble of exchange rates in which the law of one price holds. The goal of this article is to understand some interesting features of sequences of arbitrage operations, features which might well be relevant in other contexts in finance and economics.
    Date: 2011–12
  7. By: Kubota, Megumi
    Abstract: There is a renewed debate on the role of exchange rate policies as an industrial policy tool in both academic and policy circles. Policy practitioners usually examine real exchange rate misalignments to monitor the behavior of this key relative price and, if possible, exploit distortions in the traded and non-traded relative price to promote growth. Anecdotal evidence shows that some countries have pursued very active exchange rate policies to promote the export sector and enhance growth by undervaluing their currencies. The main goal of this paper is to provide a systematic characterization of real exchange rate undervaluations. The long-run real exchange rate equation is estimated using: (a) Johansen time series cointegration estimates, and (b) pooled mean group estimates for non-stationary panel data. The paper constructs a dataset of real undervaluation episodes. It first evaluates whether (and if so, to what extent) economic policies can be used to either cause or sustain real undervaluations. In this context the paper empirically models the likelihood and magnitude of sustaining real exchange rate undervaluations by examining their link to policy instruments (such as exchange rate regimes and capital controls, among other policies) using probit and Tobit models. Finally, it investigates whether foreign exchange intervention can generate persistent real exchange rate deviations from equilibrium. In general, it finds that intervention can lead to greater persistence in the incidence and magnitude of real exchange rate undervaluations.
    Keywords: Currencies and Exchange Rates,Debt Markets,Economic Theory&Research,Economic Stabilization,Emerging Markets
    Date: 2011–12–01
  8. By: Ponomarenko, Alexey (BOFIT); Solovyeva, Alexandra (BOFIT); Vasilieva, Elena (BOFIT)
    Abstract: We review some aspects of financial dollarization in Russia, applying the main relevant theories to analyze the dynamics of several dollarization indicators. An econometric model of the short run dynamics of deposit and loan dollarization is estimated for the last decade. We find that ruble appreciation was the main driver of the de-dollarization that occurred then and of the later episode of renewed dollarization. We estimate the overall (and sectoral) currency mismatches of the Russian economy. The results show a gradual improvement of the net foreign currency position of the public sector, where we have seen significant accumulation of international reserves by the Bank of Russia and repayment of government debt. Evidence is also presented for the significant currency risk vulnerability of the nonbanking private sector. Several existing empirical studies are examined in order to assess the growth losses of the Russian economy following the crisis of 2008, which was linked with the financial dollarization.
    Keywords: financial dollarization; currency mismatch; balance sheet effects; Russia
    JEL: E44 F34 G32
    Date: 2012–01–02
  9. By: Alexandros Gabrielsen; Massimiliano Marzo; Paolo Zagaglia
    Abstract: Asset liquidity in modern financial markets is a key but elusive concept. A market is often said to be liquid when the prevailing structure of transactions provides a prompt and secure link between the demand and supply of assets, thus delivering low costs of transaction. Providing a rigorous and empirically relevant definition of market liquidity has, however, provided to be a difficult task. This paper provides a critical review of the frameworks currently available for modelling and estimating the market liquidity of assets. We consider definitions that stress the role of the bid-ask spread and the estimation of its components that arise from alternative sources of market friction. In this case, intra-daily measures of liquidity appear relevant for capturing the core features of a market, and for their ability to describe the arrival of new information to market participants.
    Date: 2011–12

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