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on Monetary Economics |
| By: | Hernando Vargas H. |
| Abstract: | The Colombian economy experienced several shocks in the past ten years. The permanent fall of inflation, the adoption of inflation targeting (IT) and a financial crisis altered the transmission mechanism of monetary policy. Low inflation and IT reduced inflation persistence and contributed to anchor inflation expectations. The evidence is less conclusive with respect to the changes of the responsiveness of inflation to domestic conditions (output or marginal cost gaps). Increased competition may have encouraged a higher degree of price flexibility, but a more stable inflation environment may have raised the sensitivity of aggregate supply to inflation surprises. The short-run money-inflation relationship was broken in the presence of low inflation, exogenous shocks to the demand for money and a policy regime that stabilized short-run interest rates. The sensitivity of aggregate demand to the interest rate varied with the indebtedness of private agents and the credit channel was severed after the financial crisis. The IT regime implied a stabilization of short-run interest rates, making the monetary policy stance and objectives clearer to the public. However, interest rate pass-through appears to be incomplete and seems to respond to the varying importance of the credit channel and the general state of the economy. |
| Date: | 2007–02–01 |
| URL: | http://d.repec.org/n?u=RePEc:col:001043:002797&r=mon |
| By: | Klaus Adam; Roberto M. Billi |
| Abstract: | Does an inflation conservative central bank à la Rogoff (1985) remain desirable in a setting with endogenous fiscal policy? To provide an answer we study monetary and fiscal policy games without commitment in a dynamic stochastic sticky price economy with monopolistic distortions. Monetary policy determines nominal interest rates and fiscal policy provides public goods generating private utility. We find that lack of fiscal commitment gives rise to excessive public spending. The optimal inflation rate internalizing this distortion is positive, but lack of monetary commitment robustly generates too much inflation. A conservative monetary authority thus remains desirable. When fiscal policy is determined before monetary policy each period, the monetary authority should focus exclusively on stabilizing inflation, as this eliminates the steady state biases associated with lack of monetary and fiscal commitment. It also leads to stabilization policy that is close to if not fully optimal. |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedkrw:rwp07-01&r=mon |
| By: | Guo, Shen |
| Abstract: | We explore the optimal response of central bank when a news shock hits the economy, that is, agents’ optimistic expectation of an improvement in technology does not realize. Ramsey optimal policy and simple policy rules are studied in a two-sector model with price rigidities in each of non-durable and durable sector. We find that a simple policy rule reacting to the inflation rates in both non-durable and durable sector with appropriate weights can mimic the performance of the Ramsey policy closely. Another interesting result is that monetary policy plays an important role in generating expectation driven business cycles. |
| Keywords: | News shocks; Expectation driven business cycles; Optimal monetary policy |
| JEL: | E52 E32 |
| Date: | 2007–02–10 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:1928&r=mon |
| By: | Richard Dennis; Kai Leitemo; Ulf Söderström |
| Abstract: | We use robust control techniques to study the effects of model uncertainty on monetary policy in an estimated, semi-structural, small-open-economy model of the U.K. Compared to the closed economy, the presence of an exchange rate channel for monetary policy not only produces new trade-offs for monetary policy, but it also introduces an additional source of specification errors. We find that exchange rate shocks are an important contributor to volatility in the model, and that the exchange rate equation is particularly vulnerable to model misspecification, along with the equation for domestic inflation. However, when policy is set with discretion, the cost of insuring against model misspecification appears reasonably small. |
| Keywords: | Monetary policy |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedfwp:2007-04&r=mon |
| By: | Buiter, Willem H |
| Abstract: | Governments through the ages have appropriated real resources through the monopoly of the ‘coinage’. In modern fiat money economies, the monopoly of the issue of legal tender is generally assigned to an agency of the state, the Central Bank, which may have varying degrees of operational and target independence from the government of the day. In this paper I analyse four different but related concepts, each of which highlights some aspect of the way in which the state acquires command over real resources through its ability to issue fiat money. They are (1) seigniorage (the change in the monetary base), (2) Central Bank revenue (the interest bill saved by the authorities on the outstanding stock of base money liabilities), (3) the inflation tax (the reduction in the real value of the stock of base money due to inflation and (4) the operating profits of the central bank, or the taxes paid by the Central Bank to the Treasury. To understand the relationship between these four concepts, an explicitly intertemporal approach is required, which focuses on the present discounted value of the current and future resource transfers between the private sector and the state. Furthermore, when the Central Bank is operationally independent, it is essential to decompose the familiar consolidated ‘government budget constraint’ and consolidated ‘government intertemporal budget constraint’ into the separate accounts and budget constraints of the Central Bank and the Treasury. Only by doing this can we appreciate the financial constraints on the Central Bank’s ability to pursue and achieve an inflation target, and the importance of cooperation and coordination between the Treasury and the Central Bank when faced with financial sector crises involving the need for long-term recapitalisation or when confronted with the need to mimick Milton Friedman’s helicopter drop of money in an economy faced with a liquidity trap. |
| Keywords: | central bank budget constraint; coordination of monetary and fiscal policy; inflation targeting; inflation tax |
| JEL: | E4 E5 E6 H6 |
| Date: | 2007–02 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6152&r=mon |
| By: | Harashima, Taiji |
| Abstract: | Most explanations for the necessity of an independent central bank rely on the time-inconsistency model and therefore assume that governments are weak, foolish, or untruthful and tend to cheat people. The model in this paper indicates, however, that an independent central bank is not necessary because governments are weak or foolish. Central banks must be independent because governments are economic Leviathans. Only by severing the link between the political will of a Leviathan government and economic activities is inflation perfectly guaranteed not to accelerate. A truly independent central bank is necessary because it severs this link. |
| Keywords: | Central Bank Independence; Inflation; The Fiscal Theory of the Price Level; Leviathan; Monetary Policy |
| JEL: | E61 E58 E52 E63 |
| Date: | 2007–01–15 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:1838&r=mon |
| By: | Pierre-Richard Agénor; Peter J. Montiel |
| Abstract: | This paper develops a simple static model with credit market imperfections and flexible prices for monetary policy analysis in a fixed-exchange rate economy. Lending rates are set as a premium over the cost of borrowing from the central bank. The premium itself depends on firms' net worth. In the basic framework, banks' funding sources are perfect substitutes and the provision of liquidity by the central bank is perfectly elastic at the prevailing refinance rate. The model is used to perform a variety of experiments, such as changes in the refinance and reserve requirement rates, central bank auctions, shifts in the premium and contract enforcement costs, and changes in public spending and world interest rates. The analysis is then extended to examine credit targeting and sterilization policies. |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:man:cgbcrp:76&r=mon |
| By: | Chengsi Zhang; Denise R. Osborn; Dong Heon Kim |
| Abstract: | The New Keynesian Phillips Curve (NKPC) model of inflation dynamics based on forward-looking expectations is of great theoretical significance in monetary policy analysis. Empirical studies, however, often find that inflation inertia, rather than inflation expectations, dominate the dynamics of the short-run aggregate supply curve. This paper examines this inconsistency by investigating multiple structural changes in the NKPC for the US over 1968-2005. Both inflation expectations survey data and a rational expectations approximation are used to capture expectations. We find that forward-looking behavior plays a smaller role during the high and volatile inflation regime to 1981 than in the subsequent period of moderate inflation, providing support for the empirical coherence of sticky prices models over the last two decades. A further break in the intercept of the NKPC is identified around 2001 and this may be associated with monetary policy in the recent period. |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:man:cgbcrp:78&r=mon |
| By: | Andrew Ang; Geert Bekaert; Min Wei |
| Abstract: | Changes in nominal interest rates must be due to either movements in real interest rates, expected inflation, or the inflation risk premium. We develop a term structure model with regime switches, time-varying prices of risk, and inflation to identify these components of the nominal yield curve. We find that the unconditional real rate curve in the U.S. is fairly flat around 1.3%. In one real rate regime, the real term structure is steeply downward sloping. An inflation risk premium that increases with maturity fully accounts for the generally upward sloping nominal term structure. |
| JEL: | C50 E31 E32 E43 G12 |
| Date: | 2007–02 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:12930&r=mon |
| By: | Harashima, Taiji |
| Abstract: | The Friedman rule is strongly immune to most model modifications although it has not actually been observed. The Friedman rule implicitly assumes that a government is perfectly under the control of the representative household. This paper shows that, if a government is not perfectly under the control of the representative household, but also pursues political objectives, the optimal quantity of money generally is accompanied by positive nominal interest and inflation rates through the simultaneous optimization of government and the representative household. The fact that nominal interest and inflation rates are usually positive conversely implies that a government usually pursues political objectives. |
| Keywords: | The Optimal Quantity of Money; The Friedman rule; Inflation; The fiscal theory of the price level; Leviathan |
| JEL: | E41 E42 E63 E51 |
| Date: | 2007–01–16 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:1839&r=mon |
| By: | M. Marzo; I. Strid; P. Zagaglia |
| Date: | 2006–09 |
| URL: | http://d.repec.org/n?u=RePEc:bol:bodewp:573&r=mon |
| By: | Yueh-Yun C. O'Brien |
| Abstract: | This paper compares the compositions and definitions of monetary aggregates being published by the 30 countries belonging to the Organization for Economic Co-operation and Development (OECD) and 10 non-OCED countries. These countries are divided into 5 groups according to the similarity of their monetary aggregates and their membership in the European Union (EU) and/or OECD. The first three groups are countries in the EU who have adopted the European Central Bank's definitions of the monetary aggregates with some variations. Their monetary aggregates are discussed together and presented in one table. The monetary aggregates for the countries in the other two groups are very heterogeneous and each country is discussed separately. The criteria used to classify and define monetary aggregates by individual countries are compared and summarized. Variations among the countries' monetary aggregates resulting from emphasis on different criteria for money definitions are also addressed. |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2007-02&r=mon |
| By: | Devereux, Michael B; Sutherland, Alan |
| Abstract: | The process of financial globalization has significantly altered the environment in which national monetary policy authorities operate. What implications does this have for the design of monetary policy? The question can be properly addressed only in the context of a model where monetary policy interacts with financial market efficiency. This paper is concerned with the effects of monetary policy when international portfolio choice is endogenous. We analyze the link between monetary policy and gross national bond and equity portfolios. With endogenous portfolio structure and incomplete markets, monetary policy takes on new importance due to its impact on the distribution of returns on nominal assets. Despite this, we find that the case for price stability as an optimal monetary rule still remains. In fact, it is reinforced. Even without nominal price rigidities, price stability has a welfare benefit through its enhancement of the risk sharing properties of nominal bond returns. |
| Keywords: | international risk sharing; portfolio choice |
| JEL: | E52 E58 F41 |
| Date: | 2007–02 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6147&r=mon |
| By: | Michele Berardi |
| Abstract: | In recent literature on monetary policy and learning, it has been suggested that private sector’s expectations should play a role in the policy rule implemented by the central bank, as they could improve the ability of the policymaker to stabilize the economy. Private sector’s expectations, in these studies, are often taken to be homogeneous and rational, at least in the limit of a learning process. In this paper, instead, we consider the case in which private agents are heterogeneous in their expectations formation mechanisms and hold heterogeneous expectations in equilibrium. We investigates the impact of this heterogeneity in expectations on central bank’s policy implementation and on the ensuing economic outcomes. |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:man:cgbcrp:81&r=mon |
| By: | Carlos Gustavo Machicado (Institute for Advanced Development Studies) |
| Abstract: | This paper evaluates welfare under optimal monetary and fiscal policy in a dynamic stochastic model of currency substitution and capital. It shows that in a partially dollarized economy, the main optimal policy results, i.e. the Friedman Rule and the zero capital tax, hold. Welfare implications of these optimal policies are computed for the Bolivian economy using a second-order approximation technique. The primary conclusions are that the welfare gains under optimal monetary policy are negligible. The welfare gains when optimal fiscal policy is considered alone or in conjunction with optimal monetary policy are sizable and come from the increase in real variables and also by the increase in real balances in local currency. Thus, welfare gains are negatively related to dollarization. |
| Keywords: | Dollarization, Optimal Fiscal and Monetary Policy, Second-order approximation technique. |
| JEL: | F31 E61 E63 |
| Date: | 2006–09 |
| URL: | http://d.repec.org/n?u=RePEc:adv:wpaper:200610&r=mon |
| By: | Chengsi Zhang; Denise R. Osborn; Dong Heon Kim |
| Abstract: | Estimating the micro-founded New Keynesian Phillips Curve using rational inflation expectation proxies has often found that the output gap is not a valid measure of inflation pressure. This paper investigates the empirical success of the NKPC in explaining US inflation, using observed measures of inflation expectations and taking account of serial correlation in the stylized NKPC. Contrary to recent results indicating no role for the GDP gap, we find it to be a statistically significant driving variable for inflation while labor income share is generally insignificant. The paper also develops an extended model in which serial correlation is absent and the output gap remains a valid inflation driving force. In most of our estimations, however, lagged inflation dominates the role of inflation expectations, casting doubt on the extent to which price setting is forward-looking over the period 1968 to 2005. From an econometric perspective, the paper uses GMM estimation to account for endogeneity while also addressing concerns raised in recent studies about weak instrumental variables used in estimating NKPC models. |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:man:cgbcrp:79&r=mon |
| By: | Erdenebat Bataa; Dong H. Kim; Denise R. Osborn |
| Abstract: | Empirical studies often find that the spread between longer and shorter rates does not have predictive power for future longer rates, violating the Expectations Theory (ET). Although the predictive power of the spread for future shorter rates is largely in accordance with the ET, especially when the forecast period is long, researchers often find this holds to varying degrees across samples (country-wise or time-wise). We show this pattern may be due to the powers of all tests depending on interest rates’ maturities and their persistency in small samples. This paper also compares the powers of tests of the ET against the under/overreaction and the time varying term premium alternatives across various maturity combinations, levels of persistency and sample sizes. Tests perform best and are comparable to each other at the shortest end of the term structure, but deteriorate as the distance between maturities of longer and shorter rates increase. However, this deterioration is of varying degrees for different tests and its speed diminishes as we depart from the shortest end. In general Lagrange multiplier and distance metric tests emerge as being the most powerful and least sensitive to interest rate maturities and their persistency. |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:man:cgbcrp:84&r=mon |
| By: | Erdenebat Bataa; Dong H. Kim; Denise R. Osborn |
| Abstract: | Empirical studies often find that the spread between longer and shorter rates does not have predictive power for future longer rates, violating the Expectations Theory (ET). Although the predictive power of the spread for future shorter rates is largely in accordance with the ET, especially when the forecast period is long, researchers often find this holds to varying degrees across samples (country-wise or time-wise). We show this pattern may be due to the powers of all tests depending on interest rates’ maturities and their persistency in small samples. This paper also compares the powers of tests of the ET against the under/overreaction and the time varying term premium alternatives across various maturity combinations, levels of persistency and sample sizes. Tests perform best and are comparable to each other at the shortest end of the term structure, but deteriorate as the distance between maturities of longer and shorter rates increase. However, this deterioration is of varying degrees for different tests and its speed diminishes as we depart from the shortest end. In general Lagrange multiplier and distance metric tests emerge as being the most powerful and least sensitive to interest rate maturities and their persistency. |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:man:cgbcrp:85&r=mon |
| By: | Basci, Erdem; Erdogan, Ayse M.; Saglam, Ismail |
| Abstract: | This paper shows that unregulated decentralized equilibrium is viable under increasing returns technologies in an overlapping generations model of production with cash-in-advance constraints. We also demonstrate that the model exhibits both the Tobin effect and the reverse Tobin effect. |
| Keywords: | Increasing returns; cash-in-advance constraints; overlapping generations; Phillips curve. |
| JEL: | E52 D51 D91 D52 |
| Date: | 2006–09 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:1904&r=mon |
| By: | Carlos Gustavo Machicado (Institute for Advanced Development Studies) |
| Abstract: | This paper shows how uncertainty about liquidity demand can lead to a high degree of dollarization in the banking system. I study a model where the demand for currency in each period is random, and where it is easier for banks to borrow in local currency in times of crisis than in dollars. Banks choose a portfolio composed of local currency, dollars, and real loans. Compared to the anticipated transactions demand for each currency, I show that the bank will hold a relatively large amount of dollars and a relatively small amount of local currency. I also show the existence of a dollarization multiplier : as the anticipated transactions demand for dollars increases, the dollarization of the banking sector increases more than proportionately. |
| Keywords: | Dollarization, Banking crisis, Banking System |
| JEL: | F31 G21 G33 |
| Date: | 2006–09 |
| URL: | http://d.repec.org/n?u=RePEc:adv:wpaper:200609&r=mon |
| By: | Philip Vermeulen (European Central Bank); Daniel Dias (Banco de Portugal); Maarten Dossche (National Bank of Belgium); Erwan Gautier (Banque de France); Ignacio Hernando (Banco de España); Roberto Sabbatini (Banca d’Italia); Harald Stahl (Deutsche Bundesbank) |
| Abstract: | This paper documents producer price setting in 6 countries of the euro area: Germany, France, Italy, Spain, Belgium and Portugal. It collects evidence from available studies on each of those countries and also provides new evidence. These studies use monthly producer price data. The following five stylised facts emerge consistently across countries. First, producer prices change infrequently: each month around 21% of prices change. Second, there is substantial cross-sector heterogeneity in the frequency of price changes: prices change very often in the energy sector, less often in food and intermediate goods and least often in non-durable non- food and durable goods. Third, countries have a similar ranking of industries in terms of frequency of price changes. Fourth, there is no evidence of downward nominal rigidity: price changes are for about 45% decreases and 55% increases. Fifth, price changes are sizeable compared to the inflation rate. The paper also examines the factors driving producer price changes. It finds that costs structure, competition, seasonality, inflation and attractive pricing all play a role in driving producer price changes. In addition producer prices tend to be more flexible than consumer prices. |
| Keywords: | price-setting, producer prices |
| JEL: | E31 D40 C25 |
| Date: | 2007–02 |
| URL: | http://d.repec.org/n?u=RePEc:bde:wpaper:0703&r=mon |