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Ester Faia

1 April 2001
WORKING PAPER SERIES - No. 56
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Abstract
This paper studies the optimal choice of exchange rate regimes between two large currency areas. It provides a positive and normative analysis of alternative monetary policy rules in a model with sticky prices, monopolistic competition, and frictions in the processes of capital accumulation and acquisition of external finance. The stabilization and welfare analysis provides a sound result on the desirability of monetary policy and exchange rate flexibility as business cycle smoothing devices. Given the presence of financial frictions the paper gives a richer explanation of the mechanism behind the stabilization properties of floating exchange rates and explains the difference in sign of the international transmission of shocks compared to the model without capital. In a two country model without capital the pattern of output is mainly determined by the pattern of consumption: any movement in the exchange rate under floating exchange rates causes movements in the price of the international traded bond and in consumption and consequently in output. In the model with capital and financial frictions output mimics the movements in investment: an active monetary authority reacting to exchange rate movements generates perverse movements in the interest rate, destabilizing investment and output. The paper also suggests how monetary policy can improve financial stability, stressing the importance of the interest rate smoothing in tuning movements in investment and output and in reducing the welfare cost of financial frictions mostly under fixed exchange rates.
JEL Code
E3 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles
E42 : Macroeconomics and Monetary Economics→Money and Interest Rates→Monetary Systems, Standards, Regimes, Government and the Monetary System, Payment Systems
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
F41 : International Economics→Macroeconomic Aspects of International Trade and Finance→Open Economy Macroeconomics
1 October 2002
WORKING PAPER SERIES - No. 183
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Abstract
Major currency areas are characterized by important differences in financial structure that are clear in microeconomic data. Surprisingly, this fact is seldom discussed in the analysis of the international transmission of shocks. This paper attempts to fill the gap. First, I show some stylized facts about financial differences and cyclical correlations among the main OECD countries. Second, using a two-country model with monopolistic competition and sticky prices, calibrated to US and euro area data, I analyze the international transmission of shocks with different degrees of financial fragility in the two economies. I find, first, that financial diversity can account for heterogenous business cycle fluctuations. Differential responses to shocks are shown to occur with independent monetary policies - Taylor rules or rigid inflation targets - even with low degrees of economic and financial openness. Credible pegs help to increase the synchronization of cycles. Secondly, differences in persistence of the interest rates help to explain high persistence in the real exchange rate. Finally, weak financial systems can result in large welfare losses under symmetric and correlated shocks.
JEL Code
E3 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles
E42 : Macroeconomics and Monetary Economics→Money and Interest Rates→Monetary Systems, Standards, Regimes, Government and the Monetary System, Payment Systems
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
F41 : International Economics→Macroeconomic Aspects of International Trade and Finance→Open Economy Macroeconomics
27 April 2004
WORKING PAPER SERIES - No. 344
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Abstract
We analyze welfare maximizing monetary policy in a dynamic two-country model with price stickiness and imperfect competition. In this context, a typical terms of trade externality affects policy interaction between independent monetary authorities. Unlike the existing literature, we remain consistent to a public finance approach by an explicit consideration of all the distortions that are relevant to the Ramsey planner. This strategy entails two main advantages. First, it allows an accurate characterization of optimal policy in an economy that evolves around a steady-state which is not necessarily efficient. Second, it allows to describe a full range of alternative dynamic equilibria when price setters in both countries are completely forwardlooking and households' preferences are not restricted. In this context, we study optimal policy both in the long-run and along a dynamic path, and we compare optimal commitment policy under Nash competition and under cooperation. By deriving a second order accurate solution to the policy functions, we also characterize the welfare gains from international policy cooperation.
JEL Code
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
F41 : International Economics→Macroeconomic Aspects of International Trade and Finance→Open Economy Macroeconomics
Network
International research forum on monetary policy
5 May 2006
WORKING PAPER SERIES - No. 619
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Abstract
This paper relates the size of the cyclical inflation differentials, currently observed for euro area countries, to the differences in labor market institutions across the same set of countries. It does that by using a DSGE model for a currency area with sticky prices and labor market frictions. We show that differences in labor market institutions account well for cyclical inflation differentials. The proposed mechanism is a supply side one in which differences in labor market institutions generate different dynamics in real wages and consequently in marginal costs and inflations. We test this mechanism in the data and find that the model replicates well the empirical facts.
JEL Code
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
E24 : Macroeconomics and Monetary Economics→Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy→Employment, Unemployment, Wages, Intergenerational Income Distribution, Aggregate Human Capital
23 November 2006
WORKING PAPER SERIES - No. 698
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Abstract
This paper studies optimal monetary policy rules in a framework with sticky prices, matching frictions and real wage rigidities. Optimal monetary policy is given by a constrained Ramsey plan in which the monetary authority maximizes the agents' welfare subject to the competitive economy relations and the assumed monetary policy rule. I find that optimal policy should deviate from the strict inflation targeting since the policy maker faces a typical unemployment/inflation trade-off. In this context and unlike a standard New Keynesian model stabilizing inflation is not sufficient to stabilize the marginal cost (hence the output gap) since the latter also depends on the evolution of unemployment. The matching frictions add a congestion externality since the number of unemployed in the market and their bargaining power reduce the probability of forming matches. Hence optimal monetary policy features unemployment targeting along with inflation targeting.
JEL Code
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
E24 : Macroeconomics and Monetary Economics→Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy→Employment, Unemployment, Wages, Intergenerational Income Distribution, Aggregate Human Capital
12 January 2007
WORKING PAPER SERIES - No. 707
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Abstract
This paper studies the design of optimal monetary policy (in terms of unconstrained Ramsey allocation) in a framework with sticky prices and matching frictions. Furthermore I consider the role of real wage rigidities. Optimal policy features significant deviations from price stability in response to various shocks. This is so since search externalities generate an unemployment/inflation trade-off. In response to productivity shocks optimal policy is pro-cyclical when the worker’s bargaining power is higher than the share of unemployed people in the matching technology and viceversa. This is so since when the workers’ share of surplus is high there are many searching workers and few vacancies hence the monetary authority has an incentive to increase vacancy profitability by reducing the interest rate and increasing inflation. The opposite is true when the workers’ share of surplus is high. This implies that optimal inflation volatility is U-shaped with respect to workers’ bargaining power.
JEL Code
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
E24 : Macroeconomics and Monetary Economics→Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy→Employment, Unemployment, Wages, Intergenerational Income Distribution, Aggregate Human Capital
20 October 2010
WORKING PAPER SERIES - No. 1256
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Abstract
The recent financial crisis has highlighted the limits of the "originate to distribute" model of banking, but its nexus with the macro-economy and monetary policy remains unexplored. I build a DSGE model with banks (along the lines of Holmstr
JEL Code
E3 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles
E5 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit
G3 : Financial Economics→Corporate Finance and Governance
Network
ECB Lamfalussy Fellowship Programme