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on Monetary Economics |
| By: | Sharon Kozicki; P.A. Tinsley |
| Abstract: | This paper uses real-time briefing forecasts prepared for the Federal Open Market Committee (FOMC) to provide estimates of historical changes in the design of U.S. monetary policy and in the implied central-bank target for inflation. Empirical results support a description of policy with an effective inflation target of roughly 7 percent in the 1970s. Moreover, the evidence suggests that mismeasurement of the degree of economic slack was largely irrelevant for explaining the Great Inflation while favouring a passive-policy description of monetary policy. FOMC transcripts provide a neglected interpretation of the source of passive policy--intermediate targeting of monetary aggregates. |
| Keywords: | Central bank research; Monetary aggregates; Monetary policy implementation |
| JEL: | E3 E5 N1 |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:07-19&r=mon |
| By: | Marc-André Gosselin |
| Abstract: | The inflation targeting (IT) regime is 17 years old. With practice of IT now in more than 21 countries, there is enough evidence gathered to take stock of the IT experience. In this paper, we analyze the inflation record of IT central banks. We extend the work of Albagli and Schmidt-Hebbel (2004) by looking at a broad range of factors that can influence inflation target deviations and by identifying the empirical determinants of successful monetary policy under IT. We find that part of the cross-country and time variation in inflation deviations from targets can be explained by exchange rate movements, fiscal deficits, and differences in financial sector development. With respect to the components of the IT framework, we find that a higher inflation target and a larger inflation control range are associated with more variable inflation (and output) outcomes. Although the literature tends to suggest that greater central bank transparency is desirable, our findings imply that transparency might be associated with less satisfactory inflation performance. Interestingly, central banks using economic models do a better job of stabilizing inflation around the target and output around trend. |
| Keywords: | Central bank research; Inflation targets; Monetary policy framework |
| JEL: | E31 E52 E58 |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:07-18&r=mon |
| By: | Woodford, Michael |
| Abstract: | I consider some of the leading arguments for assigning an important role to tracking the growth of monetary aggregates when making decisions about monetary policy. First, I consider whether ignoring money means returning to the conceptual framework that allowed the high inflation of the 1970s. Second, I consider whether models of inflation determination with no role for money are incomplete, or inconsistent with elementary economic principles. Third, I consider the implications for monetary policy strategy of the empirical evidence for a long-run relationship between money growth and inflation. (Here I give particular attention to the implications of ``two-pillar Phillips curves'' of the kind proposed by Gerlach (2004).) And fourth, I consider reasons why a monetary policy strategy based solely on short-run inflation forecasts derived from a Phillips curve may not be a reliable way of controlling inflation. I argue that none of these considerations provide a compelling reason to assign a prominent role to monetary aggregates in the conduct of monetary policy. |
| Keywords: | monetarism; monetary targeting; new Keynesian model; two-pillar strategy |
| JEL: | E52 E58 |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6211&r=mon |
| By: | Roc Armenter; Martin Bodenstein |
| Abstract: | We argue that there are conditions such that any inflation targeting regime is preferable to full policy discretion, even if long-run inflation rates are identical across regimes. The key observation is that strict inflation targeting outperforms the discretionary policy response to sufficiently persistent shocks. Under full policy discretion, inflation expectations over the medium term respond to the shock and thereby amplify its impact on output. As a result, little output stabilization is achieved at the cost of large and persistent inflation fluctuations. |
| Keywords: | Inflation (Finance) ; Anti-inflationary policies ; Monetary policy |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgif:885&r=mon |
| By: | Claude Lavoie; Hope Pioro |
| Abstract: | The authors assess the performance of the Canadian economy under a variety of interest rate rules when the zero bound on nominal interest rates can bind. Their assessment is based on numerical simulations of a dynamic stochastic general-equilibrium model in a stochastic environment. Consistent with the literature, the authors find that the probability and consequences of the zero bound depend strongly on the targeted rate of inflation and that price-level targeting generally leads to better outcomes. Their results show that a non-linear rule is preferable to a linear rule under both inflation and price-level targeting, because of the zero-bound issue. This suggests that central banks should be pre-emptive and adopt an aggressive monetary policy when expected inflation falls below its desired level. The authors' results also show that the monetary authority must be much more forward looking under price-level targeting than under inflation targeting. |
| Keywords: | Inflation: costs and benefits; Interest rates; Monetary policy framework |
| JEL: | E43 E47 E52 |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocadp:07-1&r=mon |
| By: | Guenter W. Beck (Frankfurt University and CFS); Volker Wieland (Frankfurt University, CFS and CEPR) |
| Abstract: | The European Central Bank has assigned a special role to money in its two pillar strategy and has received much criticism for this decision. The case against including money in the central bank’s interest rate rule is based on a standard model of the monetary transmission process that underlies many contributions to research on monetary policy in the last two decades. In this paper, we develop a justification for including money in the interest rate rule by allowing for imperfect knowledge regarding unobservables such as potential output and equilibrium interest rates. We formulate a novel characterization of ECB-style monetary cross-checking and show that it can generate substantial stabilization benefits in the event of persistent policy misperceptions regarding potential output. |
| Keywords: | Monetary Policy, Money, Quantity Theory, Phillips Curve, European Central Bank, Policy Under Uncertainty |
| JEL: | E32 E41 E43 E52 E58 |
| Date: | 2007–03–22 |
| URL: | http://d.repec.org/n?u=RePEc:cfs:cfswop:wp200718&r=mon |
| By: | Guenter W. Beck (Frankfurt University and CFS); Volker Wieland (Frankfurt University, CFS and CEPR) |
| Abstract: | The European Central Bank has assigned a special role to money in its two pillar strategy and has received much criticism for this decision. In this paper, we explore possible justifications. The case against including money in the central bank’s interest rate rule is based on a standard model of the monetary transmission process that underlies many contributions to research on monetary policy in the last two decades. Of course, if one allows for a direct effect of money on output or inflation as in the empirical “two-pillar” Phillips curves estimated in some recent contributions, it would be optimal to include a measure of (long-run) money growth in the rule. In this paper, we develop a justification for including money in the interest rate rule by allowing for imperfect knowledge regarding unobservables such as potential output and equilibrium interest rates. We formulate a novel characterization of ECB-style monetary cross-checking and show that it can generate substantial stabilization benefits in the event of persistent policy misperceptions regarding potential output. Such misperceptions cause a bias in policy setting. We find that cross-checking and changing interest rates in response to sustained deviations of long-run money growth helps the central bank to overcome this bias. Our argument in favor of ECB-style cross-checking does not require direct effects of money on output or inflation. |
| Keywords: | Monetary Policy, Quantity Theory, Phillips Curve, European Central Bank Policy Under Uncertainty |
| JEL: | E32 E41 E43 E52 E58 |
| Date: | 2007–03–22 |
| URL: | http://d.repec.org/n?u=RePEc:cfs:cfswop:wp200717&r=mon |
| By: | Magnus Andersson (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.) |
| Abstract: | This paper examines bond and stock market volatility reactions in the euro area and the US following their respective economies’ monetary policy decisions, over a uniform sample period (April 1999 to May 2006). For this purpose, intraday data on the US and euro area bond and stock markets are used. A strong upsurge in intraday volatility at the time of the release of the monetary policy decisions by the two central banks is found, which is more pronounced for the US financial markets following Fed monetary policy decisions. Part of the increase in intraday volatility in the two economies surrounding monetary policy decisions can be explained by both news of the level of monetary policy and revisions in the expected future monetary policy path. The observed strong discrepancy between asset price reactions in the US and in the euro area following monetary policy decisions still remains a puzzle, although some tentative explanations are provided in the paper. JEL Classification: E52; E58; G14. |
| Keywords: | Monetary policy; intraday data. |
| Date: | 2007–02 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20070726&r=mon |
| By: | W.H. Buiter |
| Abstract: | The paper discusses some fundamental problems in monetary economics associated with thedetermination and role of the numéraire. The issues are introduced by formalising a proposal,attributed to Eisler, to remove the zero lower bound on nominal interest rates by unbundling thenuméraire and medium of exchange/means of payment functions of money. The monetary authoritiesmanage the exchange rate between the numéraire ('sterling') and the means of payment ('drachma').The short nominal interest rate on sterling bonds can then be used to target stability for the sterlingprice level. The paper puts question marks behind two key bits of conventional wisdom incontemporary monetary economics. The first is the assumption that the monetary authorities defineand determine the numéraire used in private transactions. The second is the proposition that pricestability in terms of that numéraire is the appropriate objective of monetary policy. The paper alsodiscusses the merits of the next step following the decoupling of the numéraire from the currency:doing away with currency altogether - the cashless economy. Because the unit of account plays such a central role in New-Keynesian models with nominalrigidities, monetary economics needs to devote more attention to numérairology - the study of theindividual and collective choice processes that govern the adoption of a unit of account and its role in economic behaviour. |
| Keywords: | Zero lower bound, cashless economy, price level determinacy, optimal inflation |
| JEL: | E3 E4 E5 E6 |
| Date: | 2007–01 |
| URL: | http://d.repec.org/n?u=RePEc:cep:cepdps:dp0776&r=mon |
| By: | Ullrich, Katrin |
| Abstract: | The discussion about country-specific influence on the interest rate decisions of the European Central Bank does not cease. To investigate the possibility of regional influence on the determination of the policy rate, we estimate Taylor-type reaction functions for the period from 1999 to 2005 and include country-specific variables of the euro zone member states. We do not find convincing evidence that country-specific economic developments influence the decisions of the ECB Governing Council. However, the maximum inflation rate and the minimum economic sentiment of the euro area seem to have an effect on the decisions. |
| Keywords: | Taylor rule, ECB, monetary policy |
| JEL: | E52 E58 |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:zewdip:5442&r=mon |
| By: | A. Kia (Department of Economics, Carleton University) |
| Abstract: | This paper focuses on internal and external factors, which influence the inflation rate in developing countries. A monetary model of inflation rate, capable of incorporating both monetary and fiscal policies as well as other internal and external factors, was developed and tested on Iranian data. It was found that, over the long run, a higher exchange rate leads to a higher price and that the fiscal policy is very effective to fight inflation. The major factors affecting inflation in Iran, over the long run, are internal rather than external. However, over the short run, the sources of inflation are both external and internal. |
| Keywords: | Demand for money, inflation, fiscal and monetary policies, external and internal factors |
| JEL: | E31 E41 E62 |
| Date: | 2006–03–15 |
| URL: | http://d.repec.org/n?u=RePEc:car:carecp:06-03&r=mon |
| By: | Carlos Montoro |
| Abstract: | We extend the New Keynesian Monetary Policy literature relaxing the assumption that the decisionsare taken by a single policymaker, considering instead that monetary policy decisions are takencollectively in a committee. We introduce a Monetary Policy Committee (MPC), whose membershave different preferences between output and inflation variability and have to vote on the level of theinterest rate. This paper helps to explain interest rate smoothing from a political economy point ofview, in which MPC members face a bargaining problem on the level of the interest rate. In thisframework, the interest rate is a non-linear reaction function on the lagged interest rate and theexpected inflation. This result comes from a political equilibrium in which there is a strategicbehaviour of the agenda setter with respect to the rest of the MPC's members. Our approach can alsoreproduce both features documented by the empirical evidence on interest rate smoothing: a) themodest response of the interest rate to inflation and output gap; and b) the dependence on laggedinterest rate; features that are difficult to reproduce in standard New Keynesian models all together. Italso provides a theoretical framework on how disagreement among policymakers can slow down theadjustment on interest rates and on "menu costs" in interest rate decisions. Furthermore, a numericalexercise shows that this inertial behaviour of the interest rate is internalised by the economic agentsthrough an increase in expected inflation. |
| Keywords: | Monetary Policy Committee, interest rate smoothing, New KeynesianEconomics, political economy |
| JEL: | E43 E52 D72 |
| Date: | 2007–02 |
| URL: | http://d.repec.org/n?u=RePEc:cep:cepdps:dp0780&r=mon |
| By: | Mierzejewski, Fernando |
| Abstract: | The extent to which the money supply affects the aggregate cash balance demanded at a certain level of nominal income and interest rates is determined by the interest-rate-elasticity and stability of the money demand. An actuarial approach is adopted in this paper for dealing with investors facing liquidity constraints and maintaining different expectations about risks. Under such circumstances, a level of surplus exists which maximises expected value. Moreover, when the distorted probability principle is introduced, the optimal liquidity demand is expressed as a Value-at-Risk and the comonotonic dependence structure determines the amount of money demanded by the economy. As a consequence, the more unstable the economy, the greater the interestrate-elasticity of the money demand. Moreover, for different parametric characterisation of risks, market parameters are expressed as the weighted average of sectorial or individual estimations, in such a way that multiple equilibria of the economy are possible. |
| Keywords: | money demand; monetary policy; economic capital; distorted risk principle; Value-at-Risk |
| JEL: | E41 G18 E52 G15 E44 |
| Date: | 2007–01 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:2424&r=mon |
| By: | Carlos Montoro (Central Bank of Peru, LSE) |
| Abstract: | We extend the New Keynesian Monetary Policy literature relaxing the assumption that the decisions are taken by a single policymaker, considering instead that monetary policy decisions are taken collectively in a committee. We introduce a Monetary Policy Committee (MPC), whose members have different preferences between output and inflation variability and have to vote on the level of the interest rate. This paper helps to explain interest rate smoothing from a political economy point of view, in which MPC members face a bargaining problem on the level of the interest rate. In this framework, the interest rate is a non-linear reaction function on the lagged interest rate and the expected inflation. This result comes from a political equilibrium in which there is a strategic behaviour of the agenda setter with respect to the rest MPC’s members. Our approach can also reproduce both features documented by the empirical evidence on interest rate smoothing: a) the modest response of the interest rate to inflation. and output gap; and. b) the dependence on lagged interest rate. Features that are difficult to reproduce alltogether in standard New Keynesian models. It also provides a theoretical framework on how disagreement among policymakers can slow down the adjustment on interest rates and on “menu costs” in interest rate decisions. Furthermore, a numerical excercise shows that this inertial behaviour of the interest rate is internalised by the economic agents through an increase in expected inflation. |
| Keywords: | Monetary Policy Committees , Interest Rate Smoothing, New Keynesian Economics, Political Economy |
| JEL: | E43 E52 D72 |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:rbp:wpaper:2007-003&r=mon |
| By: | Eijffinger, Sylvester C W; Goderis, Benedikt |
| Abstract: | This paper examines the effect of monetary policy on the exchange rate during currency crises. Using data for a number of crisis episodes between 1986 and 2004, we find strong evidence that raising the interest rate: (i) has larger adverse balance sheet effects and is therefore less effective in countries with high domestic corporate short-term debt; (ii) is more credible and therefore more effective in countries with high-quality institutions; iii) is more credible and therefore more effective in countries with high external debt; and (iv) is less effective in countries with high capital account openness. We predict that monetary policy would have had the conventional supportive effect on the exchange rate during five of the crisis episodes in our sample, while it would have had the perverse effect during seven other episodes. For four episodes, we predict a statistically insignificant effect. Our results support the idea that the effect of monetary policy depends on its impact on fundamentals, as well as its credibility, as suggested in the recent theoretical literature. They also provide an explanation for the mixed findings in the empirical literature. |
| Keywords: | capital account openness; currency crises; external debt; institutions; monetary policy; short-term debt |
| JEL: | E52 E58 |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6217&r=mon |
| By: | Ramón Adalid (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Carsten Detken (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.) |
| Abstract: | We provide systematic evidence for the association of liquidity shocks and aggregate asset prices during mechanically identified asset price boom/bust episodes for 18 OECD countries since the 1970s, while taking care of the endogeneity of money and credit. Our derivation of liquidity shocks allows for frequent shifts in velocity as they are derived as structural shocks from VARs in growth rates. Residential property price developments and money growth shocks accumulated over the boom periods are able to well explain the depth of post-boom recessions. We further suggest that liquidity shocks are a driving factor for real estate prices during boom episodes. During normal times however, the relative predictive power of liquidity shocks seems to shift from asset price inflation to consumer price inflation. The results only hold for broad money growth based liquidity shocks and not for private credit growth shocks. JEL Classification: C33, E41, E51, E58 |
| Keywords: | Liquidity shocks; asset price booms; money and credit aggregates; role of money; monetary policy; real estate prices. |
| Date: | 2007–02 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20070732&r=mon |
| By: | Vasco Curdia |
| Abstract: | This paper proposes a model to investigate the effects of monetary policy in an emerging market economy that experiences a sudden stop of capital inflows. The model features credit frictions, debt denominated in foreign currency, imported inputs, and households that have access to the international capital market only indirectly, through their ownership of leveraged firms. The sudden stop is modeled as a change in the perceptions of foreign lenders that brings about an increase in the cost of borrowing. I show that the higher the elasticity of foreign demand, the lower the contraction in output - leading, at the extreme, to the possibility of an expansion, depending on policy. A second result is that the recession is most severe in a fixed exchange rate regime. Taylor rules that react to inflation and output are more stabilizing. A comparison of alternative rules shows that low commitment to inflation stabilization allows for less contraction in output and even expansion but at the cost of much stronger contraction in capital inflows and higher interest rates. Credibility is also shown to have an important role, with low credibility and the risk of loose policy implying increased trade-offs, stronger contraction of the economy, and higher interest rates. |
| Keywords: | Emerging markets ; Monetary policy ; Capital movements ; Loans, Foreign |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:278&r=mon |
| By: | Jacek Krawczyk; Rishab Sethi (Reserve Bank of New Zealand) |
| Abstract: | Computing the optimal trajectory over time of key variables is a standard exercise in decision-making and the analysis of many dynamic systems. In practice however, it is often enough to ensure that these variables evolve within certain bounds. In this paper we study the problem of setting monetary policy in a `good enough' sense, rather than in the optimising sense more common in the literature. Important advantages of our satisficing approach over policy optimisation include greater robustness to model, parameter, and shock uncertainty, and a better characterisation of imprecisely defined monetary policy goals. Also, optimisation may be unsuitable for determining prescriptive policy in that it suggests a unique `best' solution while many solutions may be satisficing. Our analysis frames the monetary policy problem in the context of viability theory which rigorously captures the notion of satisficing. We estimate a simple closed economy model on New Zealand data and use viability theory to discuss how inflation, output, and interest rate may be maintained within some acceptable bounds. We derive monetary policy rules that achieve such an outcome endogenously. |
| JEL: | C60 E58 |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:nzb:nzbdps:2007/03&r=mon |
| By: | Meredith Beechey |
| Abstract: | Nominal forward rates are sensitive at surprisingly long horizons to macroeconomic news and monetary-policy surprises. This paper takes advantage of affine term-structure modelling to demonstrate that movements in term premia, not expected future short rates, account for most of the reaction of forward rates at long horizons. Specifically, term premia account for about three quarters of the reaction of nominal forward rates 10 to 15 years hence to the surprise component of numerous macroeconomic news announcements. This has strong implications for the interpretation of interest-rate sensitivity. Contrary to some recent conjectures, long-horizon expectations of the level of inflation and real rates appear reasonably well anchored in the United States, but the associated term premia are quite variable. |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2007-06&r=mon |
| By: | Joshua Hausman; Jon Wongswan |
| Abstract: | This paper documents the impact of U.S. monetary policy announcement surprises on foreign equity indexes, short- and long-term interest rates, and exchange rates in 49 countries. We use two proxies for monetary policy surprises: the surprise change to the current target federal funds rate (target surprise) and the revision to the path of future monetary policy (path surprise). We find that different asset classes respond to different components of the monetary policy surprises. Global equity indexes respond mainly to the target surprise; exchange rates and long-term interest rates respond mainly to the path surprise; and short-term interest rates respond to both surprises. On average, a hypothetical surprise 25-basis-point cut in the federal funds target rate is associated with about a 1 percent increase in foreign equity indexes and a 5 basis point decline in foreign short-term interest rates. A surprise 25-basis-point downward revision in the path of future policy is associated with about a ½ percent decline in the exchange value of the dollar against foreign currencies and 5 and 8 basis points declines in short- and long-term interest rates, respectively. We also find that asset prices’ responses to FOMC announcements vary greatly across countries, and that these cross-country variations in the response are related to a country’s exchange rate regime. Equity indexes and interest rates in countries with a less flexible exchange rate regime respond more to U.S. monetary policy surprises. In addition, the cross-country variation in the equity market response is strongly related to the percentage of each country’s equity market capitalization owned by U.S. investors (a financial linkage), and the cross-country variation in short-term interest rates’ responses is strongly related to the share of each country’s trade that is with the United States (a real linkage) |
| Keywords: | Interest rates ; Foreign exchange rates ; Monetary policy ; International finance |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgif:886&r=mon |
| By: | Matteo Ciccarelli (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Carlo Altavilla (University of Naples "Parthenope", Via Medina 40, 80133 Naples, Italy.) |
| Abstract: | This paper explores the role that inflation forecasts play in the uncertainty surrounding the estimated effects of alternative monetary rules on unemployment dynamics in the euro area and the US. We use the inflation forecasts of 8 competing models in a standard Bayesian VAR to analyse the size and the timing of these effects, as well as to quantify the uncertainty relative to the different inflation models under two rules. The results suggest that model uncertainty can be a serious issue and strengthen the case for a policy strategy that takes into account several sources of information. We find that combining inflation forecasts from many models not only yields more accurate forecasts than those of any specific model, but also reduces the uncertainty associated with the real effects of policy decisions. These results are in line with the model-combination approach that central banks already follow when conceiving their strategy. JEL Classification: C53; E24; E37. |
| Keywords: | Inflation forecasts; unemployment; model uncertainty. |
| Date: | 2007–02 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20070725&r=mon |
| By: | Filippo Altissimo (Brevan Howard, Almack House, 28 King Street, London, SW1Y 6XA, UK.); Benoît Mojon (Federal Reserve Bank of Chicago, 230 S La Salle St., Chicago, IL 60604, USA.); Paolo Zaffaroni (Tanaka Business School, Imperial College London, South Kensington campus, London SW7 2AZ, UK.) |
| Abstract: | An aggregation exercise is proposed that aims at investigating whether the fast average adjustment of the disaggregate inflation series of the euro area CPI translates into the slow adjustment of euro area aggregate inflation. We first estimate a dynamic factor model for 404 inflation sub-indices of the euro area CPI. This allows to decompose the dynamics of inflation sub-indices in two parts: one due to a common "macroeconomic" shock and one due to sector specific "idiosyncratic" shocks. Although "idiosyncratic" shocks dominate the variance of sectoral prices, one common factor, which accounts for 30 per cent of the overall variance of the 404 disaggregate in.ation series, is the main driver of aggregate dynamics. In addition, the heterogenous propagation of this common shock across sectoral inflation rates, and in particular its slow propagation to inflation rates of services, generates the persistence of aggregate in.ation. We conclude that the aggregation process explains a fair amount of aggregate in.ation persistence. JEL Classification: E31; E32. |
| Keywords: | Inflation dynamics; aggregation and persistence; euro area. |
| Date: | 2007–02 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20070729&r=mon |
| By: | Fernando Alvarez; Andrew Atkeson; Patrick J. Kehoe |
| Abstract: | The key question asked by standard monetary models used for policy analysis is how do changes in short term interest rates affect the economy. All of the standard models imply that such changes in interest rates affect the economy by altering the conditional means of the macroeconomic aggregates and have no effect on the conditional variances of these aggregates. We argue that the data on exchange rates imply nearly the opposite: fluctuations in interest rates are associated with nearly one-for-one changes in conditional variances and nearly no changes in conditional means. In this sense standard monetary models capture essentially none of what is going on in the data. We thus argue that almost everything we say about monetary policy using these models is wrong. |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmwp:650&r=mon |
| By: | Roberto Frenkel |
| Abstract: | This article, originally published in Spanish in La Nación, December 31, 2006, explains the mechanics of the Argentine Central Bank's intervention in exchange rates markets to target a stable and competitive exchange rate, a macroeconomic policy that has played a significant role in Argentina's economic growth since 2002. |
| JEL: | E58 E52 E42 |
| Date: | 2007–02 |
| URL: | http://d.repec.org/n?u=RePEc:epo:papers:2007-3&r=mon |
| By: | Carlo Rosa; Giovanni Verga |
| Abstract: | This paper examines the effect of European Central Bank communication on the pricediscovery process in the Euribor futures market using a new tick-by-tick dataset. First, weshow that two pieces of news systematically hit financial markets on Governing Councilmeeting days: the ECB policy rate decision and the explanation of its monetary policy stance.Second, we find that the unexpected component of ECB explanations has a significant andsizeable impact on futures prices. This indicates that the ECB has already acquired somecredibility: financial markets seem to believe that it does what it says it will do. Finally, ourresults suggest that the Euribor futures market is semi-strong form informational efficient. |
| Keywords: | market efficiency, central bank communication, news shock, tickby-tick Euriborfutures data, event-study analysis. |
| JEL: | E52 E58 G14 |
| Date: | 2006–12 |
| URL: | http://d.repec.org/n?u=RePEc:cep:cepdps:dp0764&r=mon |
| By: | Mandler, Martin |
| Abstract: | We use a Taylor rule with time-varying policy coefficients in combination with an unobserved components model for the output gap to estimate the uncertainty about future values of the Federal Funds Rate. The model makes it possible to separate ex-ante interest rate uncertainty into three components: 1) uncertainty about the Fed's future policy coefficients, 2) uncertainty about future economic fundamentals, and 3) residual uncertainty. The results show important changes in uncertainty about future short-term interest rates over time with peaks in the late 1960s/early 1970s, mid 1970s and late 1970s/early 1980s. While for one-quarter forecasts uncertainty about the Fed's policy reaction is more important than uncertainty about economic fundamentals this result is reversed for the two-quarter forecast horizon. Results from a modified model with regime shifts in the variance of the policy shocks confirm the previous findings but show changes in residual uncertainty to be important as well. |
| Keywords: | monetary policy rules; interest rate uncertainty; Kalman filter |
| JEL: | C53 C32 E52 |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:2340&r=mon |
| By: | Arnaldo MAURI |
| Abstract: | THE CURRENCY BOARD AND THE RISE OF BANKING IN EAST AFRICA. The East Africa region consists today of three independent countries, Kenya, Tanzania (formerly Tanganyika) and Uganda, which, from the early 1920’s to the achievement of independence, formed an administrative unit under British rule: the British East Africa. The paper presents an historical synthesis of the basic problems and developments of the monetary and banking system in British East Africa. The research covers the period included between the beginning of European colonisation and the attainment of independence by the three above mentioned countries and focuses on the experience with a currency board arrangement in this context. A survey on commercial banking in the region, reveals that this industry, since its rise, carried the imprinting of the British banking tradition. In the first stage of monetary evolution, owing to the influence of Indian trade and settlement in East Africa, the currency most in use was undoubtedly the Indian rupee. In that period banking industry landed in East Africa, brought in by European colonial powers. The second stage in monetary evolution began when a currency board was established, in 1919, in the British colonial possessions of East Africa, just after the acquisition, as loot, of Tanganyika, a colony previously under German rule. Originally the area of Board’s operations, i.e. the East African shilling monetary area, consisted of the three mentioned territories. Zanzibar was added in 1936. During World War II were included, temporarily, in the area also Aden and British Somaliland and eventually the former Italian colonies of Eritrea, Ethiopia and Somalia. The start of activity by the E.A. Currency Board was not easy. In 1925, when the conversion of circulating rupees was completed, because of overvaluation of silver coins in the exchange rate adopted, the EA Currency Board suffered substantial losses and the reserve ratio was 43.6 per cent. Yet the situation worsened with the crisis of the colonial economy during the depression of the 30’s, which caused a sharp decline in money supply in East Africa because of heavy redemption of local currency. In 1932 the lowest point was reached with the reserve ratio at only 9.9 per cent. Circulation of EA shillings increased rapidly after 1940 because of war economy and of a favourable balance of payments of the colonies. In addition, a great enlargement of the original currency area was achieved following British military conquests in the Horn of Africa. In 1950 the circulation was fully covered by reserves, but during the previous decades the colonial currency was mainly based on government credit. However, it was not until 1956, that the fiduciary issue was officially introduced and, by this event, reasonable opportunities for monetary policy were offered. This innovation was introduced to free part of the external reserves held in London. Prior to that act the role of the Currency Board was just passive because the automatic exchange of currency did not allow any kind of money management. It represented a simple and inexpensive mechanism directed to issue currency. A long period of British rule came to an end when the colonial territories of East Africa obtained political independence and this dramatic change marked the epilogue of the story of the colonial monetary institution. The new emerging states would not accept to renounce monetary sovereignty. Therefore the liquidation of East African Currency Board was decided and the establishment of three national central banks was officially announced simultaneously in June 1965 by the governments of Kenya, Tanzania and Uganda. The East African Currency Board ceased operations one year later. |
| Keywords: | Currency Board, East Africa, Colonial Monetary System, African Banking History |
| JEL: | G21 N27 |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:mil:wpdepa:2007-10&r=mon |
| By: | Javier Andrés; J. David López-Salido; Edward Nelson |
| Abstract: | We examine the role of money, allowing for three competing environments: the New Keynesian model with separable utility and static money demand; a non-separable utility variant with habit formation; and a version with adjustment costs for holding real balances. The last two variants imply forward-looking behavior of real money balances, as it is optimal for agents to allow their forecast of future interest rates to affect current portfolio decisions. We distinguish between these specifications by conducting a structural econometric analysis for the U.S. and the euro area. FIML estimates confirm the forward-looking character of money demand. Using these estimates we find that, in response to preference and technology shocks, real money balances are valuable in anticipating future variations in the natural interest rate. |
| Keywords: | Money ; Interest rates |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2007-005&r=mon |
| By: | Paul Castillo; Carlos Montoro; Vicente Tuesta |
| Abstract: | This paper provides a fully micro-founded New Keynesian framework to study the interactionbetween oil price volatility, pricing behavior of firms and monetary policy. We show that when oilhas low substitutability, firms find it optimal to charge higher relative prices as a premium incompensation for the risk that oil price volatility generates on their marginal costs. Overall, in generalequilibrium, the interaction of the aforementioned mechanisms produces a positive relationshipbetween oil price volatility and average inflation, which we denominate inflation premium. Wecharacterize analytically this relationship by using the perturbation method to solve the rationalexpectations equilibrium of the model up to second order of accuracy. The solution implies that theinflation premium is higher when: a) oil has low substitutability, b) the Phillips Curve is convex, andc) the central bank puts higher weight on output fluctuations. We also provide some quantitativeevidence showing that a calibrated model for the US with an estimated active Taylor rule produces asizable inflation premium, similar to the levels observed in the US during the 70s. |
| Keywords: | Second Order Solution, Oil Price Shocks, Endogenous Trade-off |
| JEL: | E52 E42 E12 C63 |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:cep:cepdps:dp0782&r=mon |
| By: | Bandholz, Harm; Clostermann, Joerg; Seitz, Franz |
| Abstract: | We analyze if and to what extent fundamental macroeconomic factors, temporary influences or more structural factors have contributed to the low levels of US bond yields over the last few years. For that purpose, we start with a general model of interest rate determination. The empirical part consists of a cointegration analysis with an error correction mechanism. We are able to establish a stable long-run relationship and find that the behavior of bond yields, even during the last two years, can well be explained. Alongside the more traditional macroeconomic determinants like core inflation, monetary policy and the business cycle, we also include foreign holdings of US Treasuries. The latter should capture the frequently mentioned structural effects on long-term interest rates. Finally, our bond yield equation outperforms a random walk model in different forecasting exercises. |
| Keywords: | bond yields; interest rates; cointegration; inflation; forecasting |
| JEL: | E47 E43 |
| Date: | 2007–02 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:2386&r=mon |
| By: | Huw Dixon and Engin Kara |
| Abstract: | We develop the Generalized Taylor Economy (GTE) in which there are many sectors with overlapping contracts of different lengths. In economies with the same average contract length, monetary shocks will be more persistent when longer contracts are present. Using the Bils-Klenow distribution of contract lengths, we find that the corre- sponding GTE tracks the US data well. When we choose a GTE with the same distribution of completed contract lengths as the Calvo, the economies behave in a similar manner. |
| Keywords: | Persistence, Taylor contract, Calvo |
| JEL: | E50 E24 E32 E52 |
| Date: | 2007–01 |
| URL: | http://d.repec.org/n?u=RePEc:bir:birmec:07-01&r=mon |
| By: | James B. Bullard; George W. Evans; Seppo Honkapohja |
| Abstract: | We study how the use of judgment or "add-factors" in macroeconomic forecasting may disturb the set of equilibrium outcomes when agents learn using recursive methods. We examine the possibility of a new phenomenon, which we call exuberance equilibria, in the New Keynesian monetary policy framework. Inclusion of judgment in forecasts can lead to self-fulfilling fluctuations in a subset of the determinacy region. We study how policymakers can minimize the risk of exuberance equilibria. |
| Keywords: | Rational expectations (Economic theory) ; Monetary policy |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2007-008&r=mon |
| By: | Angel Asensio (CEPN - Centre d'économie de l'Université de Paris Nord - [CNRS : UMR7115] - [Université Paris-Nord - Paris XIII]) |
| Abstract: | Extending Asensio's closed-economy framework (2005a,b) to a monetary union, we show that the<br />principles of governance which emanate from the so called "New Consensus in Macroeconomics"<br />(NCM), and therefore have been designed for presumed stationary regimes, may cause severe<br />dysfunctions, such as depressive macroeconomic policies and unemployment traps, in non-ergodic<br />regimes. The Keynesian approach, on the other hand, pleads in favour of important changes in the<br />current governance of the eurozone. First, since the European Central Bank can not repress distributive<br />inflationary pressures without having non-temporary depressive effects on aggregate demand and<br />employment, authorities should recognize that the best way for controlling this type of inflation rests<br />on a consensual distribution of income. Second, authorities should abandon any "optimal rule"<br />designed in order to stabilize the economy near to an imaginary "natural" trend. Keynesian uncertainty<br />rather suggests a gradual and pragmatic approach to macroeconomic policy. From this perspective, we<br />show that the European Monetary Union could take advantage of the complementarity between the<br />common monetary policy and the national budgetary and fiscal instruments. |
| Keywords: | Monetary policy, Fiscal policy, Monetary union, Macroeconomic governance,<br />Post-Keynesian |
| Date: | 2007–03–28 |
| URL: | http://d.repec.org/n?u=RePEc:hal:papers:halshs-00139025_v1&r=mon |
| By: | Marcela M. Williams; Richard G. Anderson |
| Abstract: | Despite the increasing use of electronic payments, currency retains an important role in the payments system of every country. Two aspects of currency usage drive currency design worldwide: deterring counterfeiting and making paper currency accessible to the visually impaired. Further, among the world's currencies, only U.S. banknotes are widely owned and used in transactions outside their country of issue (although the euro also has some external circulation). In this article, we compare and contrast major currencies and their design features. We conclude that the designs of the two most widely used currencies in the world-the U.S. dollar and the euro-have successfully deterred counterfeiting; data on other currencies are not public. We also conclude that, among the world's major currencies, U.S. banknotes have the fewest features to assist the visually impaired. |
| Keywords: | Paper money design ; Coinage ; Counterfeits and counterfeiting |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2007-011&r=mon |
| By: | Jasmina Arifovic; James B. Bullard; Olena Kostyshyna |
| Abstract: | We analyze the effects of social learning in a widely-studied monetary policy context. Social learning might be viewed as more descriptive of actual learning behavior in complex market economies. Ideas about how best to forecast the economy's state vector are initially heterogeneous. Agents can copy better forecasting techniques and discard those techniques which are less successful. We seek to understand whether the economy will converge to a rational expectations equilibrium under this more realistic learning dynamic. A key result from the literature in the version of the model we study is that the Taylor Principle governs both the uniqueness and the expectational stability of the rational expectations equilibrium when all agents learn homogeneously using recursive algorithms. We find that the Taylor Principle is not necessary for convergence in a social learning context. We also contribute to the use of genetic algorithm learning in stochastic environments. |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2007-007&r=mon |
| By: | Ricardo Mestre (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.) |
| Abstract: | This paper contributes to the old theme of testing for rationality of inflation expectations in surveys, using two very different surveys in parallel. Focusing on the euro area and using two well-known surveys that include questions on inflation expectations, the Consensus Forecast survey and the European Commission Household survey, a battery of tests is applied to inflation forecasts. Tests are based on a preliminary discussion of the meaning of Rational Expectations in the macroeconomic literature, and how this maps into specific econometric tests. Tests used are both standard ones already reported in the literature and less standard ones of potential interest within the framework discussed. Tests focus on in-sample properties of the forecasts, both in static and dynamic settings, and in out-of sample tests to explore the performance of the forecasts in a simulated out-of-sample setting. As a general conclusion, both surveys are found to contain potentially useful information. Although the Consensus Forecasts survey is the best one in terms of quality of the forecasts, rationality in the European Commission Household survey, once measurement issues are taken into account, cannot be ruled out. JEL Classification:C40; C42; C50; C53; E37. |
| Keywords: | Rational expectations; tests of rationality; inflation forecasting. |
| Date: | 2007–02 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20070721&r=mon |
| By: | Angel Asensio (CEPN - Centre d'économie de l'Université de Paris Nord - [CNRS : UMR7115] - [Université Paris-Nord - Paris XIII]) |
| Abstract: | Because it was designed for efficient stationary regimes, the New-Consensus Macroeconomic governance carries several drawbacks when implemented in Keynesian non-ergodic regimes. As long as Keynesian unemployment is interpreted in terms of 'natural' rate, it serves as a macroeconomic policy target in such a way that the policy mix may anchor the system far from full employment. We develop an argument that suggests a Keynesian explanation (which involves inappropriate economic policy) of what New Keynesians have referred to as unemployment hysteresis. However, difficulties do not vanish when authorities adopt the Keynesian vision of the world, for policy makers also have to deal with uncertainty. In contrast with the automatic economic-policy rules of the New Consensus Macroeconomics (NCM), we put forward a Keynesian pragmatic and progressive approach, based on intermediate targets designed with respect to the confidence that authorities have in the chances of success (which depends on the context and moves with it). Monetary and budgetary-fiscal policy interactions are discussed in such a context. Even if the monetary policy ability to reduce interest rates and increase effective demand is doubtful, it matters indirectly through avoiding increases in interest rates when fiscal and budgetary policy aims to stimulate effective demand. |
| Keywords: | Monetary policy, fiscal policy, macroeconomic governance, post-Keynesian |
| Date: | 2007–03–28 |
| URL: | http://d.repec.org/n?u=RePEc:hal:papers:halshs-00139029_v1&r=mon |
| By: | Gary Richardson; Patrick Van Horn |
| Abstract: | A banking crisis began in Austria in May 1931 and intensified in July, when runs struck banks throughout Germany. In September, the crisis compelled Britain to quit the gold standard. Newly discovered data shows that failure rates rose for banks in New York City, at the center of the United States money market, in July and August 1931, before Britain abandoned the gold standard and before financial outflows compelled the Federal Reserve to raise interest rates. Banks in New York City had large exposures to foreign deposits and German debt. This paper tests to see whether the foreign exposure of money center banks linked the financial crises on the two sides of the Atlantic. |
| JEL: | F02 F33 F34 N1 N12 N14 N2 |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:12983&r=mon |
| By: | Erwan Gautier (Banque de France, 39, rue Croix-des-Petits-Champs, F-75049 Paris Cedex 01.); Ignacio Hernando (Banco de España, Alcalá 50, E-28014 Madrid, España.); Philip Vermeulen (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Daniel Dias (Banco de Portugal, 148, rua do Comerico, 1150 Lisbon, Portugal.); Maarten Dossche (National Bank of Belgium, Boulevard de Berlaimont 14, B-1000 Brussels, Belgium.); Roberto Sabbatini (Banca dÍtalia – Research Department, Via Nazionale 91, 00184 Roma, Italy.); Harald Stahl (Deutsche Bundesbank, Economics Department, Wilhelm-Epstein-Strasse 14, D-60431 Frankfurt am Main, Germany.) |
| 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 nonfood 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. JEL Classification: E31, D40, C25 |
| Keywords: | Price-setting, producer prices |
| Date: | 2007–02 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20070727&r=mon |
| By: | Paul Castillo (London School of Economics, Central Bank of Peru); Diego Winkelried (St John’s College, University of Cambridge) |
| Abstract: | The most salient feature of financial dollarization, and the one that causes more concern to policy makers, is its persistence: even after successful macroeconomic stabilizations, dollarization ratios often remain high. In this paper we claim that this persistence is connected to the fact that the participants in the dollar deposit market are fairly heterogenous, and so is the way they form their optimal currency portfolio.We develop as simple model when agents differ in their ability to process information, which turns out to be enough to generate persistence up on aggregation. We find empirical support for this claim with data from three Latin American countries and Poland. |
| Keywords: | Dollarization, individual heterogeneity, persistence, aggregation |
| JEL: | C43 E50 F30 |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:rbp:wpaper:2007-004&r=mon |
| By: | Honohan, Patrick |
| Abstract: | Although the worldwide growth in dollarization of bank deposits has recently slowed, it has already reached very high levels in dozens of countries. Building on earlier findings that allowed the main cross-country variations in the share of dollars to be explained in terms of national policies and institutions, this paper turns to analysis of short-run variations, particularly the response of dollarization to exchange rate changes, which is shown to be too small to warrant ‘fear of floating’ by dollarized economies. But high dollarization is shown to increase the risk of depreciation and even suspension, as indicated by interest rate spreads. While specific policy is needed to deal with the risks associated with dollarization, the underlying causes of unwanted dollarization should also be tackled. |
| Keywords: | Banking; Developing countries; Dollarization; Exchange rates |
| JEL: | E44 F36 O24 |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6205&r=mon |
| By: | Juan de Dios Tena; Cesar Salazar |
| Abstract: | We present a data oriented analysis of the effect of different kind of economic shocks on Chilean output growth and inflation over the last 40 years. Two important results are: (1) foreign shocks only explain 17% of the variability of the output growth in the period 1984-2006 whereas it used to account for the 47,2% of output variability in 1966-1983; (2) The participation of foreign shocks to explain the Chilean inflation reaction becomes more importan in the last twienty years because of the price liberalization and Chile's openness to international trade. Results highlight specific features of the Chilean economy not present in other countries. |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:cte:wsrepe:ws071505&r=mon |
| By: | Christoffer Kok Sørensen (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Jung-Duk Lichtenberger (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.) |
| Abstract: | Despite the remarkable economic and financial convergence over the last ten years in the euro area, mortgage interest rates still differ across countries. This note presents some stylised facts on the heterogeneity of mortgage interest rates across euro area countries on the basis of the Eurosystem’s harmonised MFI interest rate statistics. We also attempt to provide some insights into the reasons behind these cross-country differences using the methodology recently proposed by Affinito and Farabullini (2006). We differ from Affinito and Farabullini (2006) in that we focus on one particular banking market: the market for mortgage loans. This allows us to identify more clearly the role of specific structural features characterising that market in explaining mortgage rate dispersion. More specifically, we investigate the extent to which various mortgage loan demand and supply determinants help explaining the observed dispersion. It turns out that some of the heterogeneity can be explained by these factors, in particular those that relate to the supply side. However, a substantial part of the dispersion remains unexplained suggesting that much of the heterogeneity also reflects country-specific institutional differences that are likely to be caused by differences in the regulatory and fiscal framework of the mortgage markets. In order to test this, we extend our analysis to also include institutional factors and indeed find that crosscountry differences in enforcement procedures, tax subsidies and loan-to-value ratios influence the level of mortgage rates. JEL Classification: C23; E4; F36; G21; N24. |
| Keywords: | Mortgage markets; bank interest rates; euro area countries; financial integration; panel econometrics. |
| Date: | 2007–02 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20070733&r=mon |