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on Monetary Economics |
| By: | Beck, Günter W.; Wieland, Volker |
| 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 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:bubdp1:6141&r=mon |
| By: | Aoki, Kosuke; Kimura, Takeshi |
| Abstract: | We analyse the interaction between private agents’ uncertainty about inflation target and the central bank’s data uncertainty. In our model, private agents update their perceived inflation target and the central bank estimates unobservable economic shocks as well as the perceived inflation target. Under those two uncertainties, the learning process of both private agents and the central bank causes higher order beliefs to become relevant, and this mechanism is capable of generating high persistence and volatility of inflation even though the underlying shocks are purely transitory. We also find that the persistence and volatility become smaller as the inflation target becomes more credible, that is, the private agents’ uncertainty about inflation target (and hence the bank’s data uncertainty) diminishes. |
| Keywords: | Monetary policy, central banks |
| JEL: | E52 E58 |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:bubdp1:6139&r=mon |
| By: | Woodford, Michael |
| Abstract: | Arguments for a prominent role for attention to the growth rate of monetary aggregates in the conduct of monetary policy are often based on references to low-frequency reduced-form relationships between money growth and inflation. The 'two-pillar Phillips curve' proposed by Gerlach (2004) has recently attracted a great deal of interest in the euro area, where it is sometimes supposed to provide empirical support for the wisdom of a 'two-pillar strategy' that uses distinct analytical frameworks to assess shorter-run and longer-run risks to price stability. I show, however, that regression coefficients of the kind reported by Assenmacher-Wesche and Gerlach (2006a) among others are quite consistent with a 'new Keynesian' model of inflation determination, in which the quantity of money plays no role in inflation determination, at either high or low frequencies. I also show that empirical results of this kind do not in themselves establish that money growth must be useful in forecasting inflation, either in the short run or over a longer run. Hence they provide little support for the ECB's monetary 'pillar'. |
| Keywords: | band-pass regression; ECB monetary policy strategy; monetarism |
| JEL: | E52 E58 |
| Date: | 2007–09 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6447&r=mon |
| By: | Peter Sinclair |
| Abstract: | price stability conflates two ideas: low inflation, and steady inflation. The typical quadratic objective function is unsatisfactory in various ways. Blindness to a mean-amplifying, variance-preserving transformation of inflation rates is one of them, and fixation with the year unit another. Average inflation steadiness over longer periods is valuable, but scores no weight. This paper explores these issues, and others, concerning the links that monetary policy has with both financial stability and fiscal stability. |
| Keywords: | Monetary Policy |
| JEL: | E52 |
| Date: | 2007–05 |
| URL: | http://d.repec.org/n?u=RePEc:bir:birmec:07-12&r=mon |
| By: | Giannone, Domenico; Matheson, Troy |
| Abstract: | This paper introduces a new indicator of core inflation for New Zealand, estimated using a dynamic factor model and disaggregate consumer price data. Using disaggregate consumer price data we can directly compare the predictive performance of our core indicator with a wide range of other ‘core inflation’ measures estimated from disaggregate consumer prices, such as the weighted median and the trimmed mean. The medium term inflation target of Reserve Bank of New Zealand is used as a guide to define our target measure of core inflation - a centered 2 year moving average of past and future inflation outcomes. We find that our indicator produces relatively good estimates of this characterisation of core inflation when compared with estimates derived from a range of other models. |
| Keywords: | Core inflation; Monetary policy |
| JEL: | C32 E31 E32 E52 |
| Date: | 2007–09 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6469&r=mon |
| By: | Woodford, Michael |
| Abstract: | It has recently become popular to argue that globalization has had or will soon have dramatic consequences for the nature of the monetary transmission mechanism, and it is sometimes suggested that this could threaten the ability of national central banks to control inflation within their borders, at least in the absence of coordination of policy with other central banks. In this paper, I consider three possible mechanisms through which it might be feared that globalization can undermine the ability of monetary policy to control inflation: by making liquidity premia a function of 'global liquidity' rather than the supply of liquidity by a national central bank alone; by making real interest rates dependent on the global balance between saving and investment rather than the balance in one country alone; or by making inflationary pressure a function of 'global slack' rather than a domestic output gap alone. These three fears relate to potential changes in the form of the three structural equations of a basic model of the monetary transmission mechanism: the LM equation, the IS equation, and the AS equation respectively. I review the consequences of global integration of financial markets, final goods markets, and factor markets for the form of each of these parts of the monetary transmission mechanism, and find that globalization, even of a much more thorough sort than has yet occurred, is unlikely to weaken the ability of national central banks to control the dynamics of inflation. |
| Keywords: | capital mobility; global liquidity; global slack; inflation |
| JEL: | E31 E52 F41 F42 |
| Date: | 2007–09 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6448&r=mon |
| By: | Greiber, Claus; Setzer, Ralph |
| Abstract: | This paper examines the relation between money and housing variables in the euro area and in the US. Our empirical model is based on a standard money demand relation which is augmented by housing market variables. In doing so, co-integrated money demand relationships can be established for both the euro area and the US. Furthermore, we find evidence for asset inflation channels, that is, liquidity fuels housing market developments. |
| Keywords: | money demand, asset inflation, housing, wealth |
| JEL: | E41 E52 |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:bubdp1:6135&r=mon |
| By: | Cukierman, Alex |
| Abstract: | This paper probes the limits of transparency in monetary policymaking along two dimensions: feasibility and desirability. It argues that, due to limited knowledge about the economy, even central banks that are considered champions of openness are not very clear about their measures of the output gap and about their beliefs regarding the effect of policy on inflationary expectations. Consequently feasibility constraints on transparency are more serious than stylized models of the transmission mechanism would imply. In addition no central bank has made clear statements about its objective function, including in particular the relative weight on output versus inflation stabilization, the policy discount factor and the shape of losses from the inflation and the output gaps over the possible ranges of realizations of those variables. The paper also argues that there is a trade-off between full transparency and full utilization of information in setting policy and that excessive transparency may facilitate the exertion of political pressures on the central bank. The last section of the paper abstracts from feasibility constraints and discusses the desirable levels of openness in various areas of the policymaking process. It is argued that the strongest case against immediate transparency arises when the CB has private information about problems within segments of the financial system. Premature release of information may, in such a case, destroy efficient risk sharing arrangements and long term investments by triggering a run on the financial system. This is illustrated within the context of the classic Diamond Dybvig model of bank runs. The paper also probes the desirable levels of transparency in other areas of the policymaking process like the bank's objective function, the bank's output target, forecasts of economic shocks, disagreements within the CB board and the bank's own ignorance. |
| Keywords: | monetary policy; Transparency - actual and desirable |
| JEL: | E58 E61 |
| Date: | 2007–09 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6475&r=mon |
| By: | Gosselin, Pierre; Lotz, Aileen; Wyplosz, Charles |
| Abstract: | The present paper extends the literature on central bank transparency that relies on information heterogeneity among private agents in four directions. First, it adds the interest rate to the list of signals that the central bank can reveal. Second, it allows for more than one economic fundamental. Third, it extends the range of uncertainties that matter. So far the literature has focused on uncertainty about the economic fundamentals, assumed to be estimated with known precision; we also allow for uncertainty about precision. Fourth, it derives results that are general in the sense that they do not depend on any particular social welfare criterion. Each extension sheds new light on the role of central bank transparency. Focusing on the signaling role of the interest rate, we consider various degrees of transparency, ranging from full opacity, to just publishing the interest rate, to also revealing the signals and estimates of their precision. While uncertainty about the fundamentals results in the now familiar common knowledge effect, uncertainty about information precision creates a fog effect, which reduces the quality of decisions taken by the central bank and the private sector. In the absence of the fog effect, full transparency is generally not desirable, because it deprives the central bank from the ability to optimally manipulate private sector expectations. When the central bank's fog is large, we find that full transparency is usually the best communication strategy. This result tends to survive when the private sector's fog is large. Full opacity is only desirable when the central bank is poorly informed. Another result that emerges from our analysis is that it is usually desirable for the central bank to divulge some information, even if it is erroneous, and known to be erroneous. The reason is that, when the private sector knows that the central bank is mistaken, it needs to evaluate the extent of its mistakes. |
| Keywords: | central bank transparency; information asymmetry; monetary policy |
| JEL: | E42 E52 E58 |
| Date: | 2007–09 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6454&r=mon |
| By: | Jiri Podpiera |
| Abstract: | Operational monetary policy rules are characterized by a parsimonious specification and are therefore prone to specification error when estimated on real data. I devise a policy rule estimation procedure, which is robust to marginal misspecification, and study the effects of specification error in least squares. I find the robust evidence of upward bias in policy inertia in least squares applied to most commonly used Taylor type rule. In effect, least squares learning of a central bank can lead to increasing monetary policy inertia over time. |
| Keywords: | Monetary policy inertia, policy rule. |
| JEL: | E4 E5 |
| Date: | 2006–12 |
| URL: | http://d.repec.org/n?u=RePEc:cer:papers:wp315&r=mon |
| By: | Kitov, Ivan |
| Abstract: | Potential links between inflation and unemployment in Canada have been examined. No consistent Phillips curve has been found likely due to strong changes in monetary policy of the Bank of Canada. However, there were two distinct periods where linear links between inflation and unemployment could exist - before 1983 and after 1983. A linear and lagged relationship between inflation, unemployment and labor force has been obtained for Canada. Similar relationships were reported previously for the USA, Japan, France and Austria. Changes in labor force level are simultaneously reflected in unemployment and lead inflation by two years. Therefore this generalized relationship provides a two-year ahead natural prediction of inflation based on current estimates of labor force level and unemployment rate. The goodness-of-fit for the relationship is of 0.7 for the period since 1965, i.e. including the periods of high inflation and disinflation. |
| Keywords: | inflation; unemployment; labor force; prediction; Canada |
| JEL: | C53 E31 J64 E37 |
| Date: | 2007–09–25 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:5015&r=mon |
| By: | Anthony Garratt (School of Economics, Mathematics & Statistics, Birkbeck); Gary Koop; Emi Mise; Shaun P Vahey |
| Abstract: | A popular account for the demise of the UK monetary targeting regime in the 1980s blames the weak predictive relationships between broad money and inflation and real output. In this paper, we investigate these relationships using a variety of monetary aggregates which were used as intermediate UK policy targets. We use both real-time and final vintage data and consider a large set of recursively estimated Vector Autoregressive (VAR) and Vector Error Correction models (VECM). These models differ in terms of lag length and the number of cointegrating relationships. Faced with this model uncertainty, we utilize Bayesian model averaging (BMA) and contrast it with a strategy of selecting a single best model. Using the real-time data available to UK policymakers at the time, we demonstrate that the in-sample predictive content of broad money fluctuates throughout the 1980s for both strategies. However, the strategy of choosing a single best model amplifies these fluctuations. Out-of-sample predictive evaluations rarely suggest that money matters for either inflation or real output, regardless of whether we select a single model or do BMA. Overall, we conclude that the money was a weak (and unreliable) predictor for these key macroeconomic variables. But the view that the predictive content of UK broad money diminished during the 1980s receives little support using either the real-time or final vintage data. |
| Keywords: | Money, Vector Error Correction Models, Model Uncertainty, Bayesian Model Averaging, Real Time Data |
| JEL: | C11 C32 C53 E51 E52 |
| Date: | 2007–09 |
| URL: | http://d.repec.org/n?u=RePEc:bbk:bbkefp:0714&r=mon |
| By: | Weber, Anke |
| Abstract: | This paper is the first attempt to investigate the performance of different learning rules in fitting survey data of household and expert inflation expectations in five core European economies (France, Germany, Italy, Netherlands and Spain). Overall it is found that constant gain learning performs well in out-of-sample forecasting. It is also shown that households in high inflation countries are using higher best fitting constant gain parameters than those in low inflation countries. They are hence able to pick up structural changes faster. Professional forecasters update their information sets more frequently than households. Furthermore, household expectations in the Euro Area have not converged to the inflation goal of the ECB, which is to keep inflation below to but close to 2% in the medium run. This contrasts the findings for professional experts, which seem to be more inclined to incorporate the implications of monetary union for the convergence in inflation rates into their expectations. |
| Keywords: | Monetary policy, heterogeneous expectations, adaptive learning, survey expectations |
| JEL: | D84 E31 E37 |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:bubdp1:6137&r=mon |
| By: | Edward E. Leamer |
| Abstract: | Of the components of GDP, residential investment offers by far the best early warning sign of an oncoming recession. Since World War II we have had eight recessions preceded by substantial problems in housing and consumer durables. Housing did not give an early warning of the Department of Defense Downturn after the Korean Armistice in 1953 or the Internet Comeuppance in 2001, nor should it have. By virtue of its prominence in our recessions, it makes sense for housing to play a prominent role in the conduct of monetary policy. A modified Taylor Rule would depend on a long-term measure of inflation having little to do with the phase in the cycle, and, in place of Taylor's output gap, housing starts and the change in housing starts, which together form the best forward-looking indicator of the cycle of which I am aware. This would create pre-emptive anti-inflation policy in the middle of the expansions when housing is not so sensitive to interest rates, making it less likely that anti-inflation policies would be needed near the ends of expansions when housing is very interest rate sensitive, thus making our recessions less frequent and/or less severe. |
| JEL: | E17 E3 E32 E52 |
| Date: | 2007–09 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:13428&r=mon |
| By: | Philip Lane; Jay C. Shambaugh |
| Abstract: | Our goal in this project is to gain a better empirical understanding of the international financial implications of currency movements. To this end, we construct a database of international currency exposures for a large panel of countries over 1990-2004. We show that trade-weighted exchange rate indices are insufficient to understand the financial impact of currency movements. Further, we demonstrate that many developing countries hold short foreign-currency positions, leaving them open to negative valuation effects when the domestic currency depreciates. However, we also show that many of these countries have substantially reduced their foreign currency exposure over the last decade. Last, we show that our currency measure has high explanatory power for the valuation term in net foreign asset dynamics: exchange rate valuation shocks are sizable, not quickly reversed and may entail substantial wealth shocks. |
| JEL: | F31 F32 |
| Date: | 2007–09 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:13433&r=mon |
| By: | David Andolfatto (Simon Fraser University) |
| Abstract: | In this paper, I provide a rationale for why money should earn interest; or, what amounts to the same thing, why risk-free claims to non-interestbearing money should trade at discount. I argue that interest-bearing money is essential when individual money balances are private information. The analysis also suggests one reason for why it is sufficient (as well as necessary) for interest to be paid only on large money balances; or equivalently, why bonds need only be issued in large denominations. |
| Date: | 2007–09 |
| URL: | http://d.repec.org/n?u=RePEc:sfu:sfudps:dp07-16&r=mon |
| By: | Arghyrou, Michael G (Cardiff Business School); Gregoriou, Andros; Kontonikas, Alexandros |
| Abstract: | We test for real interest parity (RIP) in the EU25 area. Our contribution is two-fold: First, we account for the previously overlooked effects of structural breaks on real interest rate differentials. Second, we test for RIP against the EMU average. For the majority of our sample countries we obtain evidence of real interest rate convergence towards the latter. Convergence, however, is a gradual process subject to structural breaks, typically falling close to the launch of the euro. Our findings have important implications relating to the single monetary policy and the progress new EU members have achieved towards joining the euro. |
| Keywords: | real interest rate parity; convergence; structural breaks; EU; EMU; |
| JEL: | F21 F32 C15 C22 |
| Date: | 2007–09 |
| URL: | http://d.repec.org/n?u=RePEc:cdf:wpaper:2007/26&r=mon |
| By: | Guimarães, Bernardo |
| Abstract: | If currency crises are triggered when the currency overvaluation hits a threshold, the expected magnitude of a devaluation, conditional on its occurrence, is substantially different from the unconditional expected currency overvaluation. That is not true if currency crises are triggered by sunspots. Therefore, implications for the behaviour of the probability and the expected magnitude of a devaluation depend on what triggers currency crises. Those two variables are not observable but can be estimated using data on exchange rate options. This paper identifies the probability and expected magnitude of a devaluation of Brazilian Real in the period leading up to the end of the Brazilian pegged exchange rate regime and contrasts the estimates to the predictions from a simple model of currency crises under different assumptions about the trigger. The empirical findings favour thresholds and learning over sunspots. |
| Keywords: | currency crises; exchange rate; options; sunspots |
| JEL: | F3 G1 |
| Date: | 2007–09 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6487&r=mon |
| By: | Gita Gopinath; Oleg Itskhoki; Roberto Rigobon |
| Abstract: | A central assumption of open economy macro models with nominal rigidities relates to the currency in which goods are priced, whether there is so-called producer currency pricing or local currency pricing. This has important implications for exchange rate pass-through and optimal exchange rate policy. We show, using novel transaction level information on currency and prices for U.S. imports, that even conditional on a price change, there is a large difference in the pass-through of the average good priced in dollars (25%) versus non-dollars (95%). This finding is contrary to the assumption in a large class of models that the currency of pricing is exogenous and is evidence of an important selection effect that results from endogenous currency choice. We describe a model of optimal currency choice in an environment of staggered price setting and show that the empirical evidence strongly supports the model's predictions of the relation between currency choice and pass-through. We further document evidence of significant real rigidities, with the pass-through of dollar pricers increasing above 50% in the long-run. Lastly, we numerically illustrate the currency choice decision in both a Calvo and a menu-cost model with variable mark-ups and imported intermediate inputs and evaluate the ability of these models to match pass-through patterns documented in the data. |
| JEL: | E31 F3 F41 |
| Date: | 2007–09 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:13432&r=mon |
| By: | Valerio Cerretano |
| Abstract: | This article describes how the Trade Facilities Act (TFA) and the liquidation of certain government-owned assets spurred the industrial intervention of the Bank of England in the 1920s. What emerges is a much greater role of the Treasury in the Bank of England's industrial intervention than has been hitherto suggested. This essay places the theme of the Bank of England's industrial intervention within the broader discussions about Treasury history and Britain's post-war reconstruction, and refines the argument that the original involvement of the Bank of England with industry merely represented an extension of its pre-war operations of branch banking and its duties as a central bank. |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:pse:psecon:2007-22&r=mon |