nep-mon New Economics Papers
on Monetary Economics
Issue of 2013‒05‒22
twenty papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Monetary Policy Shifts and the Forward Discount Puzzle By Michael Jetter; Alex Nikolsko-Rzhevskyy
  2. Monetary Policy Under Discretion Or Commitment? -An Empirical Study By Fromlet, Pia
  3. A Note on Money and the Conduct of Monetary Policy By Jagjit S. Chadha; Luisa Corrado; Sean Holly
  4. Inflation fan charts, monetary policy and skew normal distribution By Wojciech Charemza; Carlos Diaz Vela; Svetlana Makarova
  5. Business Fluctuations and Monetary Policy Rules in the Philippines: with Lessons from the 1984-1985 Contraction By Dante B. Canlas
  6. How have inflation dynamics changed over time? Evidence from the euro area and USA By Oinonen, Sami; Paloviita, Maritta; Vilmi , Lauri
  7. Central Bank Communication Affects Long-Term Interest Rates By Fernando D. Chague; Rodrigo De-Losso, Bruno C. Giovannetti, Paulo Manoel
  8. Financial Crises and Exchange Rate Policy By Luca Fornaro
  9. Inflation Persistence in Central and Eastern European Countries By Zsolt Darvas; Balázs Varga
  10. Market Deregulation and Optimal Monetary Policy in a Monetary Union By Giuseppe Fiori; Fabio Ghironi; Matteo Cacciatore
  11. Debt and Incomplete Financial Markets: A Case for Nominal GDP Targeting By Kevin D. Sheedy
  12. Measuring Currency Pressures: The Cases of the Japanese Yen, the Chinese Yuan, and the U.K. Pound By Stephen Hall; Amangeldi Kenjegaliev; P.A.V.B. Swamy; George S. Tavlas
  13. The Concepts, Consequences, and Determinants of Currency Internationalization By Hyoung-kyu Chey
  14. A Quasi-Bounded Target Zone Model - Theory and Application to Hong Kong Dollar By C. F. Lo; C. H. Hui; S. W. Chu; T. Fong
  15. The Peso Appreciation and Monetary-Fiscal Coordination By Gerardo P. Sicat
  16. The Scapegoat Theory of Exchange Rates: The First Tests By Marcel Fratzscher; Lucio Sarno; Gabriele Zinna
  17. Business Cycle Synchronization in the European Union: The Effect of the Common Currency By Periklis Gogas
  18. Exchange Rate Uncertainty and International Portfolio Flows By Guglielmo Maria Caporale; Faek Menla Ali; Nicola Spagnolo
  19. Exchange Rate Predictability By Barbara Rossi
  20. Does Inflation Walk on Unstable Paths? Rational Sunspots and Drifting Parameters By Paolo Bonomolo; Guido Ascari

  1. By: Michael Jetter; Alex Nikolsko-Rzhevskyy
    Abstract: This paper argues that considerable switches in monetary policy are able to explain a major part of the forward discount puzzle. We build a theoretical model suggesting that violations of the uncovered interest rate parity are owed to shifts in monetary policy from a destabilizing (when the Taylor principle is violated) to a stabilizing regime (when a central bank follows a Taylor-type rule). Following the switch is an adjustment period" during which forecasters gradually update their expectations, eventually restoring the parity. It is in this adjustment period, when the forward discount puzzle arises. In the second part of the paper we test the model on the Canadian dollar, German mark, and British pound, all against the US dollar. Results indicate that the forward discount puzzle loses signi cance after allowing for an adjustment period of about 1 { 2 years. Our results are robust to various di erent speci cations, such as the use of di erent maturities or base currencies. Further, it seems unlikely that our results coincide with contemporaneous events.
    Date: 2013–04–13
  2. By: Fromlet, Pia (Department of Economics)
    Abstract: In this paper, I investigate the monetary policy of five industrialized countries which have had explicit inflation targets for more than 15 years. Considering the case of discretionary policy as well as commitment, I estimate two first order conditions. The results support the theory of flexible in‡ation targeting under discretion for the United Kingdom. For New Zealand, the results under discretion suggests that monetary policymakers have been leaning with the wind rather than against the wind. The central banks of Canada, Sweden, and Australia have behaved in line with the theory of flexible in‡ation targeting under commitment.
    Keywords: Inflation targeting; optimal policy under discretion; optimal policy under commitment
    JEL: E31 E52 E58 E61
    Date: 2013–04–26
  3. By: Jagjit S. Chadha (Department of Economics, University of Kent); Luisa Corrado (University of Rome "Tor Vergata", CIMF and CReMic); Sean Holly (University of Cambridge)
    Abstract: Prior to the financial crisis mainstream monetary policy practice had become disconnected from money. We outline the basic rationale for this development using a simple model of money and credit in which we explore the conditions under which money matters directly for the conduct of policy. Then, drawing on Goodfriend and McCallum's (2007) DSGE model, we examine the circumstances under which money becomes more closely linked to inflation. We ?nd that money matters when the variance of the supply of lending dominates productivity and the velocity of money demand. This is because amplifying the role of loans supply leads to an expansion in aggregate demand, via a compression of the external ?nance premium, which is in?ationary. We consider a number of alternative monetary policy rules, and ?nd that a rule which exploits the joint information from money and the external finance premium performs best.
    Keywords: money,DSGE,policy rules,external finance premium.
    JEL: E31 E40 E51
    Date: 2013–05–13
  4. By: Wojciech Charemza; Carlos Diaz Vela; Svetlana Makarova
    Abstract: Issues related to classification, interpretation and estimation of inflationary uncertainties are addressed in the context of their application for constructing probability forecasts of inflation. It is shown that confusions in defining uncertainties lead to potential misunderstandings of such forecasts. The principal source of such confusion is in ignoring the effect of feedback from the policy action undertaken on the basis of forecasts of inflation onto uncertainties. In order to resolve this problem a new class of skew normal distributions (weighted skew normal, WSN) have been proposed and its properties derived. It is shown that parameters of WSN distribution can be interpreted in relation to the monetary policy strength and symmetry. It has been fitted to empirical distributions of inflation multi-step forecast errors of inflation for 34 countries, alongside others distributions already existing in the literature. The estimation method applied is using the minimum distance criteria between the empirical and theoretical distributions. Results lead to some constructive conclusions regarding the strength and asymmetry of monetary policy and confirm the applicability of WSN to producing probabilistic forecasts of inflation.
    Keywords: inflation forecasting; uncertainty; monetary policy; non-normality
    JEL: C54 E37 E52
    Date: 2013–05
  5. By: Dante B. Canlas (School of Economics, University of the Philippines Diliman)
    Abstract: The paper reviews recent research on macroeconomic theory of business fluctuations and its influence on monetary policy rules. It focuses on triggers to business fluctuations and the mechanisms that propagate the fluctuations once started. The Philippines is used as empirical setting. The theory’s predictions are examined using time-series data on aggregate output performance, money growth, and budget deficits of government. The paper casts a spotlight on the output contraction of 1984-1985, the longest downturn in the postwar economic history of the Philippines. The role of monetary policy and fiscal policy shocks in triggering that downturn is studied, followed by the role of subsequent macroeconomic policy adjustments that propagated the downturn. The paper points out that monetary policy rules evolved in the aftermath of the 1984-1985 downturn, culminating in the inflation-targeting rule that the monetary authority currently uses. The adoption of inflation targeting hinged on the introduction of legislation that enabled the creation of a central bank with policy and instrument independence from the fiscal authority.
    Date: 2012–06
  6. By: Oinonen, Sami (Bank of Finland Research); Paloviita, Maritta (Bank of Finland Research); Vilmi , Lauri (Bank of Finland Research)
    Abstract: This paper analyzes euro area and U.S. inflation dynamics since the beginning of the 1990s by estimating New Keynesian hybrid Phillips curves with time-varying parameters. We measure inflation expectations by subjective forecasts from Consensus Economics survey and so do not assume rational expectations. Both rolling regressions and state-space models are employed. The results indicate that in both economic areas the inflation dynamics have steadily become more forward-looking over time. We also provide evidence that the impact of the output gap on inflation has increased in recent years. Overall, diminished inflation persistence emphasizes the role of credible monetary policy in inflation dynamics.
    Keywords: inflation; Phillips curve; time-varying parameters; survey expectations
    JEL: C22 C51 E31
    Date: 2013–05–06
  7. By: Fernando D. Chague; Rodrigo De-Losso, Bruno C. Giovannetti, Paulo Manoel
    Abstract: We empirically study how the communication of the Central Bank of Brazil affects the term structure of interest rates. Using an algorithm that classifies the words from the Central Bank minutes into predetermined semantic themes, we estimate a time-series factor related to Central Bank optimism. Then, we show that the long-term interest rates are sensitive to the optimism factor: when Central Bank is more optimistic, long-term interest rates fall. The fact that minutes are released one week after the changes in the target rate allows us to identify the effect of the communication in isolation. Our result is in line with the idea that Central Bank communication can be an effective monetary policy instrument through its impact on market expectations, particularly at the longer maturities.
    Keywords: Brazilian Central Bank; central bank communication; text mining
    JEL: G14 E58
    Date: 2013–05–13
  8. By: Luca Fornaro (London School of Economics)
    Abstract: This paper develops a dynamic small open economy model featuring an occasionally binding collateral constraint and nominal wage rigidities. The goal is to study the performance of alternative exchange rate policies in economies that endogenously alternate between tranquil times and crises. Financial frictions introduce a trade-off between price and financial stability. For low levels of foreign debt the probability of a future crisis is small and the best policy consists in targeting wage inflation. For high levels of foreign debt the probability of a future crisis is high and wage inflation targeting is dominated by a flexible exchange rate targeting rule, because the latter policy does a better job in mitigating the fall in output, consumption and capital inflows during crisis events. In contrast, pegging the exchange rate is always welfare dominated by targeting wage inflation. I also find that the exchange rate regime affects both the behavior of the economy during crisis events and the crisis probability, through its impact on debt accumulation during tranquil times.
    Date: 2012
  9. By: Zsolt Darvas; Balázs Varga (OTP Fund Management and Corvinus University of Budapest)
    Abstract: This paper studies inflation persistence with time-varying-coefficient autoregressions for twelve Central-European countries, in comparison with the US and the euro-area. Inflation persistence tends to be higher in times of high inflation. Since the oil price shocks, inflation persistence declined both in the US and euro-area. In most central and eastern European countries, for which our time period covers 1993-2012, inflation persistence has also declined, with the main exceptions of the Czech Republic, Slovakia and Slovenia, where persistence seems to be rather stable. We also concluded that the OLS estimate of an autoregression is likely upward biased when the parameters change.
    Keywords: inflation persistence, flexible least squares, Kalman-filter, time-varying coefficient models
    JEL: C22 E31
    Date: 2013–02
  10. By: Giuseppe Fiori (University of Sao Paulo); Fabio Ghironi (Boston College); Matteo Cacciatore (HEC Montreal)
    Abstract: The global crisis that began in 2008 reheated the debate on market deregulation as a tool to spur economic performance. This paper addresses the consequences of increased flexibility in goods and labor markets for the conduct of monetary policy in a monetary union. We model a two-country monetary union with endogenous product creation, labor market frictions, and price and wage rigidities. We allow regulation in goods and labor markets to differ across countries. We first characterize optimal monetary policy when regulation is high and show that the Ramsey allocation requires significant departures from price stability both in the long run and over the business cycle. Welfare gains from the Ramsey-optimal policy are sizable. Second, we show that the adjustment to market reform requires expansionary policy to reduce transition costs. Third, deregulation reduces static and dynamic inefficiencies, making price stability more desirable. International coordination of reforms is beneficial as it eliminates policy tradeoffs generated by asymmetric deregulation.
    Date: 2012
  11. By: Kevin D. Sheedy
    Abstract: Financial markets are incomplete, thus for many agents borrowing is possible only by accepting a financial contract that specifies a fixed repayment. However, the future income that will repay this debt is uncertain, so risk can be inefficiently distributed. This paper argues that a monetary policy of nominal GDP targeting can improve the functioning of incomplete financial markets when incomplete contracts are written in terms of money. By insulating agents' nominal incomes from aggregate real shocks, this policy effectively completes the market by stabilizing the ratio of debt to income. The paper argues that the objective of nominal GDP should receive substantial weight even in an environment with other frictions that have been used to justify a policy of strict inflation targeting.
    Keywords: incomplete markets, heterogeneous agents, risk sharing, nominal GDP targeting
    JEL: E21 E31 E44 E52
    Date: 2013–05
  12. By: Stephen Hall; Amangeldi Kenjegaliev; P.A.V.B. Swamy; George S. Tavlas
    Abstract: We investigate bilateral currency pressures against the U.S. dollar for three currencies: the Japanese yen, the Chinese yuan, and the U.K. pound during the period 2000:Q1 to 2009:Q4. We employ a model-based methodology to measure exchange market pressure over the period. Conversion factors required to estimate the pressure on these currencies are computed using a time-varying coefficient regression. We then use our measures of currency pressures to assess deviations of exchange rates from their market-equilibrium levels. For the yen, our measure of currency pressure suggests undervaluation during the initial part of our estimation period, a period during which the Bank of Japan sold yen in the foreign exchange market. We find persistent undervaluation of the yuan throughout the estimation period, with the undervaluation peaking at about 20 per cent in 2004 and 2007. For the pound, the results indicate low pressure - - suggesting a mainly free-floating currency - - throughout the sample period. These results appear consistent with the policies pursued by the central banks of the currencies in question.
    Keywords: Exchange Market Pressure; Currency Misalignment; Time-Varying-Coefficient
    JEL: C22 F31 F41
    Date: 2013–05
  13. By: Hyoung-kyu Chey (National Graduate Institute for Policy Studies)
    Abstract: The international statuses of currencies shape a fundamental characteristic of the international monetary system, which has significant impacts on the world political economy by affecting the political as well as economic relationships among states. The study of international currencies has been long dominated largely by economists, however, with political economy research in this area quite underdeveloped. However, the 2008/9 global financial crisis, the subsequent European debt crisis and the recent active Chinese promotion of renminbi internationalization have spurred new and considerable interest among political economists on issues surrounding international currencies. Political economy study of international currencies has thus been gradually growing of late, and making notable progress. This study provides a comprehensive and systematic review of the literature on international currencies—covering both political economy and economics—with the primary aim of building a useful groundwork to help develop a better research framework for the political economy study of them. In particular, it discusses the international currency concept, the costs and benefits of international currency issuance, the determinants of currency internationalization, and the future prospects of the current dollar-centered international monetary system. This research in addition highlights a group of important issues that need further investigation by future political economy study of international currencies, by drawing special attention to the following issues: historical events, the political determinants of currency internationalization, government policy strategies, and the consequences of international currency choice.
    Date: 2013–05
  14. By: C. F. Lo (The Chinese University of Hong Kong and Hong Kong Institute for Monetary Research); C. H. Hui (Hong Kong Monetary Authority and Hong Kong Institute for Monetary Research); S. W. Chu (The Chinese University of Hong Kong); T. Fong (Hong Kong Monetary Authority)
    Abstract: The exchange rate target zone literature has often suggested that mean reversion in an exchange rate within a zone can be taken as evidence that the system is credible. While the exchange rate system in Hong Kong is perceived as having a high degree of credibility, there is mixed empirical evidence to suggest that the HKD shows mean reversion. This paper proposes a quasi-bounded process for exchange rate dynamics within a target zone, consistent with a fully credible exchange rate band in which the exchange rate cannot breach the strong-side limit while the weak-side limit is only accessible under restricted conditions of the relationship between the parameters of the drift term and stochastic part of the process. Our empirical results suggest that this model can describe the dynamics of the Hong Kong dollar where the drifting force is an increasing function of foreign reserves.
    Keywords: Stochastics Process, Target Zone, Bounded Process
    JEL: F31 G13
    Date: 2012–11
  15. By: Gerardo P. Sicat (University of the Philippines School of Economics)
    Abstract: Documentary evidence of the emergence and the eventual complete dominance of the Chinese mercantile traders (Sangleys) during the Spanish colonial period in the Philippines is first presented. We identify the critical traits in the Sangley mercantile genome and the new contractual and organizational technologies which led to the wipeout of non-Sangley merchants from the market. A Malthusian replicator dynamics is proposed to explain the wipeout process. We explain the persistence of the mercantile dominance of Sangleys via the forces serving to curve abuse of market power and non-assimilation of winning Sangley traits by non-Chinese following the Akerlof-Kranton identity economics.
    Keywords: Philippine peso exchange rate, exchange rate appreciation, monetary policy, fiscal policy, Philippine economic development
    JEL: N0 L10
    Date: 2012–10
  16. By: Marcel Fratzscher; Lucio Sarno; Gabriele Zinna
    Abstract: This paper provides an empirical test of the scapegoat theory of exchange rates (Bacchetta and van Wincoop 2004, 2011). This theory suggests that market participants may at times attach significantly more weight to individual economic fundamentals to rationalize the pricing of currencies, which are partly driven by unobservable shocks. Using novel survey data which directly measure foreign exchange scapegoats for 12 currencies and proprietary data on order flow, we find empirical evidence that strongly supports the scapegoat theory of exchange rates, with the resulting models explaining a large fraction of the variation and directional changes in exchange rates.
    Keywords: scapegoat, exchange rates, economic fundamentals, survey data
    JEL: F31 G10
    Date: 2013
  17. By: Periklis Gogas (Department of Economics, Democritus University of Thrace, Greece; The Rimini Center for Economic Analysis, Italy)
    Abstract: In this paper, I analyse the synchronization of business cycles within the E.U., as this is an important ingredient for the implementation of a successful monetary policy. The business cycles of twelve E.U. countries and two sub-groups of countries are extracted for the period 1989Q1-2010Q2. The cycle of G3, the group of the three largest European economies (Germany, France and Italy) is then used as a benchmark series for the comparisons. The sensitivity of the data to alternative cycle extraction methodologies is explored employing the Hodrick-Prescott and Baxter-King filters using alternative parameter specifications and leads/lags. The strength of cycle synchronization is measured using linear regressions, cross-correlation coefficients and the Cycle Synchronization Index (CSI). To assess whether synchronization is stronger after the introduction of the common currency, we also test two sub-samples pre- and post-EMU (1999Q1). The empirical results provide evidence that cycle synchronization within the Eurozone has become stronger in the common currency period.
    Keywords: Business Cycle, Synchronization, Eurozone
    Date: 2013–04
  18. By: Guglielmo Maria Caporale; Faek Menla Ali; Nicola Spagnolo
    Abstract: This paper examines the impact of exchange rate uncertainty on different components of portfolio flows, namely equity and bond flows, as well as the dynamic linkages between exchange rate volatility and the variability of these two types of flows. Specifically, a bivariate GARCH-BEKK-in-mean model is estimated using bilateral data for the US vis-à-vis Australia, the UK, Japan, Canada, the euro area, and Sweden over the period 1988:01- 2011:12. The results indicate that the effect of exchange rate uncertainty on equity flows is negative in the euro area, the UK and Sweden, and positive in Australia, whilst it is negative in all countries except Canada (where it is positive) in the case of bond flows. Under the assumption of risk aversion, this suggests that exchange rate uncertainty induces a home bias and causes investors to reduce their financing activities to maximise returns and minimise exposure to uncertainty. Furthermore, since exchange rate volatility and the variability of flows are interlinked, exchange rate or credit controls on these flows can be used to pursue economic and financial stability.
    Keywords: Exchange rate uncertainty, Equity flows, Bond flows, Causality-in-variance
    JEL: F31 F32 G15
    Date: 2013
  19. By: Barbara Rossi
    Abstract: The main goal of this article is to provide an answer to the question: “Does anything forecast exchange rates, and if so, which variables?†It is well known that exchange rate fluctuations are very difficult to predict using economic models, and that a random walk forecasts exchange rates better than any economic model (the Meese and Rogoff puzzle). However, the recent literature has identified a series of fundamentals/methodologies that claim to have resolved the puzzle. This article provides a critical review of the recent literature on exchange rate forecasting and illustrates the new methodologies and fundamentals that have been recently proposed in an up- to-date, thorough empirical analysis. Overall, our analysis of the literature and the data suggests that the answer to the question: "Are exchange rates predictable?" is, "It depends" –on the choice of predictor, forecast horizon, sample period, model, and forecast evaluation method. Predictability is most apparent when one or more of the following hold: the predictors are Taylor rule or net foreign assets, the model is linear, and a small number of parameters are estimated. The toughest benchmark is the random walk without drift.
    Keywords: exchange rates, forecasting, instability, forecast evaluation
    JEL: F3 C5
    Date: 2013–02
  20. By: Paolo Bonomolo (University of Pavia); Guido Ascari (Universita degli Studi di Pavia)
    Abstract: We propose a generalization of the rational expectations (RE) hypothesis: as in the original approach by Muth (1961), the case of multiple solutions is the natural case, and expectations are formed by randomizing across the infinite RE solutions. We call our approach: "rational sunspots". The infinite solutions differ in the way agents form their expectations, or more precisely in the way agents weight past data to make forecasts. It follows that our approach naturally yields drifting parameters and stochastic volatility. It also allows for the possibility of temporary explosive paths. Moreover, a simple method to distinguish between determinacy and indeterminacy is based on the Normality of the likelihood.
    Date: 2012

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