nep-mon New Economics Papers
on Monetary Economics
Issue of 2012‒07‒23
thirty-six papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. In flation Targeting, Credibility and Non-Linear Taylor Rules By Matthias Neuenkirch; Peter Tillmann
  2. Determinacy, Learnability, Plausibility, and the Role of Money in New Keynesian Models By Bennett T. McCallum
  3. Milton Friedman's Contributions to Macroeconomics and Their Influence By David Laidler
  4. Monetary Commitment and Structural Reforms: A Dynamic Panel Analysis for Transition Economies By Ansgar Belke; Lukas Vogel
  5. Market and Non-Market Monetary Policy Tools in a Calibrated DSGE Model for Mainland China By Chen, Qianying; Funke, Michael; Paetz, Michael
  6. U.S. monetary policy: a view from macro theory By William T. Gavin; Benjamin D. Keen
  7. F.A. Hayek and his rational choice of monetary arrangements By Sahoo, Ganeswar
  8. Monetary policy transmission mechanism in Poland. What do we know in 2011? By Tomasz Łyziak; Oksana Demchuk; Jan Przystupa; Anna Sznajderska; Ewa Wróbel
  9. Static and Dynamic Effects of Central Bank Transparency. By Meixing Dai
  10. Monetary Policy in a World Where Money (Also) Matters By Makram El-Shagi; Sebastian Giesen; L. J. Kelly
  11. Does Central Bank Staff Beat Private Forecasters? By Makram El-Shagi; Sebastian Giesen; A. Jung
  12. Meta Taylor Rules for the UK and Australia; Accommodating Regime Uncertainty in Monetary Policy Analysis using Model Averaging Methods By Kevin Lee; Nilss Olekalns; Kalvinder Shields
  13. Pegs, Downward Wage Rigidity, and Unemployment: The Role of Financial Structure By Stephanie Schmitt-Grohé; Martín Uribe
  14. Taylor rules and equilibrium determinacy in a two-country model with non-traded goods By Fujisaki, Seiya
  15. Deleveraging and Monetary Policy: Japan since the 1990s and the United States since 2007 By Kazuo Ueda
  16. Global Inflation Dynamics: regularities & forecasts By Askar Akaev; Andrey Korotayev; Alexey Fomin
  17. Interest Rate Pass-Through in the EMU – New Evidence from Nonlinear Cointegration Techniques for Fully Harmonized Data By Ansgar Belke; Joscha Beckmann; Florian Verheyen
  18. How Inflation Affects Macroeconomic Performance: An Agent-Based Computational Investigation By Quamrul Ashraf; Boris Gershman; Peter Howitt
  19. A "Working" Solution to the Question of Nominal GDP Targeting By Michael T. Belongia; Peter N. Ireland
  20. Exchange rate pass-through to import prices in the Euro-area: a multicurrency investigation By Olivier de Bandt; Tovonony Razafindrabe
  21. Exchange rate policy and sovereign bond spreads in developing countries By Samir Jahjah; Bin Wei; Vivian Zhanwei Yue
  22. How Inflation Affects Macroeconomic Performance: An Agent-Based Computational Investigation By Quamrul Ashraf; Boris Gershman; Peter Howitt
  23. Optimal Holdings of International Reserves: Self-Insurance against Sudden Stop By Guillermo A. Calvo; Alejandro Izquierdo; Rudy Loo-Kung
  24. Housing Bubbles and Interest Rates By Christian Hott; Terhi Jokipii
  25. Combating Widespread Currency Manipulation By Joseph E. Gagnon
  26. Reducing overreaction to central banks' disclosures:theory and experiment By Romain Baeriswyl; Camille Cornand
  27. Consequences of the euro adoption by Central and Eastern European (CEE) countries for their trade flows By Andrzej Cieślik; Jan, Jakub Michałek; Jerzy Mycielski
  28. About the sources of the inflation persistence in Russia By Ekaterina Ponomareva
  29. Currency crisis and collapse in interwar Greece: predicament or policy failure?. By [no author]
  30. Capital Controls in Brazil – Stemming a Tide with a Signal By Yothin Jinjark; Ilan Noy; Huanhuan Zheng
  31. Mitigating Turkey's trilemma trade-offs By Cortuk, Orcan; Akcelik, Yasin; Turhan, İbrahim
  32. Do Low Interest Rates Sow the Seeds of Financial Crises? By Simona E. Cociuba; Malik Shukayev; Alexander Ueberfeldt
  33. What causes banking crises? An empirical investigation By Le, Vo Phuong Mai; Meenagh, David; Minford, Patrick
  34. Controlled Dismantlement of the Euro Area in Order to Preserve the European Union and Single European Market By Stefan Kawalec; Ernest Pytlarczyk
  35. The Evolution of the Exchange Rate Pass-Through in Japan:A Re-evaluation Based on Time-Varying Parameter VARs By Etsuro Shioji
  36. "Toward an Understanding of Crises Episodes in Latin America: A Post-Keynesian Approach" By Esteban Perez Caldentey; Matias Vernengo

  1. By: Matthias Neuenkirch (Philipps-University Marburg); Peter Tillmann (Philipps-University Giessen)
    Abstract: In this paper we systematically evaluate how central banks respond to infl ation deviations from target. We present a stylized New Keynesian model in which agents' infl ation expectations are sensitive to in flation deviations from target. To (re-)establish credibility, optimal monetary policy under discretion is shown to set higher interest rates today if average in flation exceeded the target in the past. Moreover, policy responds non-linearly to past in flation gaps. This is refl ected in an additional term in the central bank's optimal instrument rule, which we refer to as the "credibility loss". Augmenting a standard Taylor (1993) rule with the latter term, we provide empirical evidence for the interest rate response for a sample of nine IT or quasi-IT economies. We find that past deviations from the in flation target are feeding back into the reaction function of seven central banks and that this in fluence is economically meaningful. A deteroriation in credibility forces central bankers to undertake larger interest rate steps (ceteris paribus).
    Keywords: In flation expectations, credibility, reaction function, Taylor rule
    JEL: C32 E31 E43 E52 E58
    Date: 2012
  2. By: Bennett T. McCallum
    Abstract: Recent mainstream monetary policy analysis focuses on rational expectation solutions that are uniquely stable. A number of recent studies have examined the question of whether typical New Keynesian (NK) models, with policy rules that satisfy the Taylor principle, also exhibit solutions with explosive inflation that cannot be ruled out by any transversality condition or any other generally accepted economic principle. This paper contributes to that debate by supporting and developing previous arguments suggesting that such explosive solutions are informationally infeasible. It also critiques prevailing notions of "determinancy" and outlines two alternative approaches to solution selection.
    JEL: C61 C62 E37 E47
    Date: 2012–07
  3. By: David Laidler (University of Western Ontario)
    Abstract: Milton Friedman's contributions to and influence on macroeconomics are discussed, beginning with his work on the consumption function and the demand for money, not to mention monetary history, which helped to undermine the post World War 2 "Keynesian" consensus in the area. His inter-related analyses of the dynamics of monetary policy's transmission mechanism, the case for a money growth rule, and the expectations augmented Phillips curve are then taken up, followed by a discussion of his influence not only directly on the monetarist policy experiments of the early 1980s, but also less directly on the regimes that underlay the "great moderation" that broke down in the crisis of 2007-2008. Friedman's seminal influence on the development of today's mainstream, stochastic, but essentially Walrasian, macroeconomic theory, rooted in his explicit deployment of econometric theory in the analysis of forward-looking maximising behaviour in 1957, and in his later work on the Phillips curve, is also assessed in the light of his own preference, which he shared with Keynes, for a pragmatic Marshallian approach to economic theorising.
    Keywords: Friedman; macroeconomics; Keynes; Keynesianism; monetarism; money; inflation; cycle; depression; monetary policy; consumption
    JEL: B22 E20 E30 E40 E50
    Date: 2012
  4. By: Ansgar Belke; Lukas Vogel
    Abstract: This paper examines the contemporaneous relationship between the exchange rate regime and structural economic reforms for a sample of CEEC/CIS transition countries. We investigate empirically whether structural reforms are complements or substitutes for monetary commitment in the attempt to improve macroeconomic performance. Both EBRD and EFW data suggest a negative relationship between flexible exchange rate arrangements and external liberalization. Another finding from the EFW sample is that economic liberalisation has tended to be stronger under better macroeconomic fundamentals, suggesting that the impact of good macroeconomic conditions as facilitating structural reforms outweighs countervailing effects in the sense of lower reform pressure.
    Keywords: exchange rate regime, structural reform, panel data, political economy of reform, transition countries
    JEL: D78 E52 E61 F36
    Date: 2012
  5. By: Chen, Qianying (BOFIT); Funke, Michael (BOFIT); Paetz, Michael (BOFIT)
    Abstract: Monetary policy in mainland China differs from conventional central banking in several respects. The central bank regulates retail lending and deposit rates, influences the credit supply via window guidance, and, in recent years has even used the required reserve ratio as a tool for fine-tuning monetary policy. This paper develops a New Keynesian DSGE model to captures China’s unconventional monetary policy toolkit. We find that credit quotas are important as the interest-rate corridor distorts the efficient reactions of the economy. Moreover, for China’s central bankers the choice of a particular monetary policy tool or a the appropriate combination of instruments depends on the source of the shock.
    Keywords: DSGE models; monetary policy; China; macroprudential policy
    JEL: E42 E52 E58
    Date: 2012–07–13
  6. By: William T. Gavin; Benjamin D. Keen
    Abstract: We use a dynamic stochastic general equilibrium model to address two questions about U.S. monetary policy: 1) Can monetary policy elevate output when it is below potential? and 2) Is the zero lower bound a trap? The model answer to the first question is yes it can, but the effect is only temporary and probably not welfare enhancing. The answer to the second question is more complicated becasue it depends on policy. It also depends on whether it is the inflation rate or the real interest rate that will adjust over the longer run if the policy rate is held near zero for an extended period. We use the Fisher equation to analyze possible outcomes for situtations where the central bank has promised to keep the interest rate near zero for an extended period.
    Keywords: Monetary policy ; Econometric models
    Date: 2012
  7. By: Sahoo, Ganeswar
    Abstract: This paper addresses the perspective of Hayek’s doctrine on monetary arrangements in the economy and his favorable argument for an international central bank over national central bank. I also discussed Hayek’s view on free banking (i.e. for the free issue of bank notes) that would enable the banks to provide more and cheaper credit. Furthermore, Hayek comes up with an intellectual debate on “rational choice” of monetary arrangements whether the commercial banks should have the right to issue bank notes (demand for free banking) which can be redeemable in the established national gold or silver currency or an international central bank. This paper focuses on Hayek’s overall philosophy on international money mechanism and his intellectual debate of rational choice between the two arrangements – free banking or an international central bank and his concerned over unstable arrangements in money mechanism,which, he believes, profoundly affects economic and social conditions of people and government. Therefore, to reach the conclusion, I outlined Hayek’s perspectives on central bank and government, then international gold standard, and finally, his choice between free banking and an international central banking which is central theme of this paper.
    Keywords: Money; Banking; Central Bank; Free Banking; Monetary Nationalism
    JEL: E31 E51 B22 E44 E42 E58 E52 E41 B53
    Date: 2012–05–02
  8. By: Tomasz Łyziak (National Bank of Poland, Economic Institute); Oksana Demchuk (National Bank of Poland, Economic Institute); Jan Przystupa (National Bank of Poland, Economic Institute); Anna Sznajderska (National Bank of Poland, Economic Institute); Ewa Wróbel (National Bank of Poland, Economic Institute)
    Abstract: In the light of the results of empirical studies presented in the Report and the literature available45 it may be concluded that the form of the monetary policy transmission mechanism in Poland is consistent with structural features of the Polish economy and coincides with those characteristic of more developed European economies, e.g. the euro area. Although the financial intermediation system is less developed than in the euro area, Poland, like the new EU Member States is characterised by a lower degree of rigidity and more frequent price adjustments (as a result of a relatively higher and more volatile inflation), due to which there exist no grounds for stating that the transmission mechanism is weaker in these countries than in the euro area countries. The characteristics of the monetary policy transmission mechanism in Poland, which changed considerably in the transition period along with the development of the financial system and changes in the monetary policy, displayed symptoms of stabilisation in 2004/2005-2007. Poland’s accession to the European Union, resulting in a major reduction of macroeconomic uncertainty, was one of the factors that contributed to this process. The monetary policy transmission mechanism was, however, disturbed by the financial crisis. Its impact on the transmission mechanism remains strong, which is demonstrated notably by the analysis of the effectiveness of transmission mechanism channels.
    Date: 2012
  9. By: Meixing Dai
    Abstract: Using a New Keynesian framework, this paper shows that, under optimal discretion and optimal pre-commitment in a timeless perspective, imperfect transparency about the relative weight that the central bank assigns to output-gap stabilization generally reduces the average reaction of inflation to inflation shocks and the volatility of inflation, but increases these of the output gap in static and dynamic terms, and more so when inflation shocks are highly persistent. On balance, when inflation shocks are not excessively persistent, opacity could improve social welfare, more likely under pre-commitment than under discretion, if the weight assigned to output-gap stabilization is low.
    Keywords: Central bank transparency (opacity), macroeconomic volatility, inflation expectations dynamics, speed of convergence to the equilibrium.
    JEL: E52 E58
    Date: 2012
  10. By: Makram El-Shagi; Sebastian Giesen; L. J. Kelly
    Abstract: While the long-run relation between money and inflation as predicted by the quantity theory is well established, empirical studies of the short-run adjustment process have been inconclusive at best. The literature regarding the validity of the quantity theory within a given economy is mixed. Previous research has found support for quantity theory within a given economy by combining the P-Star, the structural VAR and the monetary aggregation literature. However, these models lack precise modelling of the short-run dynamics by ignoring interest rates as the main policy instrument. Contrarily, most New Keynesian approaches, while excellently modeling the short-run dynamics transmitted through interest rates, ignore the role of money and thus the potential mid-and long-run effects of monetary policy. We propose a parsimonious and fairly unrestrictive econometric model that allows a detailed look into the dynamics of a monetary policy shock by accounting for changes in economic equilibria, such as potential output and money demand, in a framework that allows for both monetarist and New Keynesian transmission mechanisms, while also considering the Barnett critique. While we confirm most New Keynesian findings concerning the short-run dynamics, we also find strong evidence for a substantial role of the quantity of money for price movements.
    Keywords: monetary policy, P-Star, structural identification, Barnett critique
    JEL: E31 E52 C32
    Date: 2012–07
  11. By: Makram El-Shagi; Sebastian Giesen; A. Jung
    Abstract: In the tradition of Romer and Romer (2000), this paper compares staff forecasts of the Federal Reserve (Fed) and the European Central Bank (ECB) for inflation and output with corresponding private forecasts. Standard tests show that the Fed and less so the ECB have a considerable information advantage about inflation and output. Using novel tests for conditional predictive ability and forecast stability for the US, we identify the driving forces of the narrowing of the information advantage of Greenbook forecasts coinciding with the Great Moderation.
    Keywords: relative forecast performance, forecast stability, staff forecasts, private forecasts, real-time data
    JEL: C53 E37 E52 E58
    Date: 2012–07
  12. By: Kevin Lee; Nilss Olekalns; Kalvinder Shields
    Abstract: This paper provides a characterisation of UK and Australian monetary policy within a Taylor rule framework, accommodating uncertainties about the nature and duration of policy regimes in a flexible but easy-to-implement analysis. Our approach involves estimation and inference based on a set of Taylor rules obtained through linear regression methods, but combined into a ‘meta’ rule using model averaging techniques. Using data that were available in real time, the estimated version of the meta Taylor rule provides a useful and detailed characterisation of monetary policies in the UK and Australia over the last thirty years.
    Keywords: Taylor rule; real-time policy; model uncertainty; monetary policy in UK and Australia; interest rates
    JEL: C32 D84 E32
    Date: 2012
  13. By: Stephanie Schmitt-Grohé; Martín Uribe
    Abstract: This paper studies the relationship between financial structure and the welfare consequences of fixed exchange rate regimes in small open emerging economies with downward nominal wage rigidity. The paper presents two surprising results. First, a pegging economy might be better off with a closed than with an open capital account. Second, the welfare gain from switching from a peg to the optimal (full-employment) monetary policy might be larger in financially open economies than in financially closed ones.
    JEL: F41
    Date: 2012–07
  14. By: Fujisaki, Seiya
    Abstract: We analyze a relation between interest rate controls and equilibrium determinacy using a two-country model featuring traded and non-traded goods. In addition, parameters of preference and production may differ between the two countries. We find that macroeconomic stability strongly depends on such heterogeneity including monetary policy, and that it is easier to generate determinate equilibrium under liberalization of the economy.
    Keywords: heterogeneity; Taylor rule; open economy; non-traded goods; equilibrium determinacy
    JEL: E52 F41
    Date: 2012–07–12
  15. By: Kazuo Ueda (Graduate School of Economics, The University of Tokyo)
    Abstract: The U.S. economy in the aftermath of the Great Recession that started in 2007 has a number of similarities with Japan’s experience since the early 1990s, at least on the surface. Both economies experienced an unsustainable boom in real estate prices along with high stock market valuations, and when the bubble burst, many households and financial institutions found themselves in dire straits. One major lesson from this experience is that deleveraging attempts by individual economic agents in the aftermath of large financial imbalances can generate significant negative macroeconomic externalities. In Japan’s case, a negative feedback loop developed among falling asset prices, financial instability, and stagnant economic activity. This negative feedback loop has sometimes been called “Japanization.†As the U.S. economy works through a sluggish recovery several years after the Great Recession technically came to an end in June 2009, it can only look with horror toward Japan’s experience of two decades of stagnant growth since the early 1990s. Japan’s deleveraging became serious because the negative feedback loop was not contained in its early stage of development. The Japanese government did not act promptly to recapitalize banks that were suffering from the erosion of their capital buffer due to their large holdings of stocks. As a result, Japan’s banks only slowly recognized bad loans, while stopping lending to promising new projects. Slow, but protracted asset sales resulted in a long period of asset price declines. Nonfinancial companies perceived the deterioration of their balance sheets as permanent and cut spending drastically. As Japan’s economy stagnated, the total amount of bad loans turned out to be much larger than initially estimated. In contrast to Japan, U.S. policy authorities responded to the financial crisis since 2007 more quickly. Surely, they learned from Japan’s experience. It is also important to recognize, however, that the market-based nature of the U.S. financial system, as compared to a Japanese financial sector, which is more intertwined with government and less subject to market pressures, meant that the need for government action was more apparent in the U.S. context. When a national economy is confronted with Japanization, the central bank finds itself on the front line of policy making. As with Japan’s other policymakers, the Bank of Japan’s response in the 1990s was slow. As a result, the process of deleveraging became overly severe and protracted. This criticism of the Bank of Japan is not a new one: for example, Ben Bernanke (2000, see also 2003), then still a professor at Princeton University, criticized the Bank of Japan for not being more aggressive in its fight against deflation. Krugman (2012), Ball (2012), and others have argued that, in a provocative turnabout, Federal Reserve Chairman Ben Bernake has not been willing to push for the same aggressive monetary remedies for the United States that he earlier prescribed for Japan. Bernanke has responded by making two points: 1) the U.S. economic situation is objectively different, in the sense that Japan faced actual deflation in the late 1990s; and 2) the Fed has indeed pursued aggressively expansive monetary policy in a number of nonstandard ways (Federal Reserve, 2012b, p. 9). This paper does not seek to resolve the debate over the degree of consistency between what Bernanke wrote in the early 2000s and the policies that the Federal Reserve has undertaken since 2007. However, the paper does show that a rapid response by a central bank in a situation of financial crisis and economic stagnation can be a better choice than allowing a process of Japanization to drag on for years. In a weak economy, interest rates are already very low and the zero lower bound on interest rates limits a central bank’s ability to stimulate the economy further. Moreover, as I will explain below, nonconventional monetary policy measures work by reducing risk premiums and interest rate spreads between long-term and short-term financial instruments. However, when a long period of economic stagnation occurs, these spreads have a tendency to decline to low levels, which then limits the effectiveness of such measures. I will begin by describing how Japan’s economic situation unfolded in the early 1990s and offering some comparisons with how the Great Recession unfolded in the U.S. economy. I then turn to the Bank of Japan’s policy responses to the crisis and again offer some comparisons to the Federal Reserve. I will discuss the use of both the conventional interest rate tool--the federal funds rate in the United States, and the “call rate†in Japan--and nonconventional measures of monetary policy and consider their effectiveness in the context of the rest of the financial system.
    Date: 2012–07
  16. By: Askar Akaev; Andrey Korotayev; Alexey Fomin
    Abstract: The analysis of dollar inflation performed by the authors through the approximation of empirical data for 1913-2012 with a power-law function with an accelerating log-periodic oscillation superimposed over it has made it possible to detect a quasi-singularity point around the 17th of December, 2012. It is demonstrated that, if adequate measures are not taken, one may expect a surge of inflation around the end of this year that may also mark the start of stagflation as there are no sufficient grounds to expect the re-start of the dynamic growth of the world economy by that time. On the other hand, as the experience of the 1970s and the 1980s indicates, the stagflation consequences can only be eliminated with great difficulties and at a rather high cost, because the combination of low levels of economic growth and employment with high inflation leads to a sharp decline in consumption, aggravating the economic depression. In order to mitigate the inflationary consequences of the explosive growth of money (and, first of all, US dollar) supply it is necessary to take urgently the world monetary emission under control. This issue should become central at the forthcoming G8 and G20 summits.
    Date: 2012–07
  17. By: Ansgar Belke; Joscha Beckmann; Florian Verheyen
    Abstract: This study puts the monetary transmission process in the eurozone between 2003 and 2011 under closer scrutiny. For this purpose, we investigate the interest rate pass-through from money market to various loan rates for up to twelve countries of the European Monetary Union. Applying different cointegration techniques, we first test for a long-run relationship between loan rates and the Euro OverNight Index Average (EONIA). Based on these findings, we allow for different nonlinear patterns for shortrun dynamics of loan rates. Our investigation contributes to the literature in mainly two ways. On the one hand, we use fully harmonized data stemming from the ECB’s MFI interest rate statistics. In addition, we consider smooth transition models as an extension of conventional threshold models. Our results point to considerable differences in the size of the pass-through with respect to either different loan rates or countries. In the majority of cases, the pass-through is incomplete and the dynamics of loans adjustment are different for reductions and hikes of money market rates.
    Keywords: Interest rate pass-through; EMU; cointegration; ARDL bounds testing; smooth transition models
    JEL: E43 E52 F36 G21
    Date: 2012–07
  18. By: Quamrul Ashraf; Boris Gershman; Peter Howitt
    Abstract: We use an agent-based computational approach to show how inflation can worsen macroeconomic performance by disrupting the mechanism of exchange in a decentralized market economy. We find that increasing the trend rate of inflation above 3 percent has a substantial deleterious effect, but lowering it below 3 percent has no significant macroeconomic consequences. Our finding remains qualitatively robust to changes in parameter values and to modifications to our model that partly address the Lucas critique. Finally, we contribute a novel explanation for why cross-country regressions may fail to detect a significant negative effect of trend inflation on output even when such an effect exists in reality.
    JEL: C63 E00 E31 E50
    Date: 2012–07
  19. By: Michael T. Belongia (University of Mississippi); Peter N. Ireland (Boston College)
    Abstract: Although a number of economists have tried to revive the idea of nominal GDP targeting since the financial market collapse of 2008, relatively little has been offered in terms of a specific framework for how this objective might be achieved in practice. In this paper we adopt a strategy outlined by Holbrook Working (1923) and employed, with only minor modifications, by Hallman, et al. (1991) in the P-Star model. We then present a series of theoretical and empirical results to show that Divisia monetary aggregates can be controlled by the Federal Reserve and that the trend velocities of these aggregates, by virtue of the properties of superlative indexes, exhibit the stability required to make long-run targeting feasible.
    Keywords: nominal GDP targeting, Holbrook Working, P-Star
    JEL: E58 E52 E51
    Date: 2012–06–30
  20. By: Olivier de Bandt; Tovonony Razafindrabe
    Abstract: Using a new database of actual import price data, and not unit value indices, for several euro area countries during the period between June 2005 and April 2011, we provide new results on the Exchange Rate Pass Through (ERPT). First, we use a multi-currency approach to distinguish between invoicing strategies across the most important currencies for euro area imports and show that the effective ERPT is primarily driven by the US Dollar ERPT. The firms which invoice in US Dollar (and in Chinese Yuan) are more concerned with demand conditions, while those which invoice in British Pound are more concerned with profit margins. Second, in contrast to several papers in the empirical literature that argue that ERPT is incomplete and its value is declining, we find that short run effective ERPT is incomplete, while long run effective ERPT is complete for a large number of products. Third, we uncover significant heterogeneity across products and countries: ERPT in US Dollar and British Pound appears higher than average for raw materials (e.g. petroleum products) and lower for transformed manufacturing products (chemical, pharmaceutical products and motor vehicles), and ERPT is higher in Spain than in the other euro area countries considered. Fourth, the 2008 global crisis triggered a temporary increase in the effective ERPT.
    Date: 2012
  21. By: Samir Jahjah; Bin Wei; Vivian Zhanwei Yue
    Abstract: This paper empirically analyzes how exchange rate policy affects the issuance and pricing of international bonds for developing countries. We find that countries with less flexible exchange rate regimes pay higher sovereign bond spreads and are less likely to issue bonds. Quantitatively, changing a free-floating regime to a fixed regime decreases the likelihood of bond issuance by 4.6% and increases the bond spread by 1.3% on average. Furthermore, countries with real exchange rate overvaluation have higher bond spreads and higher bond issuance probabilities. Moreover, such positive effects of real exchange rate overvaluation tend to be magnified for countries with fixed exchange rate regimes. Our results suggest that choosing a less flexible exchange rate regime in general leads to higher borrowing costs for developing countries, especially when their currencies are overvalued.
    Date: 2012
  22. By: Quamrul Ashraf; Boris Gershman; Peter Howitt
    Abstract: We use an agent-based computational approach to show how inflation can worsen macroeconomic performance by disrupting the mechanism of exchange in a decentralized market economy. We find that increasing the trend rate of inflation above 3 percent has a substantial deleterious effect, but lowering it below 3 percent has no significant macroeconomic consequences. Our finding remains qualitatively robust to changes in parameter values and to modifications to our model that partly address the Lucas critique. Finally, we contribute a novel explanation for why cross-country regressions may fail to detect a significant negative effect of trend inflation on output even when such an effect exists in reality.
    Date: 2012
  23. By: Guillermo A. Calvo; Alejandro Izquierdo; Rudy Loo-Kung
    Abstract: This paper addresses the issue of the optimal stock of international reserves in terms of a statistical model in which reserves affect both the probability of a Sudden Stop–as well as associated output costs–by reducing the balance-sheet effects of liability dollarization. Optimal reserves are derived under the assumption that central bankers conservatively choose reserves by balancing the expected cost of a Sudden Stop against the opportunity cost of holding reserves. Results are obtained without using calibration to match observed reserves levels, providing no a priori reason for our concept of optimal reserves to be in line with observed holdings. Remarkably, however, observed reserves on the eve of the global financial crisis were–on average–not distant from optimal reserves as derived in this model, indicating that reserve over-accumulation in Emerging Markets was not obvious. However, heterogeneity prevailed across regions: from a precautionary standpoint, Latin America was closest to model-based optimal levels, while reserves in Eastern Europe lay below optimal levels, and those in Asia lay above. Nonetheless, there are other motives for reserve accumulation: we find that differences between observed reserves and precautionary-motive optimal reserves are partly explained by the perceived presence of a lender of last resort, or characteristics such as being a large oil producer. However, to a first approximation, there is no clear evidence supporting the so-called neo-mercantilist motive for reserve accumulation.
    JEL: E42 E58 F15 F31 F32 F33 F41
    Date: 2012–07
  24. By: Christian Hott; Terhi Jokipii
    Abstract: In this paper we assess whether persistently too low interest rates can cause housing bubbles. For a sample of 14 OECD countries, we calculate the deviations of house prices from their (theoretically implied) fundamental value and define them as bubbles. We then estimate the impact that a deviation of short term interest rates from the Taylor-implied interest rates have on house price bubbles. We additionally assess whether interest rates that have remained low for a longer period of time have a greater impact on house price overvaluation. Our results indicate that there is a strong link between low interest rates and housing bubbles. This impact is especially strong when interest rates are "too low for too long". We argue that, by ensuring that rates do not deviate too far from Taylorimplied rates, central banks could lean against house price fluctuations without considering house price developments directly. If this is not possible, e.g. because a single monetary policy is confronted with a very heterogenous economic development within the currency area, alternative counter cyclical measures have to be considered.
    Keywords: House Prices, Bubbles, Interest Rates, Taylor Rule
    JEL: E52 G12 R21
    Date: 2012
  25. By: Joseph E. Gagnon (Peterson Institute for International Economics)
    Abstract: Widespread currency manipulation, mainly in developing and newly industrialized economies, is the most important development of the past decade in international financial markets. In an attempt to hold down the values of their currencies, governments are distorting capital flows by around $1.5 trillion per year. The result is a net drain on aggregate demand in the United States and the euro area by an amount roughly equal to the large output gaps in the two economies. In other words, millions more Americans and Europeans would be employed if other countries did not manipulate their currencies and instead achieved sustainable growth through higher domestic demand. Gagnon identifies the 20 most egregious currency manipulators over the past 11 years. Four groups of countries stand out: (1) longstanding advanced economies such as Japan and Switzerland; (2) newly industrialized economies such as Israel, Singapore, and Taiwan; (3) developing Asian economies such as China, Malaysia, and Thailand; and (4) oil exporters such as Algeria, Russia, and Saudi Arabia. Although currency manipulation to boost trade balances is a violation of the Articles of Agreement of the International Monetary Fund (IMF), there is currently no procedure to punish or curtail it. The best forum for sanctions against currency manipulators is the World Trade Organization, operating in consultation with the IMF. Countries affected by currency manipulation would be authorized to impose tariffs on imports from manipulators. In order to get manipulators to agree to this change in international rules, the main targets of currency manipulation—the United States and the euro area—may have to play tough. One strategy would be to tax or otherwise restrict purchases of US and euro area financial assets by currency manipulators.
    Date: 2012–07
  26. By: Romain Baeriswyl; Camille Cornand
    Abstract: Financial markets are known for overreacting to public information. Central banks can reduce this overreaction either by disclosing information to a fraction of market participants only (partial publicity) or by disclosing information to all participants but with ambiguity (partial transparency). We show that, in theory, both communication strategies are strictly equivalent in the sense that overreaction can be indifferently mitigated by reducing the degree of publicity or by reducing the degree of transparency. We run a laboratory experiment to test whether theoretical predictions hold in a game played by human beings. In line with theory, the experiment does not allow the formulation of a clear preference in favor of either communication strategy. This paper then discusses the opportunity for central banks to choose between partial transparency and partial publicity to control market reaction to their disclosures.
    Keywords: heterogeneous information, public information, overreaction, transparency,coordination, experiment
    JEL: C92 D82 D84 E58
    Date: 2012
  27. By: Andrzej Cieślik (Warsaw University, Department of Economics); Jan, Jakub Michałek (Warsaw University, Department of Economics); Jerzy Mycielski (Warsaw University, Department of Economics)
    Abstract: In this paper we estimate the trade effects of the euro adoption in Central European countries using a modified gravity model. In particular, we analyze the ex post implications of accession of Slovenia and Slovakia to the Eurozone. We employ a gravity model that controls for an extended set of trade theory and policy variables. Trade theory variables include both the country size and factor proportion variables. Trade policy variables include the membership in GATT/WTO, CEFTA, OECD, EU and Europe Agreements. The gravity model is estimated using the panel data approach on a sample of CEE countries trading with the rest of the world during the period 1992-2010 using the fixed effects, random effects and Hausman-Taylor estimators. It seems that elimination of exchange rate volatility resulted in trade expansion for the CEE countries but the accession to the Eurozone did not have any significant effects on exports of Slovakia and Slovenia.
    Keywords: Central and Eastern Europe, exports, euro zone
    JEL: F14 F15 F33 F42
    Date: 2012
  28. By: Ekaterina Ponomareva (Gaidar Institute for Economic Policy)
    Abstract: The standard way to obtain the equation of New Keynesian Phillips curve is to linearize the equilibrium conditions of the Calvo model around a steady state with zero inflation. This approach is appropriate only in the low-inflation economics. This paper considers New Keynesian Phillips curve derived by linearizing the same equilibrium conditions around the time varying inflation trend. This model explains observed inflation persistence in different way and gives the different view on the ratio of agents with backward- and forward-looking expectations. In the paper estimated New Keynesian Phillips curve with time varying coefficients. This model shows that in Russia exist at least two sources of the inflation persistence.
    Keywords: : New Keynesian Phillips Curve, backward- and forward-looking expectations, inflation persistence, Bayesian VAR
    JEL: E12 E31 E52
    Date: 2012
  29. By: [no author]
    Abstract: Greece in 1928 viewed the anchoring to the Gold Exchange Standard as the imperative choice of the time in order to implant financial credibility and carry over an ambitious plan of reforms to modernise the economy. But after the pound sterling exited the system in 1931, Greece, instead of following suit, chose a defence that drove interest rates at high levels, squeezed the real economy and exhausted foreign reserves. Unable to borrow from abroad, it quitted the system in 1932 and the Drachma was heavily devalued. Despite a rise in competitiveness, the erosion of real incomes cut domestic demand, unemployment continued to rise and the country entered a period of acute social and political instability. The lessons are perhaps relevant today for the costs that Greece would face by exiting the Eurozone. A model of Balance of Payments crises with partial capital controls is employed to analyze the response of currency pegs to external shocks and examine under which circumstances the regime collapses. Its main predictions are found to be in agreement with the actual outcomes in 1932.
    Date: 2012–07
  30. By: Yothin Jinjark (SOAS, University of London); Ilan Noy (University of Hawaii and Victoria Business School in Wellington); Huanhuan Zheng (The Chinese University of Hong Kong)
    Abstract: Controls on capital inflows have been experiencing a period akin to a renaissance since the beginning of the global financial crisis in 2008, with several prominent countries choosing to impose controls; e.g., Thailand, Korea, Peru, Indonesia, and Brazil. We focus on the case of Brazil, a country that instituted five changes in its capital account regime in 2008-2011, and ask what the impacts of these policy changes were. Using the Abadie et al. (2010) synthetic control methodology, we construct counterfactuals (i.e., Brazil with no capital account policy change) for each policy change event. We find no evidence that any tightening of controls was effective in reducing the magnitudes of capital inflows, but we observe some modest and short-lived success in preventing further declines in inflows when the capital controls are relaxed as was done in the immediate aftermath of the Lehman bankruptcy in 2008 and in January 2011 by the newly inaugurated government of Dilma Rousseff. We hypothesize that price-based capital controls’ only perceptible effect are to be found in the content of the signal they broadcast regarding the government’s larger intentions and sensibilities. Brazil’s left-of-center government was widely perceived as ambivalent to markets. An imposition of controls was not perceived as ‘news’ and thus had no impact. A willingness to remove controls was perceived, however, as a noteworthy indication that the government was not as hostile to the international financial markets as many expected it to be.
    Keywords: Capital control; Brazil; Global financial crisis; Mutual fund flows; Exchange rate
    JEL: F32 G15 G18 G23 E60
    Date: 2012–07–17
  31. By: Cortuk, Orcan; Akcelik, Yasin; Turhan, İbrahim
    Abstract: We study the trilemma conguration of the Turkish economy for the period between 2002 and 2012. The paper starts by empirically testing the Mundell-Fleming theoretical concept of an \impossible trinity" (trilemma) for Turkey, following Aizenman, Chinn and Ito (ACI, 2008). This includes calculating the trilemma indices and regressing them on a constant. We show that there is a misspecication with ACI approach and improve the specication by applying a Kalman lter to the classical linear regression that enables us to capture the time-varying importance of policy decisions within the trilemma framework. By comparing the residuals of each approach, we show that Kalman lter analysis has superior results. Then, our analysis continues by revealing a role for central bank foreign reserves and required reserves in mitigating the trilemma tradeos { we show that foreign reserves to GDP ratio and required reserve ratio have positive signicant impact on the residuals obtained from the trilemma regression, thus making the policy tradeos smaller.
    Keywords: Trilemma; impossible trinity; required reserves; international reserves
    JEL: F5 F3 E4
    Date: 2012–06–19
  32. By: Simona E. Cociuba (University of Western Ontario); Malik Shukayev (Bank of Canada); Alexander Ueberfeldt (Bank of Canada)
    Abstract: A view advanced in the aftermath of the late-2000s financial crisis is that lower than optimal interest rates lead to excessive risk taking by financial intermediaries. We evaluate this view in a quantitative dynamic model where interest rate policy affects risk taking by changing the amount of safe bonds available as collateral for repo transactions. Given properly priced collateral, lower than optimal interest rates reduce risk taking. However, if intermediaries can augment their collateral by issuing assets whose risk is underestimated by rating agencies, lower than optimal interest rates contribute to excessive risk taking and amplify the severity of recessions.
    Keywords: financial intermediation; risk taking; optimal interest rate policy; capital regulation
    JEL: E44 E52 G28 D53
    Date: 2012
  33. By: Le, Vo Phuong Mai (Cardiff Business School); Meenagh, David (Cardiff Business School); Minford, Patrick (Cardiff Business School)
    Abstract: We add the Bernanke-Gertler-Gilchrist model to a modified version of the Smets-Wouters model of the US in order to explore the causes of the banking crisis. We test the model against the data on HP-detrended data and reestimate it by indirect inference; the resulting model passes the Wald test on output, inflation and interest rates. We then extract the model’s implied residuals on US unfiltered data since 1984 to replicate how the model predicts the crisis. The main banking shock tracks the unfolding ‘sub-prime’ shock, which appears to have been authored mainly by US government intervention. This shock worsens the banking crisis but ‘traditional’ shocks explain the bulk of the crisis; the non-stationarity of the productivity shock plays a key role. Crises occur when there is a ‘run’ of bad shocks; based on this sample they occur on average once every 40 years and when they occur around half are accompanied by financial crisis. Financial shocks on their own, even when extreme, do not cause crises — provided the government acts swiftly to counteract such a shock as happened in this sample.
    Keywords: DSGE; Banking; Crisis; Bootstrap
    JEL: C32 C52 E1
    Date: 2012–06
  34. By: Stefan Kawalec; Ernest Pytlarczyk
    Abstract: The Eurozone crisis mobilises an appreciable amount of the attention of politicians and the public, with calls for a decisive defence of the euro, because the single currency’s demise is said to be the beginning of the end of the EU and Single European Market. In our view, preserving the euro may result in something completely different than expected: the disintegration of the EU and the Single European Market rather than their further strengthening. The fundamental problem with the common currency is individual countries’ inability to correct their external exchange rates, which normally constitutes a fast and efficient adjustment instrument, especially in crisis times. Europe consists of nation states that constitute the major axes of national identity and major sources of government’s legitimisation. Staying within the euro zone may sentence some countries – which, for whatever reason, have lost or may lose competitiveness – to economic, social and civilizational degradation, and with no way out of this situation. This may disturb social and political cohesion in member countries, give birth to populist tendencies that endanger the democratic order, and hamper peaceful cooperation in Europe. The situation may get out of control and trigger a chaotic break-up of the euro zone, threatening the future of the whole EU and Single European Market. In order to return to the origins of European integration and avoid the chaotic break-up of the euro zone, the euro zone should be dismantled in a controlled manner. If a weak country were to leave the euro zone, it would entail panic and a banking system collapse. Therefore we opt for a different scenario, in which the euro area is slowly dismantled in such a way that the most competitive countries or group of such countries leave the euro zone. Such a step would create a new European currency regime based on national currencies or currencies serving groups of homogenous countries, and save EU institutions along with the Single European Market.
    Keywords: Eurozone crisis, Internal devaluation, Deflation, Currency devaluation, Euro breakout, Future of Europe
    JEL: E5 F15 F32 N1
    Date: 2012–06
  35. By: Etsuro Shioji (Professor, Faculty of Economics, Hitotsubashi University)
    Abstract: This paper re-examines the evolution over time of influences of the Japanese exchange rate on its exports, imports, and domestic prices. By employing the time varying parameter VAR (vector autoregression) method, this study reveals the timings of the pass-through rates changed and by how much. The sample period is January 1980 through January 2010. It shows that the pass-through rates on both import and domestic prices trended down throughout much the sample period. While the pass-through rate on domestic prices experienced a sharp decline during the 1980s and continued to decline gradually afterwards, the rate on import prices went through the second sharp decline in the latter half of the 1990s. In contrast, the pass-through rate on export prices increased, especially during the 1980s.
    Date: 2012–06
  36. By: Esteban Perez Caldentey; Matias Vernengo
    Abstract: Conventional wisdom about the business cycle in Latin America assumes that monetary shocks cause deviations from the optimal path, and that the triggering factor in the cycle is excess credit and liquidity. Further, in this view the origin of the contraction is ultimately related to the excesses during the expansion. For that reason, it follows that avoiding the worst conditions during the bust entails applying restrictive economic policies during the expansion, including restrictive fiscal and monetary policies. In this paper we develop an alternative approach that suggests that fiscal restraint may not have a significant impact in reducing the risks of a crisis, and that excessive fiscal conservatism might actually exacerbate problems. In the case of Central America, the efforts to reduce fiscal imbalances, in conjunction with the persistent current account deficits, implied that financial inflows, with remittances being particularly important in some cases, allowed for an expansion of a private spending boom that proved unsustainable once the Great Recession led to a sharp fall in external funds. In the case of South America, the commodity boom created conditions for growth without hitting the external constraint. Fiscal restraint in the South American context has resulted, in some cases, in lower rates of growth than what otherwise would have been possible as a result of the absence of an external constraint. Yet the lower reliance on external funds made South American countries less vulnerable to the external shock waves of the Great Recession than Central American economies.
    Keywords: Business Fluctuations; Great Recession; Latin America
    JEL: E32 E65 O54
    Date: 2012–07

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