Working papers published in 2004

In-depth studies for experts

Our Working Paper Series (WPS) disseminates economic research relevant to the various tasks and functions of the ECB, and provides a conceptual and empirical basis for policy-making. The Working Papers constitute “work in progress”. They are published to stimulate discussion and contribute to the advancement of our knowledge of economic matters. They are addressed to experts, so readers should be knowledgeable in economics.

Discussion papers

Discussion papers differ from standard working papers in that they are more broadly accessible and offer a more balanced perspective. While partly based on original research, they place the analysis in the wider context of the literature on the topic and also explicitly consider the policy perspective.

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No. 424
22 December 2004
An empirical study of liquidity and information effects of order flow on exchange rates

Abstract

JEL Classification

D82 : Microeconomics→Information, Knowledge, and Uncertainty→Asymmetric and Private Information, Mechanism Design

G14 : Financial Economics→General Financial Markets→Information and Market Efficiency, Event Studies, Insider Trading

G15 : Financial Economics→General Financial Markets→International Financial Markets

Abstract

We propose a simple structural model of exchange rate determination which draws from the analytical framework recently proposed by Bacchetta and van Wincoop (2003) and allows us to disentangle the liquidity and information effects of order flow on exchange rates. We estimate this model employing an innovative transaction data-set that covers all direct foreign exchange transactions completed in the USD/EUR market via EBS and Reuters between August 2000 and January 2001. Our results indicate that the strong contemporaneous correlation between order flow and exchange rates is mostly due to liquidity effects. This result also appears to carry through to the four FX intervention events that appear in our sample.

No. 423
22 December 2004
Price setting in France: new evidence from survey data
Published in: Revue d'Economie Politique, Vol 117, 2006: pp 541-554

Abstract

JEL Classification

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

D40 : Microeconomics→Market Structure and Pricing→General

L11 : Industrial Organization→Market Structure, Firm Strategy, and Market Performance→Production, Pricing, and Market Structure, Size Distribution of Firms

Abstract

This paper reports the results of a survey conducted by the Banque de France during Winter 2003-2004 to investigate the price-setting behavior of French manufacturing companies. Prices are found to adjust infrequently; the median firm modifies its price only once a year. Price reviews are more frequent than price changes; the median firm reviews its price quarterly. Firms are found to follow either time dependent, state-dependent or both pricing rules. Moreover, the chosen interval of price reviews depends on the probability that changes in the firms' environment occur. Coordination failure and nominal contracts (either written or implicit) are the most important sources of price stickiness, while pricing thresholds and physical menu costs appear to be totally unimportant. Asymmetries in price stickiness are found to be different for cost shocks compared to demand shocks: prices are more rigid downward than upward for cost shocks, while the reverse is true for demand shocks.

No. 422
20 December 2004
What determines fiscal balances? An empirical investigation in determinants of changes in OECD budget balances
Published in: Empirica (2007), vol. 34, pp. 1-14; published as “Budget Balances in OECD Countries: What Makes Them Change?”.

Abstract

JEL Classification

E61 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Policy Objectives, Policy Designs and Consistency, Policy Coordination

E62 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Fiscal Policy

H61 : Public Economics→National Budget, Deficit, and Debt→Budget, Budget Systems

H62 : Public Economics→National Budget, Deficit, and Debt→Deficit, Surplus

Abstract

Fiscal balances have deteriorated quickly in recent years, bringing back to the foreground the question what factors help explain such sharp changes. This paper takes a broad perspective at the issue regarding countries included, the range of explanatory variables tried, and the time-span. The empirical analysis shows that changes in budget balances are affected by debt growth, macroeconomic developments and political factors. In particular, we find that the run-up to EMU induced additional consolidation in Europe and that budget balances deteriorate markedly in election years. Asset prices also may affect budgets, but the impact remains limited in normal times.

No. 421
20 December 2004
EU fiscal rules: issues and lessons from political economy
Published in: International Economics and Economic Policy (2005) 2: 65-89.

Abstract

JEL Classification

D7 : Microeconomics→Analysis of Collective Decision-Making

H3 : Public Economics→Fiscal Policies and Behavior of Economic Agents

H6 : Public Economics→National Budget, Deficit, and Debt

Abstract

The paper analyses the EU fiscal rules from a political economy perspective and derives some policy lessons. Following a literature survey, the paper stresses the importance of appropriate incentives for rule compliance in an environment where national fiscal sovereignty precludes the option of centralised enforcement. In addition, the paper stresses the importance of clear and simple rules and in particular the 3% deficit limit in anchoring expectations of fiscal discipline and facilitating public and market monitoring of public finances. This, in turn, strengthens incentive for rule compliance. Moreover, the paper discusses the interests of the most important players in European fiscal rule formation and the importance of choosing the appropriate time for initiating a reform debate.

No. 420
16 December 2004
On prosperity and posterity: the need for fiscal discipline in a monetary union

Abstract

JEL Classification

D62 : Microeconomics→Welfare Economics→Externalities

E61 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Policy Objectives, Policy Designs and Consistency, Policy Coordination

E63 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Comparative or Joint Analysis of Fiscal and Monetary Policy, Stabilization, Treasury Policy

Abstract

We show how in a Blanchard-Yaari, overlapping generations framework, perfect substitutability of government bonds in Monetary Union tempts governments to exploit the enlarged common pool of savings. In Nash equilibrium all governments increase their bond financed transfers to current generations (prosperity effect) at the expense of future generations (posterity effect). The resulting deficit bias occurs even if one assumes that before Monetary Union countries had eliminated their deficit bias by designing appropriate domestic institutions. The paper provides a rationale for an increased focus on fiscal discipline in Monetary Union, without the need to assume imperfect credibility of existing Treaty provisions or to refer to extreme situations involving sovereign default. We draw on existing empirical evidence to argue that the degree of government bond substitutability within the European Monetary Union is an order of magnitude larger than in the global economy.

No. 419
1 December 2004
The design of fiscal rules and forms of governance in European Union countries

Abstract

JEL Classification

H11 : Public Economics→Structure and Scope of Government→Structure, Scope, and Performance of Government

H61 : Public Economics→National Budget, Deficit, and Debt→Budget, Budget Systems

H62 : Public Economics→National Budget, Deficit, and Debt→Deficit, Surplus

Abstract

This paper examines the development of fiscal rules and budget procedures in EU countries, and their impact of public finances since the mid-1980s. It presents a new data set on institutional reforms and their impact in Europe. Empirical pattern confirm our prediction that more stringent fiscal rules exist under large coalition governments, while the centralisation of budgetary procedures is the main form of fiscal governance elsewhere. In addition, the centralisation of procedures does not restrain public debt in countries more prone to a rules-based approach, whereas more stringent fiscal rules seem to support fiscal discipline in almost all EU countries.

No. 418
30 November 2004
Identifying the influences of nominal and real rigidities in aggregate price-setting behavior
Published in: Journal of Monetary Economics, Vol 54 (8), 2007: pp 2439-2466

Abstract

JEL Classification

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

Abstract

We formulate a generalized price-setting framework that incorporates staggered contracts of multiple durations and that enables us to directly identify the influences of nominal vs. real rigidities. Using German macroeconomic data over the period 1975Q1 through 1998Q4 toestimate this framework, we find that the data is well-characterized by a truncated Calvostyle distribution with an average duration of about two quarters. We also find that new contracts exhibit very low sensitivity to marginal cost, corresponding to a relatively high degree of real rigidity. Finally, our results indicate that backward-looking behavior is not needed to explain the aggregate data, at least in an environment with a stable monetary policy regime and a transparent and credible inflation objective.

No. 413
30 November 2004
An empirical analysis of price setting behaviour in the Netherlands in the period 1998-2003 using micro data

Abstract

JEL Classification

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

D49 : Microeconomics→Market Structure and Pricing→Other

C41 : Mathematical and Quantitative Methods→Econometric and Statistical Methods: Special Topics→Duration Analysis, Optimal Timing Strategies

Abstract

In this paper we examine pricing behaviour of retail firms in the Netherlands during 1998-2003 using a large database with monthly price quotes of 49 articles, representing different product types. We have conducted this study in order to gain in sight in the degree of nominal rigidity of consumer prices in the Netherlands. We find that prices of energy and unprocessed food are most flexible, whereas prices of services are stickiest. A multivariate analysis shows that firm size matters with prices being stickiest in small firms and most flexible in large firms and in retail firms consisting of the owners only. Furthermore, we investigate pass-through effects of VAT changes in prices. We find that VAT increases are almost completely passed on to consumers. Finally, there is some evidence indicating that pricing behaviour of retail firms was different during the introduction of the euro than in the period directly preceding it.

No. 411
30 November 2004
Fiscal discipline and the cost of public dept service: some estiames for OECD countries

Abstract

JEL Classification

E62 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Fiscal Policy

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy

H62 : Public Economics→National Budget, Deficit, and Debt→Deficit, Surplus

Abstract

We use a panel of 16 OECD countries over several decades to investigate the effects of government debts and deficits on long-term interest rates. In simple static specifications, a one-percentage-point increase in the primary deficit relative to GDP increases contemporaneous long-term interest rates by about 10 basis points. In a vector autoregression (VAR), the same shock leads to a cumulative increase of almost 150 basis points after 10 years. The effect of debt on interest rates is non-linear: only for countries with above-average levels of debt does an increase in debt affect the interest rate. World fiscal policy is also important: an increase in total OECD-government borrowing increases each country's interest rates. However, domestic fiscal policy continues to affect domestic interest rates even after controlling for worldwide debts and deficits.

No. 408
30 November 2004
The great inflation, limited asset markets participation and aggregate demand: FED policy was better than you think

Abstract

JEL Classification

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies

E65 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Studies of Particular Policy Episodes

Abstract

When enough agents do not participate in asset markets, the slope of the aggregate demand curve is reversed. Monetary policy should be passive, to ensure equilibrium determinacy and to minimize variations in output and inflation. This paper presents evidence that asset markets participation in the US was limited over the Great Inflation period and the slope of the IS curve had the 'wrong' sign. Our results may help explain the 'Great Inflation' and give optimism for FED policy. If the economy was characterized by a relatively higher degree of financial frictions over that period: (i) policy implied a determinate equilibrium and ruled out sunspot fluctuations; (ii) policy was closer to optimal than conventional wisdom dictates; (iii) responses and variability of macroeconomic variables conditional upon fundamental shocks are close to their estimated counterparts for a wide range of reasonable parameterizations. Notably, 'cost-push' shocks are enough to generate a Great Inflation.

No. 417
24 November 2004
Staggered price contracts and inflation persistence: some general results

Abstract

JEL Classification

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

Abstract

Despite their popularity as theoretical tools for illustrating the effects of nominal rigidities, some have questioned whether models based on Taylor-style staggered contracts can match the persistence of the empirical inflation process. This paper presents some general theoretical results about Taylor-style models. It is shown that these models do not have a problem matching high auto-correlations for inflation. However, they fail to explain a key feature of reduced-form Phillips-curve regressions: The positive dependence of inflation on its own lags. It is shown that staggered price contracting models instead predict that the coefficients on these lag terms should be negative.

No. 416
24 November 2004
Price setting behaviour in Spain: stylised facts using consumer price micro data
Published in: Economic Modelling, Vol 23 (4), July 2006: pp 699 as "Price setting behaviour in Spain: evidence from consumer price micro-data"

Abstract

JEL Classification

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

D40 : Microeconomics→Market Structure and Pricing→General

C25 : Mathematical and Quantitative Methods→Single Equation Models, Single Variables→Discrete Regression and Qualitative Choice Models, Discrete Regressors, Proportions

Abstract

This paper identifies the basic features of the price setting mechanism in the Spanish economy, using a large dataset that contains over 1.1 million price records and covers around 70% of the expenditure on the CPI basket. In particular, the paper identifies differences in the frequency and size of price adjustments across types of products and explores how these general features are affected by certain specific factors: seasonality, the level of inflation, changes in indirect taxation and the practice of using psychological and round prices. We find that prices do not change often but do so by a large amount, although there is a marked heterogeneity across products. Moreover, the high frequency of price reductions suggests that there is no strong downward rigidity. Our evidence also supports the use of time and state-dependent pricing strategies.

No. 415
24 November 2004
How persistent is disaggregate inflation? An analysis across EU 15 countries and HICP sub-indices
Published in: Applied Economics Letters, Vol 16(12), 2009: pp 1271-1275 as "Mean Reversion and Sales"

Abstract

JEL Classification

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

C21 : Mathematical and Quantitative Methods→Single Equation Models, Single Variables→Cross-Sectional Models, Spatial Models, Treatment Effect Models, Quantile Regressions

C22 : Mathematical and Quantitative Methods→Single Equation Models, Single Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models &bull Diffusion Processes

C14 : Mathematical and Quantitative Methods→Econometric and Statistical Methods and Methodology: General→Semiparametric and Nonparametric Methods: General

Abstract

This paper analyses the degree of inflation persistence in the EU15, the euro area and each of its member states using disaggregate price indices from the Harmonised Index of Consumer Prices. Our results reveal substantial heterogeneity across countries and indices. The overall results, based on both parametric and non-parametric persistence measures, suggest a very moderate degree of median and mean inflation persistence. For most price indices we are able to reject the unit root hypothesis, as well as the notion of disaggregate inflation exhibiting a high degree of persistence. Durable goods and services tend to be relatively less persistent than other indices. Aggregation effects, both across indices and countries, tend to be present. We find structural breaks both owing to the change in the monetary regime and to the modified treatment of sales in the official HICP series. The latter tends to reduce the measured degree of inflation persistence.

No. 414
24 November 2004
Inflation persistence in the European Union, the euro area, and the United States

Abstract

JEL Classification

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

C22 : Mathematical and Quantitative Methods→Single Equation Models, Single Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models &bull Diffusion Processes

C12 : Mathematical and Quantitative Methods→Econometric and Statistical Methods and Methodology: General→Hypothesis Testing: General

Abstract

In this paper we report results on inflation persistence using 79 inflation series covering the EU countries, the euro area and the US for five different inflation variables. The picture that emerges is one of moderate inflation persistence across the board. In particular we find euro area inflation persistence to be broadly in line with US inflation persistence. The issue of allowing for intercept dummies in the underlying inflation models is found to be of paramount importance to avoid overestimation of the level of persistence. The use of alternative measures of persistence is found to be commendable on the grounds that they complement each other in practice.

No. 407
24 November 2004
Banking consolidation and small business lending

Abstract

JEL Classification

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

G34 : Financial Economics→Corporate Finance and Governance→Mergers, Acquisitions, Restructuring, Corporate Governance

J30 : Labor and Demographic Economics→Wages, Compensation, and Labor Costs→General

Abstract

The paper investigates small business lending as an information problem. It models the effects of information asymmetries within the bank combined with fixed wages. Two kinds of inefficiencies arise in equilibrium: the credit officer either sometimes shirks or he is occasionally fired. In both cases lending falls below the first-best level. The solution, when the bank accepts the information asymmetries, is called the centralized structure. Under decentralized structure the bank employs additional supervisors to mitigate the information asymmetries within its organization. Decentralized banks manage to finance more small firms, but incur higher costs than centralized ones. Small banks are interpreted as a bank with relatively few credit officers, whom can be monitored without information asymmetries. The specification allows for investigating the effects of banking consolidation and technological change on small business lending. The model suggests that not banking size, but organizational structure is decisive in small business lending.

No. 412
19 November 2004
The real effects of money growth in dynamic general equilibrium

Abstract

JEL Classification

E20 : Macroeconomics and Monetary Economics→Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy→General

E40 : Macroeconomics and Monetary Economics→Money and Interest Rates→General

E50 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→General

Abstract

We analyse the effects of money growth within a standard New Keynesian framework and show that the interaction between staggered nominal contracts and money growth leads to a long-run trade-off between output and money growth. We explore the microeconomic mechanisms that lead to this trade-off, and show that it remains even when the contract length is endogenised.

No. 410
19 November 2004
Do options-implied RND functions on G3 currencies move around the times of interventions on the JPY/USD exchange rate?

Abstract

JEL Classification

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies

F31 : International Economics→International Finance→Foreign Exchange

F33 : International Economics→International Finance→International Monetary Arrangements and Institutions

Abstract

This paper focuses on changes in the currency options market's assessment of likely future exchange rate developments around the times of official interventions in the JPY/USD exchange rate. We estimate the options-implied risk-neutral density functions (RNDs) using daily OTC quotes for options prices with fixed moneyness that avoids the biases that typically characterise the exchange traded price quotes. We find that the episodes of interventions on the JPY/USD exchange rate coincide with systematic changes in all moments of the estimated RNDs on the JPY/USD currency pair, and in several of the moments of the estimated RNDs on the JPY/EUR and USD/EUR currency pairs. In particular, the operations where Japanese yen is sold coincide with a movement in the mean of the RND towards a weaker yen both against the US dollar and the euro, as well as with an increase in implied standard deviations. Prior to the interventions, the RNDs tend to move into opposite direction suggesting, on the average, increasingly unfavourable market conditions and leaning-against-the wind by the Japanese authorities.

No. 409
19 November 2004
Currency mismatch, uncertainty and debt maturity structure
Published in: B.E. Journals in Macroeconomics 6(1): Article 5.

Abstract

JEL Classification

F34 : International Economics→International Finance→International Lending and Debt Problems

F36 : International Economics→International Finance→Financial Aspects of Economic Integration

Abstract

The academic literature has so far little to say about the underlying causes of the large structural asset and liability imbalances of emerging markets that frequently contributed to financial crises. The aim of the paper is to contribute to filling this gap by proposing a theoretical model that links currency and maturity mismatches with real volatility in the economy. We show that if (i) a significant share of the debt is denominated in foreign currency-creating a currency mismatch- and (ii) borrowing is constrained by solvency, then currency mismatch can create and exacerbate a maturity mismatch. An important feature of the model is that higher economic or political uncertainty tightens solvency constraints and tilts the debt profile towards short term debt, thereby increasing the volatility of output. Taking the model implications to the data, we find empirical support for the model's predictions using data for 28 emerging market economies.

No. 406
7 November 2004
Labour market reform and the sustainability of exchange rate pegs
Published in: Scottish Journal of Political Economy (2010), 57(1), pp. 85-102.

Abstract

JEL Classification

E42 : Macroeconomics and Monetary Economics→Money and Interest Rates→Monetary Systems, Standards, Regimes, Government and the Monetary System, Payment Systems

F33 : International Economics→International Finance→International Monetary Arrangements and Institutions

D84 : Microeconomics→Information, Knowledge, and Uncertainty→Expectations, Speculations

Abstract

It is commonly thought that an open economy can accommodate output shocks through either exchange rate or real sector adjustments. We formalise this notion by incorporating labour market rigidities into an “escape clause” model of currency crises. We show that the absence of structural reform makes a currency peg more fragile and undermines the credibility of the monetary authority in a dynamic setting. The fragility is captured by a devaluation premium in expectations that increases the average inflation rate when the currency peg is more vulnerable to “busts” than “booms”. This interaction between macroeconomic and microeconomic rigidities suggests that a policy reform can only be consistent if it renders either exchange rates or labour markets flexible.

No. 405
7 November 2004
A joint econometric model of macroeconomic and term structure dynamics
Published in: Journal of Econometrics, March-April 2006; 131(1-2): 405-44.

Abstract

JEL Classification

E43 : Macroeconomics and Monetary Economics→Money and Interest Rates→Interest Rates: Determination, Term Structure, and Effects

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy

E47 : Macroeconomics and Monetary Economics→Money and Interest Rates→Forecasting and Simulation: Models and Applications

Abstract

We construct and estimate a joint model of macroeconomic and yield curve dynamics. A small-scale rational expectations model describes the macroeconomy. Bond yields are affine functions of the state variables of the macromodel, and are derived assuming absence of arbitrage opportunities and a flexible price of risk specification. While maintaining the tractability of the affine set-up, our approach provides a way to interpret yield dynamics in terms of macroeconomic fundamentals; time-varying risk premia, in particular, are associated with the fundamental sources of risk in the economy. In an application to German data, the model is able to capture the salient features of the term structure of interest rates and its forecasting performance is often superior to that of the best available models based on latent factors. The model has also considerable success in accounting for features of the data that represent a puzzle for the expectations hypothesis.

No. 404
5 November 2004
An analysis of systemic risk in alternative securities settlement architectures

Abstract

JEL Classification

C6 : Mathematical and Quantitative Methods→Mathematical Methods, Programming Models, Mathematical and Simulation Modeling

D4 : Microeconomics→Market Structure and Pricing

G20 : Financial Economics→Financial Institutions and Services→General

O33 : Economic Development, Technological Change, and Growth→Technological Change, Research and Development, Intellectual Property Rights→Technological Change: Choices and Consequences, Diffusion Processes

Abstract

This paper compares securities settlement gross and netting architectures. It studies settlement risk arising from exogenous operational delays and compares settlement failures between the two architectures as functions of the length of the settlement interval under different market conditions. While settlement failures are non monotonically related to the length of settlement cycles under both architectures, there is no clear cut ranking of which architecture delivers greater stability. We show that while, on average, netting systems seem to be more stable than gross systems, rare events may lead to contagious defaults that could affect the all system. Furthermore netting system are very sensitive to the number and initial distribution of traded shares.

No. 403
5 November 2004
Financial market integration and loan competition: when is entry deregulation socially beneficial?

Abstract

JEL Classification

D43 : Microeconomics→Market Structure and Pricing→Oligopoly and Other Forms of Market Imperfection

D82 : Microeconomics→Information, Knowledge, and Uncertainty→Asymmetric and Private Information, Mechanism Design

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

Abstract

The paper analyzes how the removal of barriers to entry in banking affect loan competition, bank stability and economic welfare. We consider a model of spatial loan competition where a market that is served by less efficient banks is opened to entry by banks that are more efficient in screening borrowers. It is shown that there is typically too little entry and that market shares of entrant banks are too small relative to their socially optimal level. This is because efficient banks internalize only the private but not the public benefits of their better credit assessments. Only when bank failure is very likely or very costly, socially harmful entry can occur.

No. 402
5 November 2004
Forecasting euro area inflation using dynamic factor measures of underlying inflation
Published in: Journal of Forecasting, November 2005, Vol. 24, pp. 491-503.

Abstract

JEL Classification

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

C13 : Mathematical and Quantitative Methods→Econometric and Statistical Methods and Methodology: General→Estimation: General

C32 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models, Diffusion Processes

Abstract

Standard measures of prices are often contaminated by transitory shocks. This has prompted economists to suggest the use of measures of underlying inflation to formulate monetary policy and assist in forecasting observed inflation. Recent work has concentrated on modelling large datasets using factor models. In this paper we estimate factors from datasets of disaggregated price indices for European countries. We then assess the forecasting ability of these factor estimates against other measures of underlying inflation built from more traditional methods. The power to forecast headline inflation over horizons of 12 to 18 months is adopted as a valid criterion to assess forecasting. Empirical results for the five largest euro area countries as well as for the euro area are presented.

No. 401
29 October 2004
Foreign direct investment and international business cycle comovement

Abstract

JEL Classification

E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles

F21 : International Economics→International Factor Movements and International Business→International Investment, Long-Term Capital Movements

J23 : Labor and Demographic Economics→Demand and Supply of Labor→Labor Demand

J31 : Labor and Demographic Economics→Wages, Compensation, and Labor Costs→Wage Level and Structure, Wage Differentials

Abstract

This paper investigates the relationship between bilateral FDI positions and cross-country business cycle correlations in the period 1982-2001. We find that countries that have comparatively intensive FDI relations also have more synchronized business cycles during 1995-2001. Before 1995, we also find a positive association between FDI linkages and output comovement, but this may partly reflect the effects of trade relations. Moreover, more intensive FDI links are also associated with a greater vulnerability to lagged output spillovers from abroad, whereas trade links are not. Policy implications of our research are (1) that there is an underlying tendency for business cycles to exhibit greater comovement in the future, and (2) that policy makers need to incorporate the FDI linkage among economies in their models and analytical framework for policy analysis.

No. 400
29 October 2004
Cross-country differences in monetary policy transmission

Abstract

JEL Classification

C53 : Mathematical and Quantitative Methods→Econometric Modeling→Forecasting and Prediction Methods, Simulation Methods

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

E37 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Forecasting and Simulation: Models and Applications

Abstract

This paper examines possible explanations for observed differences in the transmission of euro area monetary policy in central bank large-scale macroeconomic models. In particular it considers the extent to which these differences are due to differences in the underlying economies or (possibly unrelated) differences in the modelling strategies adopted for each country. It finds that, against most yardsticks, the cross-country variations in the results are found to be plausible in the sense that they correspond with other evidence or observed characteristics of the economies in question. Nevertheless, the role of differing modelling strategies may also play a role. Important features of the models - for instance in the treatment of expectations or wealth - can have a major bearing on the results that may not necessarily reflect differences in the underlying economies.

No. 399
29 October 2004
Sporadic manipulation in money markets with central bank standing facilities
Published in: International Journal of Central Banking, as "Manipulation in Money Markets", 3(1), special issue, March 2007, 113-148.

Abstract

JEL Classification

D84 : Microeconomics→Information, Knowledge, and Uncertainty→Expectations, Speculations

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

Abstract

In certain market environments, a large investor may benefit from building up a futures position first and trading subsequently in the spot market (Kumar and Seppi, 1992). The present paper identifies a variation of this type of manipulation that might occur in money markets with an interest rate corridor. We show that manipulation involving the use of central bank facilities would be observable only sporadically. The probability of manipulation decreases when the central bank uses an active liquidity management. Manipulation can also be reduced by widening the interest rate corridor.

No. 398
29 October 2004
Mergers and acquisitions and bank performance in Europe: the role of strategic similarities
Published in: Journal of Economics and Business 60, 3, p. 179-290

Abstract

JEL Classification

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

G34 : Financial Economics→Corporate Finance and Governance→Mergers, Acquisitions, Restructuring, Corporate Governance

Abstract

An unprecedented process of financial consolidation has taken place in the European Union over the past decade. Building on earlier US evidence, we examine the impact of strategic similarities between bidders and targets on post-merger financial performance. We find that, on average, bank mergers in the European Union resulted in improved return on capital. By making the assumption that balance-sheet resource allocation is indicative of the strategic focus of banks, we also find significantly different results for domestic and cross-border mergers. For domestic deals, it could be quite costly to integrate dissimilar institutions in terms of their loan, earnings, cost, deposits and size strategies. For cross-border mergers and acquisitions (M&As), differences of merging partners in their loan and credit risk strategies are conducive to a higher performance whereas diversity in their capital, cost structure as well as technology and innovation investments strategies are counterproductive from a performance standpoint.

No. 397
29 October 2004
Determinants of euro term structure of credit spreads

Abstract

JEL Classification

C22 : Mathematical and Quantitative Methods→Single Equation Models, Single Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models &bull Diffusion Processes

E4 : Macroeconomics and Monetary Economics→Money and Interest Rates

G15 : Financial Economics→General Financial Markets→International Financial Markets

Abstract

In this paper, we investigate the determinants of the Euro term structure of credit spreads. More specifically, we analyze whether the sensitivity of credit spread changes to financial and macroeconomic variables depends on bond characteristics such as rating and maturity. According to the structural models and empirical evidence on credit spreads, we find that changes in the level and the slope of the default-free term structure, the market return, implied volatility, and liquidity risk significantly influence credit spread changes. The effect of these factors strongly depends on bond characteristics, especially the rating and to a lesser extent the maturity. Bonds with lower ratings are more affected by financial and macroeconomic news. Furthermore, we find that liquidity risk significantly increases credit spreads, especially on lower rated bonds.

No. 396
25 October 2004
The short-term impact of government budgets on prices: evidence from macroeconomic models
Published in: Journal of Policy Modeling 30 (2008) 123-143.

Abstract

JEL Classification

E17 : Macroeconomics and Monetary Economics→General Aggregative Models→Forecasting and Simulation: Models and Applications

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

E62 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Fiscal Policy

Abstract

This paper reviews the existing empirical evidence on the short-term impact on prices of fiscal variables and assesses it against new results from harmonised simulations, conducted with six well-established econometric models used by the ECB and five national central banks (NCBs) of the Eurosystem. The outcome is also compared with results from the European Commission and the OECD models. Overall, a broad consensus appears on the impact on prices of changes in individual government budget items in the euro area. In all cases, changes in government demand and in direct taxes paid by households have a limited impact on prices in the first year while, in contrast, changes in indirect taxes and employers' social security contributions have a relatively large impact. The second year results show that the effects on prices usually take some time to materialise fully; in particular, they often become large for the public consumption shock.

No. 395
25 October 2004
Fiscal sustainability and public debt in an endogenous growth model
Published in: Journal of Pension Economics and Finance, 2010, Vol. 9 (2),277-302.

Abstract

JEL Classification

E62 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Fiscal Policy

H63 : Public Economics→National Budget, Deficit, and Debt→Debt, Debt Management, Sovereign Debt

H55 : Public Economics→National Government Expenditures and Related Policies→Social Security and Public Pensions

O41 : Economic Development, Technological Change, and Growth→Economic Growth and Aggregate Productivity→One, Two, and Multisector Growth Models

E17 : Macroeconomics and Monetary Economics→General Aggregative Models→Forecasting and Simulation: Models and Applications

Abstract

This paper investigates fiscal sustainability in an overlapping generations economy with endogenous growth coming from human capital formation through educational spending. We assess how budgetary imbalances affect economic dynamics and the outlook for economic growth, thereby providing a rationale for fiscal rules ensuring sustainability. Our results show that the appropriate response of fiscal policy to temporary shocks is not trivial in the absence of fiscal rules. Fiscal rules allow for a timely reaction, thereby avoiding possibly disruptive fiscal adjustment in the future: the more adjustment is delayed, the larger is its necessary scale. We perform a rough calibration of the model to simulate the effects of a demographic shock (change in the population growth rate) under different fiscal policy scenarios.

No. 394
30 September 2004
Liquidity, money creation and destruction, and the returns to banking
Published in: International-Economic-Review. May 2005; 46(2): 675-706

Abstract

JEL Classification

E4 : Macroeconomics and Monetary Economics→Money and Interest Rates

E5 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit

Abstract

We build on our earlier model of money in which bank liabilities circulate as medium of exchange, and investigate the provision of liquidity for a range of central-bank regulations dealing with the potential of bank failure. In our model, banks issue inside money under fractional reserves, facing the event of excess redemptions. They monitor the float of their money issue and make reserve-management decisions which affect aggregate liquidity conditions. Numerical examples demonstrate bank failure when returns to banking are low. Central-bank interventions, injecting more funds or making interest payments proportional to holdings of reserves, may improve banks' returns and society's welfare, followed by a reduction in bank failure.

No. 393
30 September 2004
The determinants of the overnight interest rate in the euro area

Abstract

JEL Classification

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies

E43 : Macroeconomics and Monetary Economics→Money and Interest Rates→Interest Rates: Determination, Term Structure, and Effects

Abstract

The overnight interest rate is the price paid for one day loans and defines the short end of the yield curve. It is the equilibrium outcome of supply and demand for bank reserves. This paper models the intertemporal decision problems in the reserve market for both central and commercial banks. All important institutional features of the euro area reserve market are included. The model is then estimated with euro area data. A permanent change in reserve supply of one billion euro moves the overnight rate by eight basis points into the opposite direction, hence, there is a substantial liquidity effect. Most of the predictable patterns for the mean and the volatility of the overnight rate are related to monetary policy implementation, but also some calendar day effects are present. Banks react sluggishly to new information. Implications for market efficiency, endogeneity of reserve supply and underbidding are studied.

No. 392
29 September 2004
The role of central bank capital revisited

Abstract

JEL Classification

E42 : Macroeconomics and Monetary Economics→Money and Interest Rates→Monetary Systems, Standards, Regimes, Government and the Monetary System, Payment Systems

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies

Abstract

This paper explores the role of central bank capital in ensuring that central banks focus on price stability in monetary policy decisions. The paper goes beyond the existing literature on this topic by developing a simple, but comprehensive, model of the relationship between a central bank's balance sheet structure and its inflation performance. The first part of the paper looks at solvency, i.e. under which conditions the "economic" capital (i.e. the discounted long term P&L) of a central bank always remains positive, despite adverse shocks, assuming a stability oriented monetary policy. The second part shows that in practice, capital is important for central banks beyond the issue of positive economic capital, when taking realistic assumptions regarding central bank independence. Capital thus remains a key tool to ensure that central banks are unconstrained in their focus on price stability in monetary policy decisions.

No. 391
29 September 2004
Comparing shocks and frictions in US and euro area business cycles: a Bayesian DSGE approach
Published in: Journal of Applied Econometrics, 20(1), January 2005

Abstract

JEL Classification

E1 : Macroeconomics and Monetary Economics→General Aggregative Models

E3 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles

Abstract

This paper estimates a DSGE model with many types of shocks and frictions for both the US and the euro area economy over a common sample period (1974-2002). The structural estimation methodology allows us to investigate whether differences in business cycle behaviour are due to differences in the type of shocks that affect the two economies, differences in the propagation mechanism of those shocks or differences in the way the central bank responds to those economic developments. Our main conclusion is that each of those characteristics is remarkably similar across both currency areas.

No. 390
29 September 2004
Financial markets' behavior around episodes of large changes in the fiscal stance

Abstract

JEL Classification

E62 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Fiscal Policy

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy

H62 : Public Economics→National Budget, Deficit, and Debt→Deficit, Surplus

Abstract

Using a panel of OECD countries from 1960 to 2002, this paper shows that financial markets value fiscal discipline. Interest rates, particularly those of long-term government bonds, decrease when countries' fiscal position improves and increase around periods of budget deteriorations. Stock market prices surge around times of substantial fiscal tightening and plunge in periods of very loose fiscal policy. In addition, the paper shows that results depend on countries' initial fiscal conditions and on the type of fiscal consolidations. Fiscal adjustments that occur in country-years with high levels of government defcit, that are implemented by cutting government spending, and that generate a permanent and substantial decrease in government debt are associated with larger reductions in interest rates and increases in stock market prices.

No. 389
14 September 2004
Forecasting with a Bayesian DSGE model: an application to the euro area
Published in: Journal of Common Market Studies, 42(4),: 841-867

Abstract

JEL Classification

E4 : Macroeconomics and Monetary Economics→Money and Interest Rates

E5 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit

Abstract

In monetary policy strategies geared towards maintaining price stability conditional and unconditional forecasts of inflation and output play an important role. This paper illustrates how modern sticky-price dynamic stochastic general equilibrium models, estimated using Bayesian techniques, can become an additional useful tool in the forecasting kit of central banks. First, we show that the forecasting performance of such models compares well with a-theoretical vector autoregressions. Moreover, we illustrate how the posterior distribution of the model can be used to calculate the complete distribution of the forecast, as well as various inflation risk measures that have been proposed in the literature. Finally, the structural nature of the model allows computing forecasts conditional on a policy path. It also allows examining the structural sources of the forecast errors and their implications for monetary policy. Using those tools, we analyse macroeconomic developments in the euro area since the start of EMU.

No. 388
7 September 2004
Euro area inflation differentials
Published in: The B.E. Journal of Macroeconomics: Vol. 7 : Iss. 1 (Topics), Article 24

Abstract

JEL Classification

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

F42 : International Economics→Macroeconomic Aspects of International Trade and Finance→International Policy Coordination and Transmission

Abstract

We build a stylised 12-country model of the euro area and use it to analyse why differences in national inflation and growth rates arise within the European monetary union. We find that inflation persistence is a key potential explanatory factor. Other more frequently mentioned reasons, like country-specific shocks or differences in the monetary transmission mechanism across countries, count less. We also look at how a monetary policy geared to area-wide average inflation affects these differentials. Our model suggests that area-wide inflation stability and low inflation differentials are complementary.

No. 387
27 August 2004
Horizontal and vertical integration and securities trading and settlement

Abstract

JEL Classification

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

G15 : Financial Economics→General Financial Markets→International Financial Markets

L13 : Industrial Organization→Market Structure, Firm Strategy, and Market Performance→Oligopoly and Other Imperfect Markets

Abstract

This paper addresses a very European issue, the consolidation of securities trading and settlement infrastructures. In a two-country model, we analyze welfare implications of different types of consolidation. We find that horizontal integration of settlement systems is better than vertical integration of exchanges and settlement systems, but vertical integration is still better than no consolidation. These findings have clear policy implications with regards to the highly fragmented European securities infrastructure.

No. 386
27 August 2004
Intergenerational altruism and neoclassical growth models
Published in: chapter 15 of the Handbook of the Economics of Giving, Altruism and Reciprocity, Volume 2, Elsevier, (2006).

Abstract

JEL Classification

E13 : Macroeconomics and Monetary Economics→General Aggregative Models→Neoclassical

D64 : Microeconomics→Welfare Economics→Altruism, Philanthropy

E62 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Fiscal Policy

C60 : Mathematical and Quantitative Methods→Mathematical Methods, Programming Models, Mathematical and Simulation Modeling→General

Abstract

This paper surveys intergenerational altruism in neoclassical growth models. It first examines Barro's approach to intergenerational altruism, whereby successive generations are linked by recursive altruistic preferences. Individuals have an altruistic concern only for their children, who in turn also have altruistic feelings for their own children. The conditions under which the Ricardian equivalence (debt neutrality) theorem applies are specified. The effectiveness of fiscal policy is further analysed in the context of an economy populated by heterogeneous families differing with respect to their degree of intergenerational altruism. Other forms of altruism, referred to as ad hoc altruism, are also examined, along with their implications for fiscal policy.

No. 385
27 August 2004
Euro area sovereign yield dynamics: the role of order imbalance

Abstract

JEL Classification

G10 : Financial Economics→General Financial Markets→General

G15 : Financial Economics→General Financial Markets→International Financial Markets

G18 : Financial Economics→General Financial Markets→Government Policy and Regulation

Abstract

We study sovereign yield dynamics and order flow in the largest euro-area treasury markets. We exploit unique transaction data to explain daily yield changes in the ten-year government bonds of Italy, France, Belgium, and Germany. We use a state space model to decompose these changes into (i) a "benchmark" yield innovation, (ii) a yield spread common factor innovation, (iii) country-specific innovations, and (iv) (transitory) noise. We relate changes in each of these factors to national order imbalance and find that Italian order imbalance impacts the common factor innovation, French and Belgian order imbalance impact country-specific innovations, and German order imbalance only changes yields temporarily. Order imbalance, however, does not have explanatory power for the most important factor: benchmark yield innovations.

No. 384
27 August 2004
Price rigidity. Evidence from the French CPI micro-data
Published in: What do thirteen million price records have to say about consumer price rigidity?, L.Baudry, H.Le Bihan, P.Sevestre and S.Tarrieu, published in: Oxford Bulletin of Economics and Statistics, 2007, vol. 69, n°2, 2007, 139-183.

Abstract

JEL Classification

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

D43 : Microeconomics→Market Structure and Pricing→Oligopoly and Other Forms of Market Imperfection

L11 : Industrial Organization→Market Structure, Firm Strategy, and Market Performance→Production, Pricing, and Market Structure, Size Distribution of Firms

Abstract

Based upon a large fraction of the price records used for computing the French CPI, we document consumer price rigidity in France. We first provide a methodological discussion of issues involved in estimating average price duration with micro-data. The average duration of prices in the sectors covered by the database (65% of CPI) is then found to be around 8 months. A strong heterogeneity across sectors both in the average duration of prices and in the pattern of price setting is reported. There is no clear evidence of downward nominal rigidity, since price cuts are almost as frequent as price rises. Moreover, the average size of a change in price is quite large in both cases. Overall, while our results do not entail a clear conclusion about the existence of menu costs, there is evidence of both time-dependent and state-dependent price setting behaviors by retailers.

No. 383
17 August 2004
Explicit inflation objectives and macroeconomic outcomes

Abstract

JEL Classification

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies

Abstract

We find evidence that adopting an explicit inflation objective plays a role in anchoring long-run inflation expectations and in reducing the intrinsic persistence of inflation. For the period 1994-2003, private-sector long-run inflation forecasts exhibit significant correlation with lagged inflation for a number of industrial economies, including the United States. In contrast, this correlation is largely absent for the five countries that maintained explicit inflation objectives over this period, indicating that these central banks have been reasonably successful in delinking expectations from realized inflation. We also show that the null hypothesis of a random walk in core CPI inflation can be clearly rejected for four of these five countries, but not for most of the other industrial countries. Finally, we provide some evidence concerning the initial effects of the adoption of explicit inflation objectives in a number of emerging-market economies.

No. 382
9 August 2004
Longer-term effects of monetary growth on real and nominal variables, major industrial countries, 1880-2001

Abstract

JEL Classification

E3 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles

Abstract

Abstract: We study how fluctuations in money growth correlate with fluctuations in real and nominal output growth and inflation. We pick cycles from each time series that last 2 to 8 (business cycles) and 8 to 40 (longer-term cycles) years, using band-pass filters. We employ a data set from 1880 to 2001 for eleven countries, without gaps. Fluctuations in money growth do not play a systematic and important role at the business cycle frequency. However, money growth leads or contemporaneously affects nominal output growth and inflation in the longer run. This result holds despite differences in policies and institutions across countries.

No. 381
9 August 2004
Fiscal rules and sustainability of public finances in an endogenous growth model

Abstract

JEL Classification

H63 : Public Economics→National Budget, Deficit, and Debt→Debt, Debt Management, Sovereign Debt

H62 : Public Economics→National Budget, Deficit, and Debt→Deficit, Surplus

O41 : Economic Development, Technological Change, and Growth→Economic Growth and Aggregate Productivity→One, Two, and Multisector Growth Models

Abstract

This paper presents a two period overlapping generations model with endogenous growth in the presence of a public sector with objectives of convergence for public debt and primary balance to GDP ratios. In order to ensure the existence of converging paths towards the target values of fiscal variables, we introduce a simple fiscal policy rule. According to this rule, the primary balance ratio is adjusted in function of the distance between the current and the target levels of the public debt and the primary surplus to GDP ratios. It is shown that the fiscal rule displaying time invariant parameters may produce non linear dynamic processes of adjustment of the fiscal ratios as well as endogenous fluctuations in the rate of growth of the economy. In addition the transitional process towards fiscal targets critically depends on the adjustment tool chosen by the fiscal authorities to implement the rule.

No. 380
6 August 2004
Optimal monetary policy under discretion with a zero bound on nominal interest rates
Published in: Journal of Monetary Economics, April 2007; 54(3): 728-52 as "Discretionary Monetary Policy and the Zero Lower Bound on Nominal Interest Rates".

Abstract

JEL Classification

C63 : Mathematical and Quantitative Methods→Mathematical Methods, Programming Models, Mathematical and Simulation Modeling→Computational Techniques, Simulation Modeling

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

Abstract

We determine optimal discretionary monetary policy in a New-Keynesian model when nominal interest rates are bounded below by zero. Nominal interest rates should be lowered faster in response to adverse shocks than in the case without bound. Such 'preemptive easing' is optimal because expectations of a possibly binding bound in the future amplify the effects of adverse shocks. Calibrating the model to the U.S. economy we find the easing effect to be quantitatively important. Moreover, significant welfare losses. Losses increase further when inflation is partly determined by lagged inflation in the Phillips curve. Targeting positive inflation rates reduces the frequency of a binding lower bound, but tends to reduce welfare compared to a target rate of zero. The welfare gains from policy commitment, however, appear significant and are much larger than in the case without lower bound.

No. 379
27 July 2004
Do financial market variables show (symmetric) indicator properties relative to exchange rate returns?
Published in: Review of World Economics, 142 (1), pp. 165-180 as "Do Financial Market variables Show Indicator Properties Relative to Exchange Rate Returns?"

Abstract

JEL Classification

F31 : International Economics→International Finance→Foreign Exchange

F32 : International Economics→International Finance→Current Account Adjustment, Short-Term Capital Movements

G15 : Financial Economics→General Financial Markets→International Financial Markets

Abstract

This paper assesses the contemporaneous, leading and lagging indicator properties of financial market variables relative to movements in six major developed country currency pairs. As indicator variables changes in various relative asset prices, short-term portfolio flows and currency options data are used. We find that changes in equity index differentials, short-term speculative flows and risk reversals on currency options prices exhibit consistent contemporaneous indicator properties and leading indicator properties for several currency pairs. Since 1999, changes in short-term interest rate differentials have gained importance as indicators. The best indicator variables explain over 50% of monthly returns of the USD/EUR and GBP/USD exchange rates and over 60% of the appreciation and depreciation episodes of the USD/EUR and JPY/EUR currency pairs.

No. 378
27 July 2004
Liquidity, information, and the overnight rate

Abstract

JEL Classification

G14 : Financial Economics→General Financial Markets→Information and Market Efficiency, Event Studies, Insider Trading

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

Abstract

We model the interbank market for overnight credit with heterogeneous banks and asymmetric information. An unsophisticated bank just trades to compensate its liquidity imbalance, while a sophisticated bank will exploit its private information about the liquidity situation in the market. It is shown that with positive probability, the liquidity effect (Hamilton, 1997) is reversed, i.e., a liquidity drainage from the banking system may generate an overall decrease in the market rate. The phenomenon does not disappear when the number of banks increases. We also show that private information mitigates the effect of an unexpected liquidity shock on the market rate, suggesting a conservative information policy from a central bank perspective.

No. 377
27 July 2004
Optimal monetary policy under commitment with a zero bound on nominal interest rates
Published in: Journal of Money Credit and Banking, Vol. 38(7), pp. 1877-1906, 2006.

Abstract

JEL Classification

C63 : Mathematical and Quantitative Methods→Mathematical Methods, Programming Models, Mathematical and Simulation Modeling→Computational Techniques, Simulation Modeling

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

Abstract

We determine optimal monetary policy under commitment in a forwardlooking New Keynesian model when nominal interest rates are bounded below by zero. The lower bound represents an occasionally binding constraint that causes the model and optimal policy to be nonlinear. A calibration to the U.S. economy suggests that policy should reduce nominal interest rates more aggressively than suggested by a model without lower bound. Rational agents anticipate the possibility of reaching the lower bound in the future and this amplifies the effects of adverse shocks well before the bound is reached. While the empirical magnitude of U.S. mark-up shocks seems too small to entail zero nominal interest rates, shocks affecting the natural real interest rate plausibly lead to a binding lower bound. Under optimal policy, however, this occurs quite infrequently and does not require targeting a positive average rate of inflation.

No. 376
23 July 2004
Raising rival's costs in the securities settlement industry

Abstract

JEL Classification

G10 : Financial Economics→General Financial Markets→General

G20 : Financial Economics→Financial Institutions and Services→General

L14 : Industrial Organization→Market Structure, Firm Strategy, and Market Performance→Transactional Relationships, Contracts and Reputation, Networks

Abstract

The competition between a central securities depository (CSD) and a custodian bank is analysed in a Stackelberg model. The CSD sets its prices first, the custodian bank follows. There are many investor banks each of which has to decide whether to use the service of the CSD or of the custodian bank. This decision depends on the prices and the investor bank's preferences for the inhomogeneous services of the two service providers. Since the custodian bank uses services provided by the CSD as input, the CSD can raise its rival's costs. However, due to network externalities, the CSD's equilibrium market share is not necessarily higher than socially optimal. This result has important policy implications that are related to a discussion currently taking place in the securities settlement industry.

No. 375
22 July 2004
Guess what: it's the settlements!

Abstract

JEL Classification

C73 : Mathematical and Quantitative Methods→Game Theory and Bargaining Theory→Stochastic and Dynamic Games, Evolutionary Games, Repeated Games

G20 : Financial Economics→Financial Institutions and Services→General

G34 : Financial Economics→Corporate Finance and Governance→Mergers, Acquisitions, Restructuring, Corporate Governance

L22 : Industrial Organization→Firm Objectives, Organization, and Behavior→Firm Organization and Market Structure

Abstract

Exchanges and other trading platforms are often vertically integrated to carry out trading, clearing and settlement as one operation. We show that such vertical silos can prevent efficiency gains from horizontal consolidation of trading and settlement platforms to be realized. Independent of the gains from such consolidation, when costs of settlement are private information, there is no mechanism that achieves the merger of the vertical silos in a way that trading and settlement are produced efficiently after the merger. Furthermore, we show that such an ex-post efficient merger can always be implemented by delegating the operation of settlement platforms to agents.

No. 374
22 July 2004
To aggregate or not to aggregate? Euro area inflation forecasting

Abstract

JEL Classification

C11 : Mathematical and Quantitative Methods→Econometric and Statistical Methods and Methodology: General→Bayesian Analysis: General

C32 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models, Diffusion Processes

C53 : Mathematical and Quantitative Methods→Econometric Modeling→Forecasting and Prediction Methods, Simulation Methods

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

E37 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Forecasting and Simulation: Models and Applications

Abstract

In this paper we investigate whether the forecast of the HICP components (indirect approach) improves upon the forecast of overall HICP (direct approach) and whether the aggregation of country forecasts improves upon the forecast of the euro-area as a whole, considering the four largest euro area countries. The direct approach provides clearly better results than the indirect approach for 12 and 18 steps ahead for the overall HICP, while for shorter horizons the results are mixed. For the euro area HICP excluding unprocessed food and energy(HICPX), the indirect forecast outperforms the direct whereas the differences are only marginal for the countries. The aggregation of country forecasts does not seem to improve upon the forecast of the euro area HICP and HICPX. This result has however to be taken with caution as differences appear to be rather small and due to the limited country coverage.

No. 373
22 July 2004
Technology shocks and robust sign restrictions in a euro area SVAR
Published in: International Economic Review, Vol 50 (3), 2009: pp 727–750.

Abstract

JEL Classification

E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles

E24 : Macroeconomics and Monetary Economics→Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy→Employment, Unemployment, Wages, Intergenerational Income Distribution, Aggregate Human Capital

Abstract

This paper provides evidence for the impact of technology, labor supply, monetary policy and aggregate spending shocks on hours worked in the Euro area. The evidence is based on a vector autoregression identified using sign restrictions that are consistent with both sticky price and real business cycle models. In contrast to most of the existing literature for the US, evidence of a positive response of hours to technology shocks is found, which is consistent with the conventional real business cycle interpretation and at odds with sticky price models. In addition, an important role for technology shocks in explaining business cycle fluctuations is found.

No. 372
23 June 2004
The operational target of monetary policy and the rise and fall of reserve position doctrine

Abstract

JEL Classification

E43 : Macroeconomics and Monetary Economics→Money and Interest Rates→Interest Rates: Determination, Term Structure, and Effects

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

B22 : History of Economic Thought, Methodology, and Heterodox Approaches→History of Economic Thought since 1925→Macroeconomics

Abstract

Before 1914, there was little doubt that central bank policy meant first of all control of short term interest rates. This changed dramatically in the early 1920s with the birth of "reserve position doctrine" (RPD) in the US, according to which a central bank should, via open market operation, steer some reserve concept, which would impact via the money multiplier on monetary aggregates and ultimate goals. While the Fed returned to an unambiguous steering of short term interest rates only in the 1990s, for example the Bank of England never adopted RPD. This paper explains the astonishing rise and fall of RPD. The endurance of RPD is explained by a symbiosis of central bankers who may have partially sympathised with RPD since it masked their responsibility for short term interest rates, and academics who were too eager to simplify away some key features of money markets and central bank operations.

No. 371
22 June 2004
Inflation persistence: facts or artefacts?

Abstract

JEL Classification

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

C22 : Mathematical and Quantitative Methods→Single Equation Models, Single Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models &bull Diffusion Processes

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

Abstract

This paper addresses some issues concerning the definition and measurement of inflation persistence in the context of the univariate approach. First, it is stressed that any estimate of persistence should be seen as conditional on the given assumption for the long run level of inflation and that such long run level should be allowed to vary through time. Second, a non-parametric measure of persistence is suggested which explores the relation between persistence and mean reversion. Third, inflation persistence in the U.S. and the Euro Area is re-evaluated allowing for a time varying mean and it is found that estimates of persistence crucially depend on the function used to proxy the mean of inflation. In particular, the widespread belief that inflation has been more persistent in the sixties and seventies than in the last twenty years is shown to obtain only for the U.S. and for the special case of a constant mean.

No. 370
22 June 2004
Inflation persistence during periods of structural change: an assessment using Greek data

Abstract

JEL Classification

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

E37 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Forecasting and Simulation: Models and Applications

Abstract

The paper estimates inflation persistence in Greece from 1975 to 2003, a period of high variation in inflation and changes in policy regimes. Two empirical methodologies, univariate autoregressive (AR) modelling and second-generation random coefficient (RC) modelling, are employed to estimate inflation persistence. The empirical results from all the procedures suggest that inflation persistence was high during the inflationary period and the first six years of the disinflationary period, while it started to decline after 1997, when inflationary expectations seem to have been stabilised, and thus, monetary policy was effective at reducing inflation. Empirical findings also detect a sluggish response of inflation to changes in monetary policy. This observed delay seems to have changed little over time.

No. 369
22 June 2004
Sovereign risk premia in the European government bond market

Abstract

JEL Classification

G12 : Financial Economics→General Financial Markets→Asset Pricing, Trading Volume, Bond Interest Rates

E43 : Macroeconomics and Monetary Economics→Money and Interest Rates→Interest Rates: Determination, Term Structure, and Effects

E62 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Fiscal Policy

H63 : Public Economics→National Budget, Deficit, and Debt→Debt, Debt Management, Sovereign Debt

Abstract

This paper provides a study of bond yield differentials among EU eurobonds issued between 1991 and 2002. Interest differentials between bonds issued by EU countries and Germany or the USA contain risk premia which increase with the debt, deficit and debt-service ratio and depend positively on the issuer's relative bond market size. Global investors' attitude towards credit risk, measured as the yield spread between low grade US corporate bonds and government bonds, also affects bond yield spreads between EU countries and Germany/USA. The start of the European Monetary Union had significant effects on the bond pricing of the member states.

No. 368
22 June 2004
Capital quality improvement and the sources of growth in the euro area
Published in: Economic Policy April 2005; 0(42): 267-284.

Abstract

JEL Classification

O3 : Economic Development, Technological Change, and Growth→Technological Change, Research and Development, Intellectual Property Rights

O47 : Economic Development, Technological Change, and Growth→Economic Growth and Aggregate Productivity→Measurement of Economic Growth, Aggregate Productivity, Cross-Country Output Convergence

D24 : Microeconomics→Production and Organizations→Production, Cost, Capital, Capital, Total Factor, and Multifactor Productivity, Capacity

E22 : Macroeconomics and Monetary Economics→Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy→Capital, Investment, Capacity

Abstract

Capital quality improvement is a general phenomenon. Therefore quality correction is needed in price indexes. There is substantial evidence of biases in the official price indexes of capital equipment. We apply to euro area statistics estimates of these biases based on US data thus deriving quality-adjusted price indexes. Adjusted for quality, productive capital stocks of equipment and software grow on average 3 percentage points faster annually - a doubling of their growth rates. Quality-adjusted output grows 0.46 percentage points faster annually - a 20 percent increase. In terms of growth accounting, quality adjustment subtracts 11 percentage points from the share of TFP in aggregate growth and adds them to the share of equipment stock. For the 1990s only the difference is even higher: 14 percentage points. When all is told, embodied technological change accounts for 46 percent of (quality-adjusted) output growth in the euro area over the period 1982 to 2000.

No. 367
9 June 2004
Factor substitution and factor augmenting technical progress in the US: a normalized supply-side system approach
Published in: Review of Economics and Statistics, 89, 1, 183-192.

Abstract

JEL Classification

C22 : Mathematical and Quantitative Methods→Single Equation Models, Single Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models &bull Diffusion Processes

E23 : Macroeconomics and Monetary Economics→Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy→Production

E25 : Macroeconomics and Monetary Economics→Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy→Aggregate Factor Income Distribution

O30 : Economic Development, Technological Change, and Growth→Technological Change, Research and Development, Intellectual Property Rights→General

O51 : Economic Development, Technological Change, and Growth→Economywide Country Studies→U.S., Canada

Abstract

Using a normalized CES function with factor-augmenting technical progress, we estimate a supply-side system of the US economy from 1953 to 1998. Avoiding potential estimation biases that have occurred in earlier studies and putting a high emphasis on the consistency of the data set, required by the estimated system, we obtain robust results not only for the aggregate elasticity of substitution but also for the parameters of labor and capital augmenting technical change. We find that the elasticity of substitution is significantly below unity and that the growth rates of technical progress show an asymmetrical pattern where the growth of laboraugmenting technical progress is exponential, while that of capital is hyperbolic or logarithmic.

No. 366
3 June 2004
The informational content of over-the-counter currency options

Abstract

JEL Classification

G13 : Financial Economics→General Financial Markets→Contingent Pricing, Futures Pricing

G14 : Financial Economics→General Financial Markets→Information and Market Efficiency, Event Studies, Insider Trading

C22 : Mathematical and Quantitative Methods→Single Equation Models, Single Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models &bull Diffusion Processes

C53 : Mathematical and Quantitative Methods→Econometric Modeling→Forecasting and Prediction Methods, Simulation Methods

Abstract

Financial decision makers often consider the information in currency option valuations when making assessments about future exchange rates. The purpose of this paper is to systematically assess the quality of option based volatility, interval and density forecasts. We use a unique dataset consisting of over 10 years of daily data on over-the-counter currency option prices. We find that the OTC implied volatilities explain a much larger share of the variation in realized volatility than previously found using market-traded options. Finally, we find that wide-range interval and density forecasts are often misspecified whereas narrow-range interval forecasts are well specified.

No. 365
3 June 2004
Exchange rates and fundamentals: new evidence from real-time data
Published in: Journal of International Money and Finance, March 2005, 24(2): 317-341.

Abstract

JEL Classification

F31 : International Economics→International Finance→Foreign Exchange

F42 : International Economics→Macroeconomic Aspects of International Trade and Finance→International Policy Coordination and Transmission

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

Abstract

This paper analyses the link between economic fundamentals and exchange rates by investigating the importance of real-time data. We find that such economic news in the United States, Germany and the euro area have indeed been a driving force behind daily US dollar - euro/DEM exchange rate developments in the period 1993-2003. The larger importance of US macroeconomic news is at least partly explained by their earlier release time compared to corresponding German and euro area news. The exchange rate is also shown to respond more strongly to news in periods of large market uncertainty and when negative or large shocks occur. Overall, the model based on real-time data is capable of explaining about 75% of the monthly directional changes of the US dollar-euro exchange rate, although it does not explain well the magnitude of the exchange rate changes.

No. 364
28 May 2004
Asset price booms and monetary policy
Published in: Macroeconomic Policies in the World Economy, Horst Siebert (ed.), Springer, Berlin, 2004.

Abstract

JEL Classification

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

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies

Abstract

The paper aims at deriving some stylised facts for financial, real, and monetary policy developments during asset price booms by means of aggregating information contained in 38 boom periods since the 1970s for 18 OECD countries. We observe 26 macroeconomic variables in a pre-boom, boom and post-boom phase. Not all booms lead to large output losses. We divide our sample in high-cost and low-cost booms and analyse the differences. High-cost booms are clearly those in which real estate prices and investment crash in the post-boom periods. In general it is difficult to distinguish a high-cost from a low-cost boom at an early stage. However, high-cost booms seem to follow very rapid growth in the real money and real credit stocks just before the boom and at the early stages of a boom. During high-cost booms, rates of change of real estate prices and consumption growth are significantly higher and the investment (especially housing) GDP ratio deviation from trend rises faster over the whole boom period. There is also evidence that high-cost booms are associated with significantly looser monetary policy conditions over the boom period, especially towards the late stage of a boom. We finally discuss the results with regard to the theoretical literature. The looser monetary policy at the later stage of high-cost booms could be interpreted in different ways. It could be that excessively loose monetary policy contributes to extending the boom and exacerbating the real and financial imbalances. Alternatively, observed monetary policy could reflect a desirable, pre-emptive loosening in anticipation of an asset price crash to come.

No. 343
28 May 2004
Monetary discretion, pricing complementarity and dynamic multiple equilibria
International research forum on monetary policy
Published in: Quarterly Journal of Economics, Vol 119 (4), November 2004: pp 1513-1553

Abstract

JEL Classification

E5 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit

E61 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Policy Objectives, Policy Designs and Consistency, Policy Coordination

D78 : Microeconomics→Analysis of Collective Decision-Making→Positive Analysis of Policy Formulation and Implementation

Abstract

In a plain-vanilla New Keynesian model with two-period staggered price-setting, discretionary monetary policy leads to multiple equilibria. Complementarity between pricing decisions of forward-looking firms underlies the multiplicity, which is intrinsically dynamic in nature. At each point in time, the discretionary monetary authority optimally accommodates the level of predetermined prices when setting the money supply because it is concerned solely about real activity. Hence, if other firms set a high price in the current period, an individual firm will optimally choose a high price because it knows that the monetary authority next period will accommodate with a high money supply. Under commitment, the mechanism generating complementarity is absent: the monetary authority commits not to respond to future predetermined prices. Multiple equilibria also arise in other similar contexts where (i) a policymaker cannot commit, and (ii) forward-looking agents determine a state variable to which future policy responds.

No. 363
19 May 2004
Communication and exchange rate policy
Published in: Journal of Macroeconomics, Vol 30 (4), December 2008: pp 1651-1672.

Abstract

JEL Classification

E61 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Policy Objectives, Policy Designs and Consistency, Policy Coordination

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies

F31 : International Economics→International Finance→Foreign Exchange

Abstract

This paper deals with the very short-term influence of "oral interventions" on the exchange rate of major currencies. The paper finds that official communication, as reported by wire services, are effective in influencing the US dollar-euro and yen-US dollar exchange rates in the desired direction on intervention days. Oral interventions are found to be substantially more effective if they deviate from the prevalent policy "mantra". They also tend to reduce market volatility whereas actual interventions raise volatility. A key result of the paper is that oral interventions are effective independently from the stance and direction of monetary policy as well as the occurrence of actual interventions. This suggests that oral interventions might constitute, on a short-term basis, an effective and largely autonomous policy tool.

No. 362
19 May 2004
Oil price shocks and real GDP growth: empirical evidence for some OECD countries
Published in: Applied Economics, 37 (2), pp. 201-228.

Abstract

JEL Classification

E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles

Q43 : Agricultural and Natural Resource Economics, Environmental and Ecological Economics→Energy→Energy and the Macroeconomy

Abstract

This paper assesses empirically the effects of oil price shocks on the real economic activity of the main industrialised countries. Multivariate VAR analysis is carried out using both linear and nonlinear models. The latter category includes three approaches employed in the literature, namely, the asymmetric, scaled and net specifications. We find evidence of a non-linear impact of oil prices on real GDP. In particular, oil price increases are found to have an impact on GDP growth of a larger magnitude than that of oil price declines, with the latter being statistically insignificant in most cases. Among oil importing countries, oil price increases are found to have a negative impact on economic activity in all cases but Japan. Moreover, the effect of oil shocks on GDP growth differs between the two oil exporting countries in our sample, with the UK being negatively affected by an oil price increase and Norway benefiting from it.

No. 361
18 May 2004
Excess reserves and implementation of monetary policy of the ECB
Published in: Journal of Policy Modelling, Vol. 28, No. 5, pp. 491-510.

Abstract

JEL Classification

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies

Abstract

This paper explains to what extent excess reserves are and should be relevant today in the implementation of monetary policy, focusing on the specific case of the operational framework of the Eurosystem. In particular, this paper studies the impact that changes to the operational framework for monetary policy implementation have on the level and volatility of excess reserves. A 'transaction costs' model that replicates the rather specific intra-reserve maintenance period pattern of excess reserves in the euro area is developed. Simulation results presented not only show that excess reserves may increase considerably under some changes to the operational framework, but also that their volatility and hence unpredictability could.

No. 360
18 May 2004
Optimal monetary policy rules for the euro area: an analysis using the area wide model
Published in: Journal of Common Market Studies, 2005, 43, 3, 507-537.

Abstract

JEL Classification

E4 : Macroeconomics and Monetary Economics→Money and Interest Rates

E5 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit

Abstract

In this paper, we analyze optimal monetary policy rules in a model of the euro area, namely the ECB’s Area Wide Model, which embodies a high degree of intrinsic persistence and a limited role for forward-looking expectations. These features allow us, in large measure, to differentiate our results from many of those prevailing in New Keynesian paradigm models. Specifically, our exercises involve analyzing the performance of various generalized Taylor rules both from the literature and optimized to the reference model. Given the features of our modelling framework, we find that optimal policy smoothing need only be relatively mild. Furthermore, there is substantial gain from implementing forecast-based as opposed to outcome-based policies with the optimal forecast horizon for inflation ranging between two and three years. Benchmarking against fully optimal policies, we further highlight that the gain of additional states in the rule may compensate for a reduction of communicability. Thus, the paper contributes to the debate on optimal monetary policy in the euro area, as well as to the conduct of monetary policy in face of substantial persistence in the transmission mechanism.

No. 359
18 May 2004
The longer term refinancing operations of the ECB
Published in: Journal of Banking and Finance 31: 1521-1543, 2007.

Abstract

JEL Classification

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

D44 : Microeconomics→Market Structure and Pricing→Auctions

Abstract

This paper employs individual bidding data to analyze the empirical performance of the longer term refinancing operations (LTROs) of the European Central Bank (ECB). We investigate how banks' bidding behavior is related to a series of exogenous variables such as collateral costs, interest rate expectations, market volatility and to individual bank characteristics like country of origin, size and experience. Panel regressions reveal that a bank's bidding depends on bank characteristics. Yet, different bidding behavior generally does not translate into differences concerning bidder success. In contrast to the ECB's main refinancing operations, we find evidence for the winner's curse effect in LTROs. Our results indicate that LTROs do neither lead to market distortions nor to unfair auction outcomes.

No. 358
14 May 2004
Did the pattern of aggregate employment growth change in the euro area in the late 1990s?
Published in: Applied Economics, August 2006, 38 (15), 1783-1807.

Abstract

JEL Classification

C2 : Mathematical and Quantitative Methods→Single Equation Models, Single Variables

E24 : Macroeconomics and Monetary Economics→Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy→Employment, Unemployment, Wages, Intergenerational Income Distribution, Aggregate Human Capital

H50 : Public Economics→National Government Expenditures and Related Policies→General

J23 : Labor and Demographic Economics→Demand and Supply of Labor→Labor Demand

Abstract

The paper examines whether the pattern of growth in euro area employment seen in the period 1997-2001 differed from that recorded in the past and what could be the reasons for that. First, a standard employment equation is estimated for the euro area as a whole. This shows that the lagged impact of both output growth and real labour cost growth, together with a productivity trend and employment "inertia", can account for most of the employment developments between 1970 and the early 1990s. Conversely, these traditional determinants can only explain part of the employment development seen in recent years (1997-2001). Second, the paper shows sound evidence of a structural break in the aggregate employment equation in the late 1990s. Third, the paper provides some tentative explanations for this change in aggregate employment developments, using in particular country panels of institutional variables and of active labour market policies but also cross-sectional analyses. Among the relevant factors likely to have contributed to rising aggregate employment in recent years are changes in the sectoral composition of euro area employment, the strong development of part-time jobs, lower labour tax rates and possibly less stringent employment protection legislation and greater subsidies to private employment.

No. 357
14 May 2004
Seasonal adjustment and the detection of business cycle phases
Published in: Journal of Applied Econometrics (2008), 23(2), pp. 257-278.

Abstract

JEL Classification

E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles

C22 : Mathematical and Quantitative Methods→Single Equation Models, Single Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models &bull Diffusion Processes

C80 : Mathematical and Quantitative Methods→Data Collection and Data Estimation Methodology, Computer Programs→General

Abstract

To date, there has been little investigation of the impact of seasonal adjustment on the detection of business cycle expansion and recession regimes. We study this question both analytically and through Monte Carlo simulations. Analytically, we view the occurrence of a single business cycle regime as a structural break that is later reversed, showing that the effect of the linear symmetric X-11 filter differs with the duration of the regime. Through the use of Markov switching models for regime identification, the simulation analysis shows that seasonal adjustment has desirable properties in clarifying the true regime when this is well underway, but it distorts regime inference around turning points, with this being especially marked after the end of recessions and when the one-sided X-11 filter is employed.

No. 356
14 May 2004
Developing a euro area accounting matrix: issues and applications
Published in: Poverty, Inequality and Development, de Janvry, A. and R. Kanbur (eds.), Kluwer Academic Press 2006.

Abstract

JEL Classification

E00 : Macroeconomics and Monetary Economics→General→General

E19 : Macroeconomics and Monetary Economics→General Aggregative Models→Other

Abstract

Abstract: An important part of external or policy shocks is transmitted throughout the economy via various channels of transactions. To analyse such channels and to predict the impact of shocks, it is expedient to know who recently exchanged what with whom and for what purpose. The most appropriate format for presenting intersectoral linkages at the national level is in a National Accounting Matrix (NAM). A NAM is defined as the presentation of a sequence of integrated accounts and balancing items in a matrix that elaborates the linkages between a supply and use table and institutional sector accounts. This paper compiles the first pilot Euro Area Accounting Matrix (EAAM) and considers its usefulness for the euro area’s economic analysis. It also reports on the solution of a number of aggregation and consolidation issues that arise when constructing a multi-country accounting matrix.

No. 355
7 May 2004
Production interdependence and welfare

Abstract

JEL Classification

E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles

F31 : International Economics→International Finance→Foreign Exchange

F41 : International Economics→Macroeconomic Aspects of International Trade and Finance→Open Economy Macroeconomics

Abstract

The international welfare effects of a country's monetary policy shocks have been controversial in the new open economy macro (i.e., NOEM) literature. While a unilateral monetary expansion increases the production efficiency in each country, it affects the terms of trade in favor of one country against another depending on the currencies of price setting. In this paper, we incorporate multiple stages of production and trade into a standard NEOM model to capture world production interdependence, and show that increased world production interdependence tends to magnify the e±ciency-improvement effect while dampening the terms-of-trade effect. As a consequence, a unilateral monetary expansion can be mutually beneficial regardless of in which currency prices are set. In this sense, international monetary policy transmission may not be a source of potential conflict in a world with production interdependence.

No. 354
6 May 2004
Taking stock: monetary policy transmission to equity markets
Published in: Journal of Money, Credit and Banking 36(4), 2004, pp 719-737.

Abstract

JEL Classification

G14 : Financial Economics→General Financial Markets→Information and Market Efficiency, Event Studies, Insider Trading

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

Abstract

This paper analyses the effects of US monetary policy on stock markets. We find that, on average, a tightening of 50 basis points reduces returns by about 3%. Moreover, returns react more strongly when no change had been expected, when there is a directional change in the monetary policy stance and during periods of high market uncertainty. We show that individual stocks react in a highly heterogeneous fashion and relate this heterogeneity to financial constraints and Tobin's q. First, we show that there are strong industry-specific effects of US monetary policy. Second, we find that for the individual stocks comprising the S&P500 those with low cashflows, small size, poor credit ratings, low debt to capital ratios, high price-earnings ratios or high Tobin's q are affected significantly more. The use of propensity score matching allows us to distinguish between firmand industry-specific effects, and confirms that both play an important role.

No. 353
28 April 2004
Towards the estimation of equilibrium exchange rates for CEE acceding countries: methodological issues and a panel cointegration perspective
Published in: Economic Systems, Vol 29 (2): pp 130-143 as "Pitfalls in estimating equilibrium exchange rates for transition economies". Also published in Journal of Comparative Economics, Vol 34 (3), September 2006: pp 499-517.

Abstract

JEL Classification

C23 : Mathematical and Quantitative Methods→Single Equation Models, Single Variables→Panel Data Models, Spatio-temporal Models

F31 : International Economics→International Finance→Foreign Exchange

Abstract

This paper provides a discussion of methodological issues relating to the estimation of the long-run relationship between exchange rates and fundamentals for Central and Eastern European acceding countries, focusing on the so-called behavioural equilibrium exchange rate (BEER) approach. Given the limited availability and reliability of data as well as the rapid structural change acceding countries have been undergoing in the transition phase, this paper identifies several pitfalls in following the most straightforward and standard econometric procedures. As an alternative, it looks at the merits of a two-step strategy that consists of estimating the relationship between exchange rates and economic fundamentals in a panel cointegration setting - using a sample which excludes acceding countries - and then "extrapolating" the estimated relationships to the latter. While focusing on the first step of such a strategy, the paper also delves into discussing technical aspects underlying the "extrapolation" stage. As a result, the paper endows the reader with the methodological and empirical ingredients for computing equilibrium exchange rates for acceding countries, providing estimates for the long-run coefficients between real exchange rates and economic fundamentals and a discussion of how to apply these results to acceding countries data.

No. 352
28 April 2004
Forecasting inflation with thick models and neural networks
Published in: Economic Modelling, 2005, 22, 5, 848-567

Abstract

JEL Classification

C12 : Mathematical and Quantitative Methods→Econometric and Statistical Methods and Methodology: General→Hypothesis Testing: General

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

Abstract

This paper applies linear and neural network-based "thick" models for forecasting inflation based on Phillips-curve formulations in the USA, Japan and the euro area. Thick models represent "trimmed mean" forecasts from several neural network models. They outperform the best performing linear models for "real-time" and "bootstrap" forecasts for service indices for the euro area, and do well, sometimes better, for the more general consumer and producer price indices across a variety of countries.

No. 351
28 April 2004
Interest rate determination in the interbank market
Published in: European Economic Review 52 (2008) 412-440;

Abstract

JEL Classification

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies

Abstract

The purpose of this paper is to study the determinants of equilibrium in the market for daily funds. We use the EONIA panel database which includes daily information on the lending rates applied by contributing commercial banks. The data clearly shows an increase in both the time series volatility and the cross section dispersion of rates towards the end of the reserve maintenance period. These increases are highly correlated. With respect to quantities, we find that the volume of trade as well as the use of the standing facilities are also larger at the end of the maintenance period. Our theoretical model shows how the operational framework of monetary policy causes a reduction in the elasticity of the supply of funds by banks throughout the reserve maintenance period. This reduction in the elasticity together with market segmentation and heterogeneity are able to generate distributions for the interest rates and quantities traded with the same properties as in the data.

No. 350
28 April 2004
Exchange-rate policy and the zero bound on nominal interest rates
Published in: American Economic Review, Papers and Proceedings, 2004, 94(2): 80-84.

Abstract

JEL Classification

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies

E61 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Policy Objectives, Policy Designs and Consistency, Policy Coordination

Abstract

In this paper, we study the effectiveness of monetary policy in a severe recession and deflation when nominal interest rates are bounded at zero. We compare two alternative proposals for ameliorating the effect of the zero bound: an exchange-rate peg and price-level targeting. We conduct this quantitative comparison in an empirical macroeconometric model of Japan, the United States and the euro area. Furthermore, we use a stylized micro-founded two-country model to check our qualitative findings. We find that both proposals succeed in generating inflationary expectations and work almost equally well under full credibility of monetary policy. However, price-level targeting may be less effective under imperfect credibility, because the announced price-level target path is not directly observable.

No. 349
28 April 2004
Estimating the rank of the spectral density matrix
Published in: Journal of Time Series Analysis, February 2005, Vol. 26, No 1, pp. 37-48.

Abstract

JEL Classification

C12 : Mathematical and Quantitative Methods→Econometric and Statistical Methods and Methodology: General→Hypothesis Testing: General

C32 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models, Diffusion Processes

C52 : Mathematical and Quantitative Methods→Econometric Modeling→Model Evaluation, Validation, and Selection

Abstract

The rank of the spectral density matrix conveys relevant information in a variety of statistical modelling scenarios. This note shows how to estimate the rank of the spectral density matrix at any given frequency. The method presented is valid for any hermitian positive definite matrix estimate that has a normal asymptotic distribution with a covariance matrix whose rank is known.

No. 348
28 April 2004
Financial openness and growth: short-run gain, long-run pain?
Published in: Review of International Economics, 16(1), 69-95, 2008.

Abstract

JEL Classification

F33 : International Economics→International Finance→International Monetary Arrangements and Institutions

F34 : International Economics→International Finance→International Lending and Debt Problems

F36 : International Economics→International Finance→Financial Aspects of Economic Integration

F43 : International Economics→Macroeconomic Aspects of International Trade and Finance→Economic Growth of Open Economies

Abstract

No empirical evidence has yet emerged for the existence of a robust positive relationship between financial openness and economic growth. This paper argues that a key reason for the elusive evidence is the presence of a time-varying relationship between openness and growth over time: countries tend to gain in the short-term, immediately following capital account liberalisation, but may not grow faster or even experience temporary growth reversals in the medium- to long-term. The paper finds substantial empirical evidence for the existence of such an intertemporal trade-off for 45 industrialised and emerging market economies. The acceleration of growth immediately after liberalisation is found to be often driven by an investment boom and a surge in portfolio and debt inflows. By contrast, the quality of domestic institutions, the size of FDI inflows and the sequencing of the liberalisation process are found to be important driving forces for growth in the medium to longer term.

No. 347
28 April 2004
Firms' investment decisions in response to demand and price uncertainty
Published in: Applied Economics, Volume 40, August-September 2008

Abstract

JEL Classification

D21 : Microeconomics→Production and Organizations→Firm Behavior: Theory

D24 : Microeconomics→Production and Organizations→Production, Cost, Capital, Capital, Total Factor, and Multifactor Productivity, Capacity

D81 : Microeconomics→Information, Knowledge, and Uncertainty→Criteria for Decision-Making under Risk and Uncertainty

D92 : Microeconomics→Intertemporal Choice→Intertemporal Firm Choice, Investment, Capacity, and Financing

C23 : Mathematical and Quantitative Methods→Single Equation Models, Single Variables→Panel Data Models, Spatio-temporal Models

Abstract

We estimate the effect of demand and price uncertainty on firms' investment decisions from a panel of manufacturing firms. Uncertainty measures are derived from firms' subjective qualitative expectations. They are close to their theoretical counterparts, the variances of future demand and price shocks. We find that demand uncertainty depresses planned and realized investment, while price uncertainty is insignificant. This is consistent with the behavior of monopolistic firms with irreversible capital (Caballero, 1991). Further, firms revise their investment plans very little. They may do so in response to new information on sales growth, but not as a result of reduced uncertainty.

No. 346
28 April 2004
Perpetual youth and endogenous labour supply: a problem and a possible solution

Abstract

JEL Classification

D91 : Microeconomics→Intertemporal Choice→Intertemporal Household Choice, Life Cycle Models and Saving

E63 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Comparative or Joint Analysis of Fiscal and Monetary Policy, Stabilization, Treasury Policy

Abstract

In the "perpetual youth" overlapping-generations model of Blanchard and Yaari, if leisure is a "normal" good then some agents will have negative labour supply. We suggest a solution to this problem by using a modified version of Greenwood, Hercowitz and Huffman's utility function. The modification incorporates real money balances, so that the model may be used to analyse monetary as well as fiscal policy. In a Walrasian version of the economy, we show that increased government debt and increased government spending raise the interest rate and lower output, while an open-market operation to increase the money supply lowers the interest rate and raises output.

No. 345
27 April 2004
Optimal monetary and fiscal policy: a linear-quadratic approach
International research forum on monetary policy
Published in: M. Gertler and K. Rogoff, eds, NBER Macroeconomics Annual 2003, Vol 18: 271-333.

Abstract

JEL Classification

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

E61 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Policy Objectives, Policy Designs and Consistency, Policy Coordination

E63 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Comparative or Joint Analysis of Fiscal and Monetary Policy, Stabilization, Treasury Policy

Abstract

We propose an integrated treatment of the problems of optimal monetary and fiscal policy, for an economy in which prices are sticky and the only available sources of government revenue are distorting taxes. Our linear-quadratic approach allows us to nest both conventional analyses of optimal monetary stabilization policy and analyses of optimal tax-smoothing as special cases of our more general framework. We show how a linear-quadratic policy problem can be derived which yields a correct linear approximation to the optimal policy rules from the point of view of the maximization of expected discounted utility in a dynamic stochastic general-equilibrium model. Finally, we derive targeting rules through which the monetary and fiscal authorities may implement the optimal equilibrium.

No. 344
27 April 2004
Ramsey monetary policy and international relative prices
International research forum on monetary policy

Abstract

JEL Classification

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

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.

No. 342
27 April 2004
Equal size, equal role? Interdependence between the euro area and the United States
International research forum on monetary policy
Published in: The Economic Journal, Vol 115, October 2005: pp 930-50

Abstract

JEL Classification

E43 : Macroeconomics and Monetary Economics→Money and Interest Rates→Interest Rates: Determination, Term Structure, and Effects

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

F42 : International Economics→Macroeconomic Aspects of International Trade and Finance→International Policy Coordination and Transmission

Abstract

This paper investigates whether the degree and the nature of economic and monetary policy interdependence between the United States and the euro area have changed with the advent of EMU. Using real-time data, it addresses this issue from the perspective of financial markets by analysing the effects of monetary policy announcements and macroeconomic news on daily interest rates in the United States and the euro area. First, the paper finds that the interdependence of money markets has increased strongly around EMU. Although spillover effects from the United States to the euro area remain stronger than in the opposite direction, we present evidence that US markets have started reacting also to euro area developments since the onset of EMU. Second, beyond these general linkages, the paper finds that certain macroeconomic news about the US economy have a large and significant effect on euro area money markets, and that these effects have become stronger in recent years. Finally, we show that US macroeconomic news have become good leading indicators for economic developments in the euro area. This indicates that the higher money market interdependence between the United States and the euro area is at least partly explained by the increased real integration of the two economies in recent years.

No. 341
27 April 2004
Benefits and spillovers of greater competition in Europe: a macroeconomic assessment
International research forum on monetary policy

Abstract

JEL Classification

C51 : Mathematical and Quantitative Methods→Econometric Modeling→Model Construction and Estimation

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

Abstract

Using a general-equilibrium simulation model featuring nominal rigidities and monopolistic competition in product and labor markets, this paper estimates the macroeconomic benefits and international spillovers of an increase in competition. After calibrating the model to the euro area vs. the rest of the industrial world, the paper draws three conclusions. First, greater competition produces large effects on macroeconomic performance, as measured by standard indicators. In particular, we show that differences in competition can account for over half of the current gap in GDP per capita between the euro area and the US. Second, it may improve macroeconomic management by increasing the responsiveness of wages and prices to market conditions. Third, greater competition can generate positive spillovers to the rest of the world through its impact on the terms of trade.

No. 340
27 April 2004
Indeterminacy with inflation-forecast-based rules in a two-bloc model
International research forum on monetary policy

Abstract

JEL Classification

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

E37 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Forecasting and Simulation: Models and Applications

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies

Abstract

We examine the performance of forward-looking inflation-forecast-based rules in open economies. In a New Keynesian two-bloc model, a methodology first employed by Batini and Pearlman (2002) is used to obtain analytically the feedback parameters/horizon pairs associated with unique and stable equilibria. Three key findings emerge: first, indeterminacy occurs for any value of the feedback parameter on inflation if the forecast horizon lies too far into the future. Second, the problem of indeterminacy is intrinsically more serious in the open economy. Third, the problem is compounded further in the open economy when central banks respond to expected consumer, rather than producer price inflation.

No. 339
27 April 2004
Understanding the effects of government spending on consumption
International research forum on monetary policy

Abstract

JEL Classification

E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles

E62 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Fiscal Policy

Abstract

Recent evidence on the effect of government spending shocks on consumption cannot be easily reconciled with existing optimizing business cycle models. We extend the standard New Keynesian model to allow for the presence of rule-of-thumb (non-Ricardian) consumers. We show how the interaction of the latter with sticky prices and deficit financing can account for the existing evidence on the effects of government spending.

No. 338
27 April 2004
The optimal degree of discretion in monetary policy
International research forum on monetary policy
Published in: Econometrica, Vol 73 (5), September 2005: pp 1431-75

Abstract

JEL Classification

E5 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit

E6 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies

E61 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Policy Objectives, Policy Designs and Consistency, Policy Coordination

Abstract

How much discretion should the monetary authority have in setting its policy? This question is analyzed in an economy with an agreed-upon social welfare function that depends on the randomly fluctuating state of the economy. The monetary authority has private information about that state. In the model, well-designed rules trade off society's desire to give the monetary authority discretion to react to its private information against society's need to guard against the time inconsistency problem arising from the temptation to stimulate the economy with unexpected inflation. Although this dynamic mechanism design problem seems complex, society can implement the optimal policy simply by legislating an inflation cap that specifies the highest allowable inflation rate. The more severe the time inconsistency problem, the more tightly the cap constrains policy and the smaller is the degree of discretion. As this problem becomes sufficiently severe, the optimal degree of discretion is none.

No. 337
27 April 2004
The decline of activist stabilization policy: natural rate misperceptions, learning, and expectations
International research forum on monetary policy
Published in: Journal of Economic Dynamics and Control, Vol 29 (11), November 2005: pp 1927-50

Abstract

JEL Classification

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

Abstract

We develop an estimated model of the U.S. economy in which agents form expectations by continually updating their beliefs regarding the behavior of the economy and monetary policy. We explore the effects of policymakers' misperceptions of the natural rate of unemployment during the late 1960s and 1970s on the formation of expectations and macroeconomic outcomes. We find that the combination of monetary policy directed at tight stabilization of unemployment near its perceived natural rate and large real-time errors in estimates of the natural rate uprooted heretofore quiescent inflation expectations and destabilized the economy. Had monetary policy reacted less aggressively to perceived unemployment gaps, inflation expectations would have remained anchored and the stagflation of the 1970s would have been avoided. Indeed, we find that less activist policies would have been more effective at stabilizing both inflation and unemployment. We argue that policymakers, learning from the experience of the 1970s, eschewed activist policies in favor of policies that concentrated on the achievement of price stability, contributing to the subsequent improvements in macroeconomic performance of the U.S. economy.

No. 336
27 April 2004
The great inflation of the 1970s
International research forum on monetary policy

Abstract

JEL Classification

E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

Abstract

Was the high inflation of the 1970s mostly due to incomplete information about the structure of the economy (an unavoidable mistake as suggested by Orphanides, 2000)? Or, to weak reaction to expected inflation and/or excessive policy activism that led to indeterminacies (a policy mistake, a scenario suggested by Clarida, Gali and Gertler, 2000)? We study this question within the NNS model with policy commitment and imperfect information, requiring that the model have satisfactory overall empirical performance. We find that both explanations do a good job in accounting for the great inflation. Even with the commonly used specification of the interest policy rule, high and persistent inflation can occur following a significant productivity slowdown if policymakers significantly and persistently underestimate "core" inflation.

No. 335
22 April 2004
Has euro-area inflation persistence changed over time?
Published in: Review of Economics and Statistics, Vol 87 (4), November 2005: pp 709-20

Abstract

JEL Classification

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

Abstract

This paper analyzes the stability over time of the econometric process for Euro-area inflation since 1970, focusing in particular on the behaviour of the so-called persistence parameter (the sum of the coefficients on the lagged dependent variables). Perhaps surprisingly, in light of the Lucas critique, our principal finding is that there appears to be relatively little instability in the parameters of the Euro-area inflation process. Full-sample estimates of the persistence parameter are generally close to one, and we fail to reject the hypothesis that this parameter has been stable over time. We discuss how these results provide some indirect evidence against rational expectations models with strong forward-looking elements, such as the New-Keynesian Phillips curve.

No. 334
22 April 2004
Is inflation persistence intrinsic in industrial economies?

Abstract

JEL Classification

C11 : Mathematical and Quantitative Methods→Econometric and Statistical Methods and Methodology: General→Bayesian Analysis: General

C22 : Mathematical and Quantitative Methods→Single Equation Models, Single Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models &bull Diffusion Processes

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

Abstract

We apply both classical and Bayesian econometric methods to characterize the dynamic behavior of inflation for twelve industrial countries over the period 1984-2003, using four different price indices for each country. In particular, we estimate a univariate autoregressive (AR) model for each series, and consider the possibility of a structural break at an unknown date. For many of these countries, we find strong evidence for a break in the intercept of the AR equation in the late 1980s or early 1990s. Allowing for a break in intercept, the inflation measures generally exhibit relatively low inflation persistence. Evidently, high inflation persistence is not an inherent characteristic of industrial economies.

No. 333
22 April 2004
The pricing behaviour of Italian firms: new survey evidence on price stickiness

Abstract

JEL Classification

E30 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→General

D40 : Microeconomics→Market Structure and Pricing→General

Abstract

This study examines price setting behaviour of Italian firms on the basis of the results of a survey conducted by Banca d'Italia in early 2003 on a sample of around 350 firms belonging to all economic sectors. Prices are mostly fixed following standard mark-up rules, although customer-specific characteristics have a role, in particular in manufacturing and services where price discrimination across customers matters. Rival prices mostly affect pricesetting strategies in industrial firms. In reviewing their prices, firms follow either state-dependent rules or a combination of time and state-dependent ones. Concerning the frequency of price adjustments, a considerable degree of stickiness emerges both at the stage in which firms evaluate their pricing strategies and the stage in which they actually implement the price change. In 2002 most firms changed their price only once. Three alternative explanations of nominal rigidity are ranked highest by the firms interviewed: explicit contracts, tacit collusive behaviour and the perception of the temporary nature of the shock. Prices respond asymmetrically to shocks, depending on the direction of the adjustment (positive vs negative) and the source of the shock (demand vs supply). Real rigidities - captured by the degree of market competition, customers' search costs, the sensitivity of profits to changes in demand - play an important role in determining this asymmetry. Moreover, whereas cost shocks impact more when prices have to be raised than when they have to be reduced, demand decreases are more likely to induce a price change than demand increases.

No. 332
22 April 2004
Stylised features of price setting behaviour in Portugal: 1992-2001

Abstract

JEL Classification

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles

L11 : Industrial Organization→Market Structure, Firm Strategy, and Market Performance→Production, Pricing, and Market Structure, Size Distribution of Firms

Abstract

This paper identifies the empirical stylized features of price setting behaviour in Portugal using the micro-datasets underlying the consumer and the producer price indexes. The main conclusions are the following: 1 in every 4 prices change each month; there is a considerable degree of heterogeneity in price setting practices; consumer prices of goods change more often than consumer prices of services; producer prices of consumption goods vary more often than producer prices of intermediate goods; for comparable commodities, consumer prices change more often than producer prices; price reductions are common, as they account for around 40 per cent of total price changes; price changes are, in general, sizable; finally, the price setting patterns at the consumer level seem to depend on the level of inflation as well as on the type of outlet.

No. 331
22 April 2004
How frequently do prices change? Evidence based on the micro data underlying the Belgian CPI

Abstract

JEL Classification

D21 : Microeconomics→Production and Organizations→Firm Behavior: Theory

D40 : Microeconomics→Market Structure and Pricing→General

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

Abstract

This paper examines the degree of price rigidity in Belgian consumer prices, using a large database. As to the observed degree of rigidity, the results reveal a substantial amount of heterogeneity, not only across but also within product categories. While prices turn out to be perfectly flexible for some product categories, they tend to be very sticky for others. Each month, nearly 17 p.c. of the consumer prices change on average and the median duration of a price spell is close to 13 months. A substantial subset of our results is compatible with state-dependent pricing, while other results suggest that some timedependency exists as well. The majority of price changes are price increases, but price decreases are not uncommon, except for services. The size of price changes is important. Price changes do not seem to be highly synchronised across price-setters within relatively homogenous product categories.

No. 330
21 April 2004
The demand for euro area currencies: past, present and future

Abstract

JEL Classification

E41 : Macroeconomics and Monetary Economics→Money and Interest Rates→Demand for Money

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies

Abstract

The present paper analyses currency in circulation in the euro area since the beginning of the 1980s. After a comprehensive literature review on this topic we present some stylised facts on currency holdings in the euro area countries as well as at an aggregate euro area level. The next chapter develops a theoretical model, which extends traditional money demand models to also incorporate arguments for the informal economy and foreign demand for specific currencies. In the empirical sections we first estimate the demand for euro legacy currencies in total and for small and large denominations within a cointegration framework. We find significant differences between the determinants of holdings of small and large denominations as well as overall currency demand. While small-value banknotes are mainly driven by domestic transactions, the demand for large-value banknotes depends on a short-term interest rate, the exchange rate of the euro as a proxy for foreign demand and inflation variability. Large-value banknotes seem to be therefore used to an important extent as a store of value domestically and abroad. As monetary policy is mainly interested in getting information on the demand for currency used for domestic transactions we also try several approaches in this direction. All the methods applied result in rather low levels of transaction balances used within the euro area of around 25% to 35% of total currency. After this we deal with possibly changing cost-benefit-considerations of the use of cash due to the introduction of euro notes and coins. Overall, there seems no evidence so far of a substantial decline of the demand for currency in the euro area.

No. 329
6 April 2004
On the determinants of euro area FDI to the United States: the knowledge- capital-Tobin's Q framework

Abstract

JEL Classification

F21 : International Economics→International Factor Movements and International Business→International Investment, Long-Term Capital Movements

F23 : International Economics→International Factor Movements and International Business→Multinational Firms, International Business

Abstract

The long-run determinants of euro area FDI to the United States during the period 1980-2001 are explained by employing the Tobin's Q-model of investment. By using the fixed effects panel estimator, stock market developments in the euro area countries - including a measure adjusted for economic developments common to both the United States and the euro area - are found to influence euro area FDI to the United States. Moreover, the inclusion of the Tobin's Q enhances the traditional knowledge-capital framework specification. Overall, the empirical findings suggest that euro area patents (ownership advantage), various variables related to productivity in the United States (location advantage), the volume of bilateral telephone traffic to the United States relative to euro area GDP (ownership advantage), euro area stock market developments (Tobin's Q), and the real exchange rate are statistically significant determinants of euro area FDI to the United States.

No. 328
6 April 2004
Non-fundamental exchange rate volatility and welfare

Abstract

JEL Classification

C32 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models, Diffusion Processes

F31 : International Economics→International Finance→Foreign Exchange

F41 : International Economics→Macroeconomic Aspects of International Trade and Finance→Open Economy Macroeconomics

Abstract

We lay out an empirical and a theoretical model to analyze the effects of non-fundamental exchange rate volatility on economic activity and welfare. In the first part of the paper, the GARCH-SVARmodel is applied to measure empirically the effect of the conditional exogenous exchange rate volatility on the conditional mean of the endogenous variables in our open economy VAR. Our results for Canada, Germany and UK indicate that the effects of exchange rate uncertainty are small empirically. In the second part, we investigate the effect of non-fundamental exchange rate volatility in a stochastic open economy model. The second order approximation method of Sims [2003] is applied to the model equilibrium conditions. We show that in a model with habit persistence, even non-fundamental exchange rate volatility that generate only small variation in the unconditional mean of the variables might induce economically significant welfare changes.

No. 327
6 April 2004
Diversification in euro area stock markets: country versus industry

Abstract

JEL Classification

G11 : Financial Economics→General Financial Markets→Portfolio Choice, Investment Decisions

G15 : Financial Economics→General Financial Markets→International Financial Markets

Abstract

The harmonisation of fiscal and economic policy within the European Monetary Union (EMU) has had a considerable impact on the economies of member countries in the past decade. In particular, several studies indicate that the proceeding economic integration among euro area countries has important consequences for the factors driving asset returns in financial markets. This study concentrates on the implications of the changing structure of security returns for asset management. Using recent euro area stock markets data, we find clear evidence that diversification over industries yields more efficient portfolios than diversification over countries. We show that this result is robust with respect to the information technology-hype and different volatility regimes. This contrasts with e.g. Rouwenhorst (1999), who finds, based on a different methodology and a different sample period, that country diversification strategies are superior. We regard this paper as a robustness check challenging the existing strand of literature and show that Rouwenhorst's (1999) conclusions seem to be outdated.

No. 326
26 March 2004
The Great Depression and the Friedman-Schwartz hypothesis
Published in: Journal of Money, Credit and Banking 35(6, Part 2), December 2003: 1119-1197.

Abstract

JEL Classification

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

E40 : Macroeconomics and Monetary Economics→Money and Interest Rates→General

E51 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Money Supply, Credit, Money Multipliers

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies

N12 : Economic History→Macroeconomics and Monetary Economics, Industrial Structure, Growth, Fluctuations→U.S., Canada: 1913?

Abstract

We evaluate the Friedman-Schwartz hypothesis that a more accommodative monetary policy could have greatly reduced the severity of the Great Depression. To do this, we first estimate a dynamic, general equilibrium model using data from the 1920s and 1930s. Although the model includes eight shocks, the story it tells about the Great Depression turns out to be a simple and familiar one. The contraction phase was primarily a consequence of a shock that induced a shift away from privately intermediated liabilities, such as demand deposits and liabilities that resemble equity, and towards currency. The slowness of the recovery from the Depression was due to a shock that increased the market power of workers. We identify a monetary base rule which responds only to the money demand shocks in the model. We solve the model with this counterfactual monetary policy rule. We then simulate the dynamic response of this model to all the estimated shocks. Based on the model analysis, we conclude that if the counterfactual policy rule had been in place in the 1930s, the Great Depression would have been relatively mild.

No. 325
26 March 2004
What are the spill-overs from fiscal shocks in Europe? An empirical analysis
Published in: What Are the Trade Spill-Overs from Fiscal Shocks in Europe? An Empirical Analysis, published in De Economist. June 2005; 153(2): 167-97

Abstract

JEL Classification

E62 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Fiscal Policy

E63 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Comparative or Joint Analysis of Fiscal and Monetary Policy, Stabilization, Treasury Policy

F42 : International Economics→Macroeconomic Aspects of International Trade and Finance→International Policy Coordination and Transmission

Abstract

We use a Vector Auto Regression (VAR) analysis to explore the (spill-over) effects of fiscal policy shocks in Europe. To enhance comparability with the existing literature, we first analyse the effects of these shocks at the national level. Here, we employ identification based on Choleski decomposition and a structural VAR, both of which lead to the same results. Then, we turn to study the cross-border spill-overs of fiscal shocks via the trade channel. Fiscal expansions in Germany, France and Italy lead to significant increases in imports from a number of European countries. In order to mimic the case of monetary union, we also shut off the effects via the short-term interest rate and the nominal exchange rate and find a slight strengthening on average of the cross-country spill-overs from a fiscal expansion. These results suggest that it may be worthwhile to further investigate the possibility of enhanced fiscal coordination.

No. 324
17 March 2004
Fundamentals and joint currency crises
Published in: Journal of Empirical Finance (2010), 17(2), pp. 241-54, as “Heavy tails and currency crises”.

Abstract

JEL Classification

G12 : Financial Economics→General Financial Markets→Asset Pricing, Trading Volume, Bond Interest Rates

F31 : International Economics→International Finance→Foreign Exchange

G39 : Financial Economics→Corporate Finance and Governance→Other

C49 : Mathematical and Quantitative Methods→Econometric and Statistical Methods: Special Topics→Other

Abstract

In this note we demonstrate that in affine models for bilateral exchange rates, the nature of return interdependence during crises depends on the tail properties of the fundamentals' distributions. We denote crisis linkages as either strong or weak, in the sense that the dependence remains or vanishes asymptotically. We show that if one currency return reaches crisis levels, the probability that the other currency breaks down as well vanishes asymptotically if the fundamentals' distributions exhibit light tails (like e.g. the normal). However, if the marginal distributions exhibit heavy tails, the probability that the other currency breaks down as well remains strictly positive even in the limit. This result implies that linearity and heavy tails are sufficient conditions for joint or contagious currency crises to happen systematically through fundamentals.

No. 323
17 March 2004
On the indeterminacy of new-Keynesian economics
Published in: Macroeconomic Dynamics (2008), 12(1), pp. 60-74; published as "What we don't know about the Monetary Transmission Mechanism and why we don't know it".

Abstract

JEL Classification

C39 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Other

C62 : Mathematical and Quantitative Methods→Mathematical Methods, Programming Models, Mathematical and Simulation Modeling→Existence and Stability Conditions of Equilibrium

D51 : Microeconomics→General Equilibrium and Disequilibrium→Exchange and Production Economies

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies

Abstract

We study identiÞcation in a class of three-equation monetary models. We argue that these models are typically not identiÞed. For any given exactly identiÞed model, we provide an algorithm that generates a class of equivalent models that have the same reduced form. We use our algorithm to provide four examples of the consequences of lack of identiÞcation. In our Þrst two examples we show that it is not possible to tell whether the policy rule or the Phillips curve is forward or backward looking. In example 3 we establish an equivalence between a class of models proposed by Benhabib and Farmer [1] and the standard new-Keynesian model. This result is disturbing since equilibria in the Benhabib-Farmer model are typically indeterminate for a class of policy rules that generate determinate outcomes in the new-Keynesian model. In example 4, we show that there is an equivalence between determinate and indeterminate models even if one knows the structural equations of the model.

No. 322
17 March 2004
Modelling inflation in the euro area
Published in: Gunnar Bårdsen, Øyvind Eitrheim, Eilev S. Jansen and Ragnar Nymoen: The Econometrics of Macroeconomic Modelling, Oxford University Press (Advanced Texts in Econometrics), Oxford 2005 (Chapter 8).

Abstract

JEL Classification

C22 : Mathematical and Quantitative Methods→Single Equation Models, Single Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models &bull Diffusion Processes

C32 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models, Diffusion Processes

C52 : Mathematical and Quantitative Methods→Econometric Modeling→Model Evaluation, Validation, and Selection

C53 : Mathematical and Quantitative Methods→Econometric Modeling→Forecasting and Prediction Methods, Simulation Methods

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

Abstract

The paper presents an incomplete competition model (ICM), where inflation is determined jointly with unit labour cost growth. The ICM is estimated on data for the Euro area and evaluated against existing models, i.e. the implicit inflation equation of the Area Wide model (AWM) - cf. Fagan, Henry and Mestre (2001) - and estimated versions of the (single equation) P* model and a hybrid New Keynesian Phillips curve. The evidence from these comparisons does not invite decisive conclusions. There is, however, some support in favour of the (reduced form) AWM inflation equation. It is the only model that encompasses a general unrestricted model and it forecast encompasses the competitors when tested on 20 quarters of one step ahead forecasts.

No. 321
17 March 2004
Frequency domain principal components estimation of fractionally cointegrated processes
Published in: Applied Economics Letters. October 2004; 11(13): 837-42

Abstract

JEL Classification

C22 : Mathematical and Quantitative Methods→Single Equation Models, Single Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models &bull Diffusion Processes

Abstract

In this paper we study the zero frequency spectral properties of fractionally cointegrated long memory processes and introduce a new frequency domain principal components estimator of the cointegration space and the factor loading matrix for the long memory factors. We find that for fractionally differenced (fractionally) cointegrated processes the squared multiple coherence at the zero frequency is equal to one, the spectral density matrix at the zero frequency is singular, and the factor loading and cointegrating matrices can be obtained from the eigenvectors of the spectral matrix at the zero frequency, associated with the positive and zero roots, respectively. A Monte Carlo simulation reveals that the proposed principal components estimator has already good properties with relatively small sample sizes.

No. 320
17 March 2004
Institutions and service employment: a panel study for OECD countries
Published in: Labour. June 2005; 19(2): 343-72

Abstract

JEL Classification

J21 : Labor and Demographic Economics→Demand and Supply of Labor→Labor Force and Employment, Size, and Structure

L80 : Industrial Organization→Industry Studies: Services→General

L51 : Industrial Organization→Regulation and Industrial Policy→Economics of Regulation

Abstract

We live in a service economy, but the extent of development of service employment differs across developed countries. This paper assesses the role of structural factors and institutions in explaining the common patterns and main differences in the recent expansion of service employment in OECD countries. It finds that GDP per capita, the size of the government sector and the extent of urbanization are positively associated with the service employment share. However, the evidence suggests that laws and institutions such as product market regulations, unions and more coordinated wage-setting systems are hampering the expansion of service employment.

No. 319
17 March 2004
Risk sharing through financial markets with endogenous enforcement of trades

Abstract

JEL Classification

C73 : Mathematical and Quantitative Methods→Game Theory and Bargaining Theory→Stochastic and Dynamic Games, Evolutionary Games, Repeated Games

D60 : Microeconomics→Welfare Economics→General

G10 : Financial Economics→General Financial Markets→General

H41 : Public Economics→Publicly Provided Goods→Public Goods

K42 : Law and Economics→Legal Procedure, the Legal System, and Illegal Behavior→Illegal Behavior and the Enforcement of Law

Abstract

When people share risk in financial markets, intermediaries provide costly enforcement for most trades and, hence, are an integral part of financial markets' organization. We assess the degree of risk sharing that can be achieved through financial markets when enforcement is based on the threat of exclusion from future trading as well as on costly enforcement intermediaries. Starting from constrained efficient allocations and taking into account the public good character of enforcement we study a Lindahl-equilibrium where people invest in asset portfolios and simultaneously choose to relax their borrowing limits by paying fees to an intermediary who finances the costs of enforcement. We show that financial markets always allow for optimal risk sharing as long as markets are complete, default is prevented in equilibrium and intermediaries provide costly enforcement competitively. In equilibrium, costly enforcement translates into both agent-specific borrowing limits and price schedules that include a separate default premium. Enforcement costs - or, equivalently, default premia - increase borrowing costs, while interest rates per se depend on the change in enforcement over time.

No. 318
17 March 2004
Gross job flows and institutions in Europe
Published in: Labour Economics, August 2004, 11(4): 469-485.

Abstract

JEL Classification

J23 : Labor and Demographic Economics→Demand and Supply of Labor→Labor Demand

J60 : Labor and Demographic Economics→Mobility, Unemployment, Vacancies, and Immigrant Workers→General

Abstract

We examine job flows in the 1990s for a sample of 13 European countries. By using a dataset of continuing firms that covers all sectors, we find firm characteristics to be important determinants of job flows, with smaller and younger firms within services typically having a larger degree of job turnover. Once controlled for firm and sectoral effects, the role of institutions in the dynamics of job creation and destruction is examined. As expected, employment protection is found to reduce job flows. Similarly, countries with higher unemployment benefits and more coordinated wage bargaining systems are characterised by lower job flows.

No. 317
8 March 2004
Fiscal policy and inflation volatility

Abstract

JEL Classification

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

E62 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Fiscal Policy

Abstract

Among the harmful effects of inflation, the negative consequences of inflation volatility are of particular concern. These include higher risk premia, hedging costs and unforeseen redistribution of wealth. This paper presents panel estimations for a sample of OECD countries which suggest that activist fiscal policies may have an important impact on CPI inflation volatility. Major results are robust for unconditional and conditional inflation volatility, the latter derived from country-specific GARCH models, and across different data frequencies, time periods and econometric methodologies. From a policy perspective, these results point to the possibility of further destabilising effects of discretionary fiscal policies, in addition to their potential to destabilise output.

No. 316
4 March 2004
Cooperation in international banking supervision

Abstract

JEL Classification

F36 : International Economics→International Finance→Financial Aspects of Economic Integration

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

L51 : Industrial Organization→Regulation and Industrial Policy→Economics of Regulation

Abstract

This paper analyzes cooperation between sovereign national authorities in the supervision and regulation of a multinational bank. We take a political economy approach to regulation and assume that supervisors maximize the welfare of their own country. The communication between the supervisors is modeled as a 'cheap talk' game. We show that: (1) unless the interests of the countries are perfectly aligned, Þrst best closure regulation cannot be implemented; (2) the more aligned the interests are, the higher is welfare; (3) the bank can allocate its investments strategically across countries to escape closure.

No. 315
4 March 2004
Option-implied asymmetries in bond market expectations around monetary policy actions of the ECB
Published in: Journal of Economics and Business, Jan.-Feb. 2005; 57(1): 23-38.

Abstract

JEL Classification

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

G10 : Financial Economics→General Financial Markets→General

G13 : Financial Economics→General Financial Markets→Contingent Pricing, Futures Pricing

Abstract

This paper uses data on German government bond futures options to examine the behaviour of market expectations around monetary policy actions of the European Central Bank (ECB). In particular, this paper focuses on the asymmetries in bond market expectations, as measured by the skewness of option-implied probability distributions of future bond yields. The results show that market expectations are systematically asymmetric around monetary policy actions of the ECB. Around monetary policy tightening, option-implied yield distributions are positively skewed, indicating that market participants attach higher probabilities for sharp yield increases than for sharp decreases. Correspondingly, around loosening of the policy, implied yield distributions are negatively skewed, suggesting that markets assign higher probabilities for sharp yield decreases than for increases. Furthermore, the results indicate that market expectations are significantly altered around monetary policy actions, as asymmetries in market expectations tend to increase before changes in the monetary policy stance, and to decrease afterwards.

No. 314
3 March 2004
Exchange rate risks and asset prices in a small open economy

Abstract

JEL Classification

F31 : International Economics→International Finance→Foreign Exchange

F41 : International Economics→Macroeconomic Aspects of International Trade and Finance→Open Economy Macroeconomics

G12 : Financial Economics→General Financial Markets→Asset Pricing, Trading Volume, Bond Interest Rates

G15 : Financial Economics→General Financial Markets→International Financial Markets

Abstract

The paper proposes a multi-factor international asset pricing model in which the exchange rate is allowed to be co-determined by a risk factor imperfectly correlated to other priced risks in the economy. The significance of this factor can be established as long as one is able to observe a proxy for the foreign cash order flow. Then, the asset pricing model is decomposed into the standard ICCAPM no-arbitrage setup characterized by a pricing kernel, in which, however, the "autarky" exchange rate is unobserved, and an additional equation that links this autarchic currency price with the FX order flow. The model is put in the state space form. The unobserved variables span the macroeconomic risk factors with an impact on the asset markets and determine the dynamics of the pricing kernel, the autarchic exchange rate and the FX order flow. A comparison of models allowing for an independent OF risk factor with a restricted one, where the forex order flow plays no role, should disclose the existence of a "nonfundamental" source of a systematic divergence of the observed and the autarchic (i.e. fundamental) FX returns. The model is calibrated and tested on the Czech koruna/euro exchange rate in a setting with seven Czech and euro area asset returns.

No. 313
27 February 2004
The high-yield segment of the corporate bond market: a diffusion modelling approach for the United States, the United Kingdom and the euro area
Published in: De Bondt G. and D. Marqués-Ibáñez (2005), High-yield bond diffusion in the United States, the United Kingdom and the euro area, Journal of Financial Services Research 27,2, 163-181.

Abstract

JEL Classification

G32 : Financial Economics→Corporate Finance and Governance→Financing Policy, Financial Risk and Risk Management, Capital and Ownership Structure, Value of Firms, Goodwill

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy

Abstract

This study empirically examines the development of the high-yield segment of the corporate bond market in the United States, as a pioneer country, and the United Kingdom and the euro area, as later adopting countries. Estimated diffusion models show for the United States a significant pioneer influence factor and autonomous speed of diffusion. The latter is found to be higher in Europe than in the United States as also macroeconomic factors are considered. The high-yield bond diffusion pattern is significantly affected by financing need variables, e.g. leverage buy-outs, mergers and acquisitions, and industrial production growth, and return or financing cost variables, e.g. stock market return and the spread between the yield on speculative-grade and BBB-rated investment-grade bonds. These findings suggest that the diffusion of new financial products depends on the macroeconomic environment and can be quickly in case of the diffusion from a pioneer country to later adopting countries.

No. 312
27 February 2004
Similarities and convergence in G-7 cycles
Published in: Journal of Monetary Economics, April 2007; 54(3): 850-78

Abstract

JEL Classification

C11 : Mathematical and Quantitative Methods→Econometric and Statistical Methods and Methodology: General→Bayesian Analysis: General

C33 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Panel Data Models, Spatio-temporal Models

E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles

Abstract

This paper examines the properties of G-7 cycles using a multicountry Bayesian panel VAR model with time variations, unit specific dynamics and cross country interdependences. We demonstrate the presence of a significant world cycle and show that country specific indicators play a much smaller role. We detect differences across business cycle phases but, apart from an increase in synchronicity in the late 1990s, find little evidence of major structural changes. We also find no evidence of the existence of an Euro area specific cycle or of its emergence in the 1990s.

No. 311
27 February 2004
Current accounts dynamics in OECD and EU acceding countries - an intertemporal approach
Published in: Journal of Economic Integration 21(3): 593-618.

Abstract

JEL Classification

F32 : International Economics→International Finance→Current Account Adjustment, Short-Term Capital Movements

F41 : International Economics→Macroeconomic Aspects of International Trade and Finance→Open Economy Macroeconomics

Abstract

The paper extends the standard intertemporal model of the current account to include two important stylised facts: (1) the persistence of current account positions and (2) the relevance of the fiscal balance. Specifically, the paper derives a closed form solution for consumption in the presence of habit persistence and liquidity constraints, which allows us to obtain a dynamic model for the current account where fiscal deficits have an effect. The model is estimated for a panel of 33 countries, including the ten EU acceding countries and structural current account positions are derived. A parsimonious specification including relative income, relative investment and the fiscal balance explains well past current account developments. A key finding of the paper is that, from an intertemporal perspective, current accounts in most acceding countries are currently broadly in line with their structural current account positions.

No. 310
27 February 2004
International equity flows and returns: a quantative equilibrium approach

Abstract

JEL Classification

F30 : International Economics→International Finance→General

G12 : Financial Economics→General Financial Markets→Asset Pricing, Trading Volume, Bond Interest Rates

G14 : Financial Economics→General Financial Markets→Information and Market Efficiency, Event Studies, Insider Trading

G15 : Financial Economics→General Financial Markets→International Financial Markets

Abstract

This paper considers the role of foreign investors in developed-country equity markets. It presents a quantitative model of trading that is built around two new assumptions: (i) both the foreign and domestic investor populations contain investors of different sophistication, and (ii) investor sophistication matters for performance in both public equity and private investment opportunities. The model delivers a unified explanation for three stylized facts about US investors' international equity trades: (i ) trading by US investors occurs in bursts of simultaneous buying and selling, (ii ) Americans build and unwind foreign equity positions gradually and (iii ) US investors increase their market share in a country when stock prices there have recently been rising. The results suggest that heterogeneity within the foreign investor population is much more important than heterogeneity of investors across countries.

No. 309
27 February 2004
Monetary policy shocks in the euro area and global liquidity spillovers
Published in: International Journal of Finance & Economics, Vol 13 (3), July 2008: pp 205–218.

Abstract

JEL Classification

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

F01 : International Economics→General→Global Outlook

Abstract

This paper analyses the international transmission of monetary shocks with a special focus on the effects of foreign money ("global liquidity") on the euro area. We estimate structural VAR models for the euro area and the global economy including a global liquidity aggregate. The impulse responses obtained show that a positive shock to extra-euro area liquidity leads to permanent increases in the euro area M3 aggregate and the price level, a temporary rise in real output and a temporary appreciation of the real effective exchange rate of the euro. Moreover, we find that innovations in global liquidity play an important role in explaining price and output fluctuations in the euro area and in the global economy.

No. 308
27 February 2004
International risk-sharing and the transmission of productivity shocks

Abstract

JEL Classification

F32 : International Economics→International Finance→Current Account Adjustment, Short-Term Capital Movements

F33 : International Economics→International Finance→International Monetary Arrangements and Institutions

F41 : International Economics→Macroeconomic Aspects of International Trade and Finance→Open Economy Macroeconomics

Abstract

A central puzzle in international finance is that real exchange rates are volatile and, in stark contradiction to effcient risk-sharing, negatively correlated with cross-country consumption ratios. This paper shows that incomplete asset markets and a low price elasticity of tradables can account quantitatively for these properties of real exchange rates. The low price elasticity stems from distribution services, intensive in local inputs, which drive a wedge between producer and consumer prices and lower the impact of terms-of-trade changes on optimal agents' decisions. Two very different patterns of the international transmission of productivity improvements generate the observed degree of risk-sharing: one associated with a strengthening, the other with a deterioration of the terms of trade and real exchange rate. Evidence on the effect of technology shocks to U.S. manufacturing, identified through long-run restrictions, is found in support of the first transmission pattern, questioning the presumption that terms-of-trade movements foster international risk-pooling.

No. 305
17 February 2004
A structural common factor approach to core inflation estimation and forecasting

Abstract

JEL Classification

C22 : Mathematical and Quantitative Methods→Single Equation Models, Single Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models &bull Diffusion Processes

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

Abstract

In the paper we propose a new methodological approach to core inflation estimation, based on a frequency domain principal components estimator, suited to estimate systems of fractionally cointegrated processes. The proposed core inflation measure is the scaled common persistent factor in inflation and excess nominal money growth and bears the interpretation of monetary inflation. The proposed measure is characterised by all the properties that an "ideal" core inflation process should show, providing also a superior forecasting performance relative to other available measures.

No. 307
16 February 2004
Budgetary forecasts in Europe - the track record of stability and convergence programmes

Abstract

JEL Classification

C53 : Mathematical and Quantitative Methods→Econometric Modeling→Forecasting and Prediction Methods, Simulation Methods

E17 : Macroeconomics and Monetary Economics→General Aggregative Models→Forecasting and Simulation: Models and Applications

H62 : Public Economics→National Budget, Deficit, and Debt→Deficit, Surplus

Abstract

We analyse the performance of budgetary and growth forecasts of all stability and convergence programmes submitted by EU member states over the last decade. Differences emerge for the bias in budgetary projections across countries. As a second step we explore whether economic, political and institutional factors can explain this pattern. Our analysis indicates that the cyclical position and the form of fiscal governance are major determinants of forecast biases. Projected changes in the budgetary position are mainly affected by the cycle, the need of convergence before EMU and by electoral cycles.

No. 306
16 February 2004
A markup model of inflation for the euro area

Abstract

JEL Classification

C22 : Mathematical and Quantitative Methods→Single Equation Models, Single Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models &bull Diffusion Processes

C32 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models, Diffusion Processes

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

Abstract

Equilibrium correction models of the price level are often used to model inflation. Such models assume that the long-run markup of prices over costs is fixed, but this may not be true for the Euro area economy, which has undergone major structural reforms over the last 25 years. We allow for shifts in the markup factor through estimating an equation that includes a timevarying intercept. The model fits the data better than a linear alternative, and suggests that a reduction in the price-cost markup contributed to disinflation in the Euro area during the 1980s.

No. 304
11 February 2004
Equilibrium unemployment, job flows and inflation dynamics

Abstract

JEL Classification

E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles

J41 : Labor and Demographic Economics→Particular Labor Markets→Labor Contracts

J64 : Labor and Demographic Economics→Mobility, Unemployment, Vacancies, and Immigrant Workers→Unemployment: Models, Duration, Incidence, and Job Search

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

Abstract

In order to explain the joint fluctuations of output, inflation and the labor market, this paper first develops a general equilibrium model that integrates a theory of equilibrium unemployment into a monetary model with nominal price rigidities. Then, it estimates a set of structural parameters characterizing the dynamics of the labor market using an application of the minimum distance estimation. The estimated model can explain the cyclical behavior of employment, hours per worker, job creation and job destruction conditional on a shock to monetary policy. Moreover, allowing for variation of the labor input at the extensive margin leads to a significantly lower elasticity of marginal costs with respect to output. This helps to explain the sluggishness of inflation and the persistence of output after a monetary policy shock. The ability of the model to account for the joint dynamics of output and inflation rely on its ability to explain the dynamics in the labor market.

No. 303
11 February 2004
Fiscal policy events and interest rate swap spreads: evidence from the EU
Published in: Journal of International Financial Markets, Institutions & Money (2007). 17 (3): 261-276.

Abstract

JEL Classification

C22 : Mathematical and Quantitative Methods→Single Equation Models, Single Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models &bull Diffusion Processes

G15 : Financial Economics→General Financial Markets→International Financial Markets

H30 : Public Economics→Fiscal Policies and Behavior of Economic Agents→General

Abstract

In this paper we assess the importance given in capital markets to the credibility of the European fiscal framework. We evaluate to which extent relevant fiscal policy events taking place in the course of 2002 produced a reaction in the long-term bond segment of the capital markets. Firstly, we identify the fiscal policy events and qualitatively assess the views of capital market participants. Secondly, we estimate the impact of these fiscal events on the interest rate swap spreads, which is our measure for the risk premium. According to our results the reaction of swap spreads, where it turned out to be significant, has been mostly around five basis points or less.

No. 302
11 February 2004
Deposit insurance, moral hazard and market monitoring
Published in: Review of Finance 8 (4), pp. 571-602, December 2004.

Abstract

JEL Classification

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

The paper analyses the relationship between deposit insurance, debt-holder monitoring, and risk taking. In a stylised banking model we show that deposit insurance may reduce moral hazard, if deposit insurance credibly leaves out non-deposit creditors. Testing the model using EU bank level data yields evidence consistent with the model, suggesting that explicit deposit insurance may serve as a commitment device to limit the safety net and permit monitoring by uninsured subordinated debt holders. We further find that credible limits to the safety net reduce risk taking of smaller banks with low charter values and sizeable subordinated debt shares only. However, we also find that the introduction of explicit deposit insurance tends to increase the share of insured deposits in banks' liabilities.

No. 301
27 January 2004
Inflation and relative price asymmetry

Abstract

JEL Classification

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

Abstract

By placing store-level price data into bivariate Structural VAR models of inflation and relative price asymmetry, this study evaluates the quantitative importance of idiosyncratic pricing shocks in short-run aggregate price change dynamics. Robustly to alternative definitions of the relative price, identification schemes dictated by two-sided (S,s) pricing theory and measures of asymmetry in the relative price distribution, idiosyncratic shocks explain about 25 to 30 percent of the forecast error variance in inflation at the 12-month horizon. While the contemporaneous correlation between inflation and relative price asymmetry is positive, idiosyncratic shocks lead to a substantial build-up in inflation only after two to five months following the initial disturbance.

No. 300
27 January 2004
Developing statistical indicators of the integration of the euro area banking system

Abstract

JEL Classification

C43 : Mathematical and Quantitative Methods→Econometric and Statistical Methods: Special Topics→Index Numbers and Aggregation

D40 : Microeconomics→Market Structure and Pricing→General

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

L11 : Industrial Organization→Market Structure, Firm Strategy, and Market Performance→Production, Pricing, and Market Structure, Size Distribution of Firms

Abstract

This paper discusses a wide range of indicators of the degree of integration of the euro area banking system. It is concerned with volume data, a less developed field of research compared with studies on prices/rates. We first set out a methodological framework, a mixture of elementary and more sophisticated statistics which can also be used in other contexts and datasets. We then apply this framework to unconsolidated balance sheet data of banks, aggregated at the national level. The paper offers three main empirical conclusions. First, within the euro area the gap between the cross-border banking activity in wholesale and retail markets is widening. Second, at the same time, with the exception of the home bias, even in retail markets there is increasing neutrality towards the location of the counterparty. Third, following a moderate decline in the wake of EMU, London is once again gaining market shares.

No. 299
9 January 2004
Import prices and pricing-to-market effects in the euro area

Abstract

JEL Classification

C32 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models, Diffusion Processes

E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation

F14 : International Economics→Trade→Empirical Studies of Trade

F47 : International Economics→Macroeconomic Aspects of International Trade and Finance→Forecasting and Simulation: Models and Applications

Abstract

Pricing-to-market (PTM) behaviour implies that exporters adjust their prices to the prevailing prices in their export markets. For the importing country, PTM effects can be interpreted as a measure of the stability of domestic prices against foreign price and exchange rate developments. PTM behaviour can be attributed to the level of competitiveness and price stickiness in the importing country. This paper investigates PTM behaviour in the euro area from the importing country's perspective, for both individual countries and the euro area as a whole. Analysis firstly involves the estimation of PTM effects in the five largest euro area countries. Secondly, PTM effects in the euro area as a whole are estimated to be slightly higher than one half. The results from illustrative simulations suggest that the increase in euro-area inflation during the first two years of monetary union can be largely attributed to oil price and exchange rate developments.

Disclaimer: Please keep in mind that the papers are published in the name of the author(s). Their views do not necessarily reflect those of the ECB.