nep-mon New Economics Papers
on Monetary Economics
Issue of 2013‒12‒15
twenty-two papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. The Six Major Puzzles in International Macroeconomics: Is there a Common Cause? By Maurice Obstfeld; Kenneth Rogoff; Ben Bernanke; Kenneth Rogoff
  2. Reputational Constraints on Monetary Policy By K. Brunner; A. Meltzer
  3. Euro Area monetary policy transmission in Estonia By Gertrud Errit; Lenno Uusküla
  4. Rethinking Pro-Growth Monetary Policy in Africa: Monetarist versus Keynesian Approach By NGUENA, CHRISTIAN LAMBERT
  5. Asymmetric Effects of Monetary Policy in the U.S. and Brazil By Pragidis, Ioannis; Gogas, Periklis; Tabak, Benjamin
  6. Optimal Monetary Responses to Oil Discoveries By Samuel Wills
  7. Why Does Monetary Policy Respond to the Real Exchange Rate in Small Open Economies? A Bayesian Perspective By Carlos Garcia
  8. Estimation and Inference under Weak Identi…cation and Persistence: An Application on Forecast-Based Monetary Policy Reaction Function By Jui-Chung Yang; Ke-Li Xu
  9. Estimates of Fundamental Equilibrium Exchange Rates, November 2013 By William R. Cline
  10. Monetary Policy, Output and Prices- Peláezs Contributions and a Sequential Multiple-horizon Non-causation Test for the period 1861-1970 By Erik Alencar de Figueiredo; Claudio Shikida; Ari Francisco Araújo Jr
  11. Identifying monetary policy shocks via heteroskedasticity: a Bayesian approach By Dmitry Kulikov; Aleksei Netšunajev
  12. Dilemma not Trilemma? Capital Controls and Exchange Rates with Volatile Capital Flows By Emmanuel Farhi; Ivan Werning
  13. Euro at Risk: The Impact of Member Countries Credit Risk on the Stability of the Common Currency By Thorsten Lehnert; Lamia Bekkour; Xisong Jin; Fanou Rasmouki; Christian Wolff
  14. Fear of a two-speed monetary union: what does a basic correlation scatter plot tell us? By Jean-Sébastien Pentecôte
  15. Demand for Liquidity and Welfare Cost of Inflation by Cohort and Age of Households By Yaz Terajima; Jose-Victor Rios-Rull; Césaire Meh; Shutao Cao
  16. Combining Monetary and Fiscal Policy in an SVAR for a Small Open Economy By Alfred A. Haug; Tomasz Jedrzejowicz; Anna Sznajderska
  17. Electoral cycles in international reserves: Evidence from Latin America and the OECD By Jorge M. Streb; Daniel Lema; Pablo Garofalo
  18. The EMS, the EMU, and the Transition to a Common Currency By Kenneth Froot; Kenneth Rogoff; Olivier Blanchard; Stanley Fischer
  19. Purchasing power parity and the Taylor rule By Hyeongwoo Kim, Ippei Fujiwara, Bruce E. Hansen, Masao Ogaki
  20. External Debt and Taylor Rules In a Small Open Economy By Shigeto Kitano; Kenya Takaku
  21. Exchange Rate Volatility and Inflation Upturn in Nigeria: Testing for Vector Error Correction Model By Adeniji, Sesan
  22. "Lost at Sea: The Euro Needs a Euro Treasury" By Jorg Bibow

  1. By: Maurice Obstfeld; Kenneth Rogoff; Ben Bernanke; Kenneth Rogoff
    Abstract: The central claim in this paper is that by explicitly introducing costs of international trade (narrowly, transport costs but more broadly, tariffs, nontariff barriers and other trade costs), one can go far toward explaining a great number of the main empirical puzzles that international macroeconomists have struggled with over twenty-five years. Our approach elucidates J. McCallum's home bias in trade puzzle, the Feldstein-Horioka saving-investment puzzle, the French-Poterba equity home bias puzzle, and the Backus-Kehoe- Kydland consumption correlations puzzle. That one simple alteration to an otherwise canonical international macroeconomic model can help substantially to explain such a broad arrange of empirical puzzles, including some that previously seemed intractable, suggests a rich area for future research. We also address a variety of international pricing puzzles, including the purchasing power parity puzzle emphasized by Rogoff, and what we term the exchange-rate disconnect puzzle.' The latter category of riddles includes both the Meese-Rogoff exchange rate forecasting puzzle and the Baxter-Stockman neutrality of exchange rate regime puzzle. Here although many elements need to be added to our extremely simple model, we can still show that trade costs play an essential role.
  2. By: K. Brunner; A. Meltzer
  3. By: Gertrud Errit; Lenno Uusküla
    Abstract: This paper studies the effect of a monetary policy shock in the euro area on the main Estonian economic and financial variables between 2000 and 2012. Using a standard structural vector autoregression (SVAR) model we find strong and persistent effects on Estonian GDP, private consumption, corporate investment and imports. A monetary policy shock has also strong and sluggish effects on the housing loan and consumer credit interest rates. The estimated reaction of Estonian GDP and the GDP deflator-based inflation rate is about four times stronger than the reaction of euro area-wide aggregates. The Estonian money market interest rate (the 3-month Talibor) reacts about twice as strongly as the euro area money market interest rate (the 3-month Euribor). We also show that this finding is sensitive to the inclusion of the data from the years of the recent financial and economic crisis. We conjecture that household interest rates can play an important role in propagating monetary policy shocks in Estonia.
    Keywords: monetary policy, SVAR, Estonia, euro area
    JEL: E32 E52 C32
    Date: 2013–12–09
    Abstract: The relative positive economic growth experienced by most African countries in the recent decade has come with insufficient demand stimulation. The concern of poverty at the forefront of economic policy, the need for inclusive growth and sustainable development, inter alia, brings forward the inevitable question of the monetary policy responsibility. Accordingly, the monetarist theory that focuses on price stability inherently neglects the demand stimulation aspect of economic prosperity. Since the mid 1980s, the monetarist school driven by its central aim of fighting inflation and maintaining credibility in markets and economic agents has been priority for monetary authorities (especially in Africa). To this effect, while good results in terms of inflation targeting has been achieved in many African countries; economic growth has sometimes been low. Hence, in light of the above, using a statistical and theoretical debate method, the Credible Monetary Policy (CMP) paradox is traceable to Africa. Accordingly, with the promising economic environment in Africa, we recommend the promotion of a monetary policy oriented toward improving economic growth under the constraint of price stability. In light of the above view, there are some note worthy signs such the recent decision by the two CFA zone central banks to either maintain interest rates at a low level or reduce it despite tightening measures of monetary policy taken by the European Central Bank (ECB) earlier in the year. In the same vein, the central bank of South Africa has maintained its policy of low interest rates with an objective of economic expansion. Since, the 2008 financial crisis, the consolidation of the Federal Reserve’s declared final objective of lowering interest rates and making emergency loans is an eloquent example to reassure African central banks in the choice of the pro-growth monetary policy option.
    Keywords: Pro growth monetary policy; CMP paradox; Financing enterprises; African central bank.
    JEL: B40 E52
    Date: 2010–12–08
  5. By: Pragidis, Ioannis (Democritus University of Thrace, Department of Economics); Gogas, Periklis (Democritus University of Thrace, Department of Economics); Tabak, Benjamin (Bank of Brazil)
    Abstract: We empirically test the effects of anticipated and unanticipated monetary policy shocks on the growth rate of real industrial production and explicitly test for different types of asymmetries in monetary policy implementation for two major international economies, the U.S. and Brazil. We depart from the conventional method of VAR analysis to estimate unanticipated monetary shocks and instead we use a combination of other methods. We first identify the Taylor rule that best describes the reaction of both central banks and then we test both forward looking linear and nonlinear models concluding that a Logistic Smooth Transition Autoregressive (LSTAR) forward looking model of the Taylor rule best describes the US FED Funds rate while a linear Taylor rule with the inclusion of a dummy variable best describes the reaction of the Central Bank of Brazil (BCB). We then use in-sample forecast errors in order to derive or identify the unexpected monetary shocks for both countries. In line with Cover (1992), we use these shocks to explore any asymmetries in the conduct of monetary policy on the growth rate of real industrial production. We also find asymmetries between anticipated and unanticipated monetary shocks as well as between effects of positive and negative shocks.
    Keywords: Taylor rule; monetary policy; nonlinear effects; LSTAR
    JEL: E40 E52 E58
    Date: 2013–12–07
  6. By: Samuel Wills
    Abstract: Monetary policy can play an important role in managing oil discoveries. Ideally governments will use fiscal policy to smooth consumption of oil income. In practice this often does not happen, as governments delay spending until oil revenues are received. This induces changes in the economy, both at discovery and when spending begins. In this paper we consider how monetary policy should respond. The paper makes three contributions. The first is to show that an oil discovery causes the real exchange rate to appreciate twice: when forward-looking households and then the government increase their consumption. This can cause a recession under standard monetary regimes, as firms anticipate the second appreciation. The second contribution is to micro-found the objective of monetary policy. The central bank should stabilise inflation, the output gap and the fiscal gap. It will also try to appreciate the non-oil terms of trade, to exploit the asymmetry from owning oil wealth. The third is to derive a closed form for optimal monetary policy, which will respond in advance to expected changes in government demand. This will delay the second real appreciation until the government can take up the slack left by private demand. Optimal policy significantly improves welfare relative to standard monetary regimes, and is well approximated by a simple Taylor rule that responds to expected changes in the natural level of output.
    Keywords: Natural resources, oil, optimal monetary policy, small open economy, anticipated windfall
    JEL: E52 E62 F41 O13 Q30 Q33
    Date: 2013–08–30
  7. By: Carlos Garcia (Facultad de Economía y Negocios, Universidad Alberto Hurtado)
    Abstract: To estimate how monetary policy works in small open economies, we build a dynamic stochastic general equilibrium model that incorporates the basic features of these economies. We conclude that the monetary policy in a group of small open economies (including Australia, Chile, Colombia, Peru, and New Zealand) is rather similar to that observed in closed economies. Our results also indicate, however, that there are strong differences due to shocks from the international financial markets (mainly risk premium shocks). These differences explain most of the variability of the real exchange rate, which has important reallocation effects in the short run. Our results are consistent with an old idea from the Mundell-Fleming model: namely, a real depreciation to confront a risk premium shock is expansive or procyclical, in contradiction to the predictions of the balance sheet effect, the J curve effect, and the introduction of working capital into RBC models. In line with this last result, we have strong evidence that only in one of the five countries analyzed in this study does not intervene the real exchange rate, the case of New Zealand.
    Keywords: small open economy models; monetary policy rules; exchange rates; Bayesian econometrics
    JEL: F33 E52 F41
    Date: 2012–11
  8. By: Jui-Chung Yang; Ke-Li Xu
    Abstract: The reaction coefficients of expected inflations and output gaps in the forecast-based monetary policy reaction function may be merely weakly …identified when the smoothing coefficient is close to unity and the nominal interest rates are highly persistent. In this paper we modify the method of Andrews and Cheng (2012, Econometrica)on inference under weak / semi-strong identification to accommodate the persistence issue. Our modification involves the employment of asymptotic theories for near unit root processes and novel drifting sequence approaches. Large sample properties with a desired smooth transition with respect to the true values of parameters are developed for the nonlinear least squares (NLS) estimator and its corresponding t / Wald statistics of a general class of models. Despite the not-consistent-estimability, the conservative confidence sets of weakly-identified parameters of interest can be obtained by inverting the t / Wald tests. We show that the null-imposed least-favorable confidence sets will have correct asymptotic sizes, and the projection-based method may lead to asymptotic over-coverage. Our empirical application suggests that the NLS estimates for the reaction coefficients in U.S.Âs forecast-based monetary policy reaction function for 1987:3Â2007:4 are not accurate sufficiently to rule out the possibility of indeterminacy.
    JEL: C12 C22 E58
    Date: 2013–12–08
  9. By: William R. Cline (Peterson Institute for International Economics)
    Abstract: Since the previous estimates of fundamental equilibrium exchange rates (FEERs) in May 2013, numerous exchange rates have moved substantially in response to the US Federal Reserve's announcement that it would likely begin to "taper" its quantitative easing. Despite widespread concern that this "taper shock" has wreaked havoc in international capital and currency markets, exchange rate misalignments have tended to narrow in the past six months. Overvalued currencies have corrected downward in Turkey, South Africa, India, Indonesia, and even Australia. Medium-term surplus estimates have moderated in Taiwan, Sweden, Switzerland, and Japan, narrowing the extent of their undervaluations. Cases of large misalignments persist, however, with Singapore once again undervalued by 21 percent, New Zealand again overvalued by nearly 18 percent, and Turkey still overvalued by 18 percent despite some correction. The overvaluation of the dollar and undervaluation of the Chinese renminbi remain modest and no longer constitute the severe imbalances of 2006–07.
    Date: 2013–12
  10. By: Erik Alencar de Figueiredo; Claudio Shikida; Ari Francisco Araújo Jr
    Abstract: This paper aims to examine if the use of modern protocol for time series data analysis corroborates the results found previously in the literature. Specically, we inspect the non structuralists arguments developed in the 1970s about monetary policy eects. The contributions of this paper are-(a) to review the non-structuralist arguments made by Carlos Manuel Pelaez and Wilson Suzigan and in Pelaez's later works and (b) to test the causality between money, output, and prices, as well as the authors central argument on the importance of monetary policy, using the sequential multiple-horizon non-causation test developed by Hill (2007). Pelaez and Suzigan's original results are corroborated, since monetary policy (measured by monetary base) has an effect on nominal rather than on real output.
    Date: 2013
  11. By: Dmitry Kulikov; Aleksei Netšunajev
    Abstract: In this paper we contribute to the literature on the identification of macroeconomic shocks by proposing a Bayesian SVAR with timevarying volatility of innovations that depend on a hidden Markov process, referred to as an MS-SVAR. With sufficient statistical information in the data, the distinct volatility regimes of the errors allow all the structural SVAR matrices and impulse response functions to be identified without the need for conventional a priori parameter restrictions. We give mathematical identification conditions and propose a flexible Gibbs sampling approach for the posterior inference on MS-SVAR parameters. The new methodology is applied to the US, euro area and Estonian macroeconomic series, where the effects of monetary policy and other shocks are examined.
    Keywords: Markov switching model, volatility regimes, Bayesian inference, monetary policy shocks, SVAR analysis
    JEL: C11 C32 C54
    Date: 2013–12–09
  12. By: Emmanuel Farhi; Ivan Werning
    Abstract: We consider a standard New Keynesian model of a small open economy with nominal rigidities and study optimal capital controls. Consistent with the Mundellian view, we find that the exchange rate regime is key. However, in contrast with the Mundellian view, we find that capital controls are desirable even when the exchange rate is flexible. Optimal capital controls lean against the wind and help smooth out capital flows.
    Date: 2013–01
  13. By: Thorsten Lehnert; Lamia Bekkour; Xisong Jin; Fanou Rasmouki; Christian Wolff (LSF)
    Abstract: In this paper, we empirically investigate the impact of the credit risk of Eurozone member countries on the stability of the Euro. In practice, in the absence of eurobonds, euro-area credit risk is induced though the credit default swaps of the member countries. The stability of the euro is examined by decomposing dollareuro exchange rate options into the moments of the risk-neutral distribution. We document that during the sovereign debt crisis changes in the creditworthiness of member countries have significant impact on the stability of the euro. In particular, an increase in member countries credit risk results in an increase of volatility of the dollar-euro exchange rate along with soaring tail risk induced through the riskneutral kurtosis. We find that member countries credit risk is a major determinant of the euro crash risk as measured by the risk-neutral skewness. We propose a new indicator for currency stability by combining the risk-neutral moments into an aggregated risk measure and show that our results are robust to this change in measure. Noticeable is the fact that during the sovereign debt crisis, the creditworthiness of countries with vulnerable fiscal positions is the main riskendangering factor of the euro-stability.
    Keywords: European sovereign debt crisis, currency options, credit default swaps, currency stability, risk-neutral distribution, crash risk, tail risk.
    JEL: G13 F31
    Date: 2012
  14. By: Jean-Sébastien Pentecôte (CREM - Centre de Recherche en Economie et Management - CNRS : UMR6211 - Université de Rennes 1 - Université de Caen Basse-Normandie)
    Abstract: I extend the Bayoumi-Eichengreen (1993) approach by extracting new information from a scatter plot of correlation coefficients between shocks in order to better visualize how far a given country is from a monetary union. Indexes of distance and relative strength can be derived from either a nonlinear or a linear combination of correlations in connexion with distinct welfare loss functions. Using quarterly data on ten countries over 1979:I-2011:IV, shocks have become more symmetric within, but also outside, the euro area. Despite less asymmetry in shock asymmetry since 1999, new statistical tests support the idea of a two-speed EMU.
    Keywords: monetary union, euro, shock asymmetry, distance, VAR identification
    Date: 2013–12–11
  15. By: Yaz Terajima (Bank of Canada); Jose-Victor Rios-Rull (University of Minnesota); Césaire Meh (Bank of Canada); Shutao Cao (Bank of Canada)
    Abstract: Cross-sectional data show that money holding differs significantly over household consumption and age. Liquidity demand for money (i.e., money holding per dollar of consumption) decreases as household consumption increases. It also increases with household age conditional on the level of consumption. Observed age differences in money holdings contain not only age-specific information but also cohort-specific one. Using a life-cycle model, this paper disentangles these two effects on money demand and quantifies welfare gains of reducing the long-run inflation rate. We dynamically calibrate the model to micro data and macroeconomic conditions over time. We find that, although a large part of the observed cross-sectional age differences in money demand can be accounted for by some age effects, cohort effects play a non-negligible part, supporting a presence of financial innovation. In addition, changing inflation has significantly different impacts across household groups due to their heterogeneity in money holding. When inflation increases from the 2009 level to 10%, we find the aggregate welfare loss in consumption to be 1.34%. These losses are accrued mostly by generations that are currently alive and less by future cohorts. Finally, poorer households lose more than their rich peers.
    Date: 2013
  16. By: Alfred A. Haug (Department of Economics, University of Otago, New Zealand); Tomasz Jedrzejowicz (National Bank of Poland); Anna Sznajderska (National Bank of Poland)
    Abstract: This paper combines a monetary structural vector-autoregression (SVAR)with a fiscal SVAR for Poland. Fiscal foresight, in the form of implementation lags, is accounted for with respect to both discretionary government spending and tax changes. We demonstrate the importance of combining monetary and fiscal transmission mechanisms. However, ignoring fiscal foresight has no statistically significant effects. We calculate an initial government spending multiplier of 0.14, which later peaks at 0.48. The tax multiplier is close to zero. We also find that monetary policy in Poland transmits mainly through the real sector, that is through real GDP and the real exchange rate.
    Keywords: Structural vector autoregressions, monetary and fiscal policy, fiscal foresight, narrative approach
    JEL: E52 E62 C51
    Date: 2013–10
  17. By: Jorge M. Streb; Daniel Lema; Pablo Garofalo
    Abstract: In Latin America there is ample evidence of exchange rate depreciations after elections. Hence, we turn to the behavior of international reserves over the 1980–2005 period to investigate if exchange rates are temporarily stabilized before elections. Using annual, quarterly, and monthly data to define the election year, we find that international reserves fall significantly before elections, which indeed suggests a policy of stabilizing exchange rates. The patterns observed in the region are not replicated in OECD countries. However, once we control for legislative checks and balances on executive discretion in countries with strong compliance with the law, the behavior of both regions becomes remarkably similar. We find that lower effective checks and balances can explain why reserves fall before elections in Latin America. The electoral cycles in reserves and exchange rates in Latin America can be interpreted in terms of the fiscal dominance of monetary policy.
    Keywords: monetary policy, checks and balances, fiscal dominance, political budget cycles, temporal aggregation
    JEL: D72 D78 H60
    Date: 2013–10
  18. By: Kenneth Froot; Kenneth Rogoff; Olivier Blanchard; Stanley Fischer
  19. By: Hyeongwoo Kim, Ippei Fujiwara, Bruce E. Hansen, Masao Ogaki
    Abstract: It is well-known that there is a large degree of uncertainty around Rogoff's (1996) consensus half-life of the real exchange rate. To obtain a more efficient estimator, we develop a system method that combines the Taylor rule and a standard exchange rate model to estimate half-lives. Further, we propose a median unbiased estimator for the system method based on the generalized method of moments with nonparametric grid bootstrap confidence intervals. Applying the method to real exchange rates of 18 developed countries against the US dollar, we find that most half-life estimates from the single equation method fall in the range of 3 to 5 years with wide confidence intervals that extend to positive infinity. In contrast, the system method yields median-unbiased estimates that are typically shorter than one year with much sharper 95% confidence intervals. Our Monte Carlo simulation results are consistent with an interpretation of these results that the true half-lives are short but long half-life estimates from single equation methods are caused by the high degree of uncertainty of these methods.
    Keywords: purchasing power parity; Taylor Rule; half-life of PPP deviations;median unbiased estimator; Grid-t Confidence Interval
    JEL: C32 E52 F31
    Date: 2013
  20. By: Shigeto Kitano (Research Institute for Economics & Business Administration (RIEB), Kobe University, Japan); Kenya Takaku (Graduate School of Economics, Nagoya University)
    Abstract: We develop a dynamic stochastic general equilibrium model of a small open economy in which both price rigidity and financial friction exist. We compare two cases featuring different interest rate rules. Both cases use the standard Taylor-type interest rate rules, but the second case also considers external debt levels. We find that when friction in foreign borrowing is large, adding an external debt level to Taylor rules improves welfare. The welfare curve, however, exhibits a hump shape since excessive reactions to changes in external debt reduce welfare.
    Keywords: External debt; Taylor rules; small open economy; DSGE; welfare; emerging market economies
    JEL: E5 F4
    Date: 2013–11
  21. By: Adeniji, Sesan
    Abstract: Abstract This paper empirically examines the impact of exchange rate volatility on inflation in Nigeria using annual time series data from 1986 – 2012. The methodology employed includes: ADF, PP and KPSS test of unit root, Johansen Julius cointegration test, VECM, granger causality test, impulse response function and variance decomposition. The unit root test result shows that all variables are stationary at first difference, while Maxi-eigen value shows a long run relationship between the variables. VECM result established positive and significant relationship between inflation, exchange rate volatility, money supply and fiscal deficit, while gross domestic product show negative relationship. Granger causality outcome shows a bi-directional relationship between all the variables. Subsequently, exchange rate volatility is deduced to influence inflation in Nigeria. Therefore, it becomes imperative for the government to understand and control the various channels through which exchange rate transmits to affect inflation in Nigeria, check the growth of money supply, increase the level of productivity in the country and lastly cut down public sector expenditure and possibly make a shift from excessive consumption expenditure to capital expenditure believing this will reduce the burden of fiscal deficit and the rate of inflation.
    Keywords: Exchange rate volatility, inflation upturn, vecm, granger causality, impulse response and variance decomposition
    JEL: E31 E51 E62
    Date: 2013–12–08
  22. By: Jorg Bibow
    Abstract: The euro crisis remains unresolved even as financial markets may seem calm for now. The current euro regime is inherently flawed, and recent reforms have failed to turn this dysfunctional regime into a viable one. Our investigation is informed by the "cartalist" critique of traditional "optimum currency area" theory (Goodhart 1998). Various proposals to rescue the euro are assessed and found lacking. A "Euro Treasury" scheme operating on a strict rule and specifically designed not to be a transfer union is proposed here as a condition sine qua non for healing the euro’s potentially fatal birth defects. The Euro Treasury proposed here is the missing element that will mend the current fiscal regime, which is unworkable without it. The proposed scheme would end the currently unfolding euro calamity by switching policy from a public thrift campaign that can only impoverish Europe to a public investment campaign designed to secure Europe’s future. No mutualization of existing national public debts is involved. Instead, the Euro Treasury is established as a means to pool eurozone public investment spending and have it funded by proper eurozone treasury securities.
    Keywords: Euro Crisis; Currency Union; Fiscal Union; Transfer Union; Cartalism; Lender of Last Resort; European Integration
    JEL: E02 E42 E58 E61 E62 F36 G01
    Date: 2013–11

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