ECON-784 -- Seminar in International Money and Finance
Prof. Martha Starr
Department of Economics
American University
Fall 2007
Telephone:
(202) 885-3747
Office: Roper Hall 201
Office hours: Tuesdays
3:00-6:00 pm, Fridays 11:15-2:15 pm
Email:
mstarr@american.edu
Please put “econ-784 seminar” in the subject
line
Class website: AU blackboard
Course
Description:
This is
an advanced PhD seminar course, preparing students to write a dissertation in monetary
economics or international money and finance. Essential to this process is
leaving behind the role of passive “consumer” of economic knowledge -- and transitioning
into the role of active and effective “producer” of it. This seminar aims to facilitate
this process in three ways, corresponding to the three sections of the class.
First, we
will delve into important theoretical and methodological developments that have
been motivating much international monetary and financial research recently --
namely, New Open-Economy macroeconomic theory and dynamic stochastic general
equilibrium (DSGE) models. Exploring this new literature should be beneficial
for possibly identifying new avenues for approaching research questions. This
section of the class will be primarily lecture-style.
Second,
we will engage in active review and critique of current applied research on
international monetary and financial topics. The research to be reviewed covers
not necessarily top-tier journal
articles -- but rather interesting or innovative efforts to bring economic
modeling and/or econometric analysis to bear on contemporary research
questions. In this section of the class, extending over 5-6 weeks, each student
will read ~1 paper per week, chosen from a cluster of thematically interrelated
papers; the student will concisely present that paper to the class, in each
case identifying the paper’s key research question, methodology, contribution
to the literature, strengths, and weaknesses. Because a good number of papers will
be covered during this interval, students will acquire broad exposure to
contemporary lines of research – as well as developing and refining their
abilities to distinguish between more and less compelling ways of tackling
research topics.
Third,
students will develop their own research projects, revolving around:
identifying a good research topic, motivating interest in it based on related
research and policy debates, situating its original contribution relative to
existing work in the area, defining a good methodology for tackling the issue
(including data and/or econometric method), and taking some notable steps
towards implementing the project. It is not necessary, by the end of the class,
to have a completed, polished, fully-implemented research paper (although that
would be great). Rather, the paper should show compelling, well-thought-through
progress towards getting such a paper off the ground. Ideas for research
projects and progress in implementing them will be discussed throughout the
semester.
Readings
The
following books are available at the AU bookstore and represent valuable
resources for understanding New Open-Economy macro and contemporary
macroeconometric methods respectively.
§
Fabio
Canova, Methods for Applied Macroeconomic
Research. Princeton University Press, 2007.
§
Nelson
Mark, International macroeconomics &
finance. Blackwell, 2001.
Other readings
will be posted in Blackboard.
Grading:
Grades
will be assigned based on the required research paper, presentations of research
papers in weeks 5-11 of the class, and general class participation.
|
Week |
DATE |
Activity(ies) |
|
0 |
Aug. 28 |
General
discussion of research interests |
|
1 |
Sept. 4
|
Economic
research in international money & finance: Resources and issues |
|
2 |
Sept.
11 |
Theory:
New open-economy macro |
|
3 |
Sept.
18 |
Econometric
methods, Part I: DSGE models |
|
4 |
Sept.
25 |
Econometrics,
methods Part II: SVARs and dynamic panel data models |
|
5 |
Oct. 2 |
Paper
cluster #1: Examples of DSGE models |
|
6 |
Oct. 9 |
Paper
cluster #2: Inflation targeting in
emerging-market countries |
|
7 |
Oct. 16 |
Paper
cluster #3: Inflation targeting and financial stability |
|
8 |
Oct. 23 |
Presentations
and discussions of research ideas |
|
9 |
Oct. 30 |
Paper
cluster #4: Exchange rate issues |
|
10 |
Nov. 6 |
Paper
cluster #5: Commodity-price aspects of monetary and financial policies |
|
11 |
Nov. 13 |
Paper
cluster #6: Other issues |
|
|
Nov. 20 |
No
class (because Friday classes meet this day) |
|
12 |
Nov. 27 |
Student
presentations – first batch |
|
13 |
Dec. 4 |
Student
presentations – second batch |
R E A D I N G S
Note: Lest this list look inordinately long, remember that in
Weeks 6-11, you have to read only the paper you will present.
WEEK
1: Economic research in international money & finance: Resources and issues
§
John
Cochrane, “Writing tips for PhD students.”
§
Don
Davis, “PhD research for thesis students: Where do I start?”
§
David
Romer, “David Romer's Rules for Making It through Graduate School and Finishing
Your Dissertation: ‘Out in Five’”
WEEK
2: Theory: New open-economy macro
§
Mark,
Chapter 9
§
Lane,
Philip (2001), “The
new open economy macroeconomics: A survey,” Journal of International
Economics 54 pp 235-266. http://www.tcd.ie/Economics/TEP/1999_papers/TEPNo3PL99.pdf
§
Maurice
Obstfeld, “Keynote Speech: Exchange Rates and Adjustment: Perspectives from the
New Open-Economy Macroeconomics,”
http://www.imes.boj.or.jp/english/publication/mes/2002/me20-s1-4.pdf
§
Lucio Sarno, “Toward a New Paradigm in Open Economy Modeling:
Where Do We Stand?” Federal Reserve Bank of St. Louis Economic Review, May/June
2001. http://research.stlouisfed.org/publications/review/01/04/21-36Sarno.qxd.pdf
§
David
Bowman and Brian Doyle, “New Keynesian Open-Economy Models and Their
Implications for Monetary Policy,” Federal Reserve Board, International Finance
Discussion Paper (2003).
http://www.federalreserve.gov/pubs/ifdp/2003/762/ifdp762.pdf
§
Bergin,
Paul R. “How Well Can the New Open Economy
Macroeconomics Explain the Exchange Rate and Current Account?” Journal of International Money and Finance,
vol. 25, no. 5, August 2006, pp. 675-701.
http://www.econ.ucdavis.edu/faculty/bergin/research/eca17.pdf
WEEK
3: Empirical methodology, I: Dynamic stochastic general equilibrium models
§
Selections
from Canova, pages TBA
§
Smets,
Frank, and Raf Wouters. “An Estimated Dynamic Stochastic General Equilibrium Model
of the Euro Area,” Journal of the European Economic Association, 2003.
http://www.ecb.int/pub/pdf/scpwps/ecbwp171.pdf
§
Thomas A. Lubik and Frank
Schorfheide. “Do central banks respond to exchange rate movements? A
structural investigation,” Journal of Monetary Economics, Vol. 54, No. 4 (May), pp. 1069-1087.
http://www.econ.jhu.edu/people/lubik/soe.pdf
We estimate a small-scale, structural general equilibrium
model of a small open economy using Bayesian methods. Our main focus is the
conduct of monetary policy in Australia, Canada, New Zealand and the UK. We
consider generic Taylor-type rules, where the monetary authority reacts in
response to output, inflation, and exchange-rate movements. We perform
posterior odds tests to investigate the hypothesis whether central banks do
target exchange rates. The main result of this paper is that the central banks
of Australia and New Zealand do not, whereas the Bank of Canada and the Bank of
England do include the nominal exchange rate in its policy rule. This result is
robust for various specification of the policy rule. We also find that
terms-of-trade movements do not contribute significantly to domestic business
cycles.
A GAUSS
program that implements the solution algorithm is available at http://www.econ.upenn.edu/~schorf.
§
Dennis Botman, Philippe Karam, Douglas
Laxton and David Rose. “DSGE
Modeling at the Fund: Applications and Further Developments.” Aug. 2007.
Researchers in policymaking
institutions have expended significant effort to develop a new generation of
macro models with more rigorous micro-foundations. This paper provides a summary
of the applications of two of these models. The Global Economy Model is a quarterly
model that features a large assortment of nominal and real rigidities, which
are necessary to create plausible short-run dynamics. However, because this
model is based on a representative-agent paradigm, its Ricardian features make
it unsuitable to study many fiscal policy issues. The Global Fiscal Model,
which is an annual model that uses an overlapping generations structure, has
been designed to analyze the longer-term consequences of alternative fiscal
policies.
WEEK
4: Other macro/econometric methods: SVARS and dynamic panel-data models
§
Selections
from Canova, pages TBA
§
Michael Hutchison and Ilan Noy.“Sudden stops and the Mexican wave: currency crises, capital flow
reversals and output loss in emerging markets.” FEDERAL RESERVE BANK
OF SAN FRANCISCO. Pacific Basin Working Paper Series. 02-03. Apr, 2002 -- http://people.ucsc.edu/~hutch/JDE2005.pdf
Sudden
Stops are the simultaneous occurrence of a currency/balance of payments crisis
with a reversal in capital flows (Calvo, 1998). We investigate the output
effects of financial crises in emerging markets, focusing on whether
sudden-stop crises are a unique phenomenon and whether they entail an
especially large and abrupt pattern of output collapse (a “Mexican wave”).
Using a panel data set over the 1975-97 period and covering 24 emerging-market
economies, we distinguish between the output effects of currency crises,
capital inflow reversals, and sudden-stop crises. We find that sudden-stop
crises have a large negative, but short-lived, impact on output growth over and
above that found with currency crises. The empirical results are robust to
alternative model specifications, lag structures and using estimation
procedures (IV and GMM) that correct for bias associated with simultaneity and
estimation of dynamic panel
models with country-specific effects.
§
Tor
Jacobson, Per Jansson, Anders Vredin, Anders Warne. “Monetary policy analysis
and inflation targeting in a small open economy: A VAR approach,” Journal of Applied Econometrics. Jul/Aug
2001. Vol. 16, Iss. 4; p. 487
Empirical monetary policy research has
increased in the last decade, possibly because deregulation and explicit monetary targets have made monetary policy issues more
interesting. In particular, within the inflation targeting framework it has
been argued that inflation forecasts can be used as optimal intermediate
targets for monetary policy, and
the development of empirical models that have good forecasting properties is
therefore important. It is shown that a VAR model with long-run restrictions,
justified by economic theory, is useful for both forecasting inflation and for
analyzing other issues that are central to the conduct of monetary policy.
§
Leon Berkelmans, “Credit and Monetary Policy: An
Australian SVAR.” (2005)
http://ideas.repec.org/p/rba/rbardp/rdp2005-06.html
Credit is an important macroeconomic variable that helps
to drive economic activity and is also dependent on economic activity. This
paper estimates a small structural vector auto-regression (SVAR) model for
Australia to examine the intertwined relationships of credit with other key
macroeconomic variables. At short horizons, shocks to the interest rate, the
exchange rate, and past shocks to credit are found to be important for credit
growth. Over longer horizons, shocks to output, inflation and commodity prices play a
greater role.
Week
5, Paper cluster 1: EXAMPLES OF DSGE MODELS
1.1
Vasco Cúrdia and Daria Finocchiaro, “Monetary Regime Change and Business Cycles,” Federal
Reserve Bank of New York Staff
Reports,
no. 294 (July 2007)
http://www.newyorkfed.org/research/staff_reports/sr294.pdf
This paper analyzes how changes in monetary policy regimes
influence the business cycle in a small open economy. We estimate a dynamic
stochastic general equilibrium (DSGE) model on Swedish data, explicitly taking
into account the 1993 monetary regime change, from exchange rate targeting to
inflation targeting. The results confirm that monetary policy reacted primarily
to exchange rate movements in the target zone and to inflation in the
inflation-targeting regime. Devaluation expectations were the principal source
of volatility in the target zone period. In the inflation-targeting period, labor
supply and preference shocks have become relatively more important.
1.2
Malin Adolfson, Stefan Laséen, Jesper Lindé. “Evaluating
an Estimated New Keynesian Small
Open
Economy Model.” (2007). http://www.riksbank.se/upload/Dokument_riksbank/Kat_foa/2007/wp_203.pdf
This paper estimates and tests a new Keynesian
small open economy model in the tradition of Christiano, Eichenbaum, and Evans
(2005) and Smets and Wouters (2003) using
Bayesian estimation techniques on Swedish data from 1980-2004. To account for
the switch to an inflation targeting regime in 1993 we allow for a discrete
break in the central bank’s instrument rule. The empirical results indicate
that allowing for such a regime shift is indeed supported by the data. As one
of the key-equations in the model is the uncovered interest rate parity (UIP)
condition, which is well known to be rejected empirically, we explore the consequences
of modifying the UIP condition to allow for a negative correlation between the risk
premium and the expected change in the nominal exchange rate. The results show
that the modification increases the persistence in the real exchange rate and
that this model has an empirical advantage compared with the standard UIP
specification.
1.3
Corsetti,
Giancarlo, Luca Dedola, and Sylvain Leduc, “DSGE models of high exchange-rate
volatility and low
pass-through,” Federal Reserve Board, International Finance Discussion Paper
No. 845 (Nov. 2005).
http://www.federalreserve.gov/pubs/ifdp/2005/845/ifdp845.pdf
This paper develops a
quantitative, dynamic, open-economy model which endogenously generates high exchange
rate volatility, whereas a low degree of pass-through stems from both nominal
rigidities (in the form of local currency pricing) and price discrimination. We
model real exchange rate volatility in response to real shocks by reconsidering
and extending two approaches suggested by the quantitative literature (one by
Backus Kehoe and Kydland [1995], the other by Chari, Kehoe and McGrattan
[2003]), within a common framework with incomplete markets and segmented
domestic economies. Our model accounts for a variable degree of ERPT over
different horizons. In the short run, we find that a very small amount of
nominal rigidities--consistent with the evidence in Bils and Klenow
[2004--lowers the elasticity of import prices at border and consumer level to
27% and 13%, respectively. Still, exchange rate depreciation worsens the terms
of trade -- in accord with the evidence stressed by Obstfeld and Rogoff [2000].
In the long run, exchange-rate pass-through coefficients are also below one, as
a result of price discrimination. The latter is an implication of distribution
s
1.4
Pablo A. Acosta, Emmanuel K.K. Lartey, and Federico
S. Mandelman, “Remittances
and the
Dutch Disease”, Atlanta
Fed Working Paper 2007-8, April 2007
http://www.frbatlanta.org/filelegacydocs/wp0708.pdf
Using data
for El Salvador and Bayesian techniques, we develop and estimate a two-sector
dynamic stochastic general equilibrium model to analyze the effects of
remittances in emerging market economies. We focus our study on whether rising
levels of remittances result in the Dutch disease phenomenon in recipient
economies. We find that, whether altruistically motivated or otherwise, an
increase in remittances flows leads to a decline in labor supply and an
increase in consumption demand that is biased toward non-tradables. The
increase in demand for non-tradables, coupled with higher production costs,
results in an increase in the relative price of non-tradables, which further
causes the real exchange rate to appreciate. The higher non-tradable prices
serve as an incentive for an expansion of that sector, culminating in
reallocation of labor away from the tradable sector. This resource reallocation
effect eventually causes a contraction of the tradable sector. A vector auto-regression
analysis provides results that are consistent with the dynamics of the model.
1.5
Ivan
Tchakarov & Selim Elekdag & Alejandro Justiniano. “An Estimated Small Open Economy Model of the
Financial Accelerator.” (2005). http://www.imf.org/external/pubs/ft/wp/2005/wp0544.pdf
This paper develops a small open
economy model where entrepreneurs partially finance investment using foreign
currency denominated debt subject to a risk premium above and beyond
international interest rates. We use Bayesian estimation techniques to evaluate
the importance of balance sheet vulnerabilities combined with the presence of
the financial accelerator for emerging market countries. Using
Korean data, we obtain an estimate for the external risk premium, indicating
the importance of the financial accelerator and potential balance sheet
vulnerabilities for macroeconomic fluctuations. Furthermore, our estimates of
the Taylor rule imply a strong preference to smooth both exchange
rate and interest rate fluctuations.
1.6
Elif? IO aspect of new open-economy macro: Pinelopi
K. Goldberg, Rebecca Hellerstein,
“Framework for Identifying the Sources of
Local-Currency Price Stability with an Empirical
Application.” NBER Working Paper No. 13183 (June 2007). {access through ALADIN}
The
inertia of the local-currency prices of traded goods in the face of
exchange-rate changes is a well-documented phenomenon in International
Economics. This paper develops a framework for identifying the sources of
local-currency price stability. The empirical approach exploits manufacturers'
and retailers' first-order conditions in conjunction with detailed information
on the frequency of price adjustments in response to exchange-rate changes, in
order to quantify the relative importance of fixed costs of repricing,
local-cost non-traded components, and markup adjustment by manufacturers and retailers
in the incomplete transmission of exchange-rate changes to prices. The approach
is applied to micro data from the beer market. We find that: (a) wholesale
prices appear more rigid than retail prices; (b) price adjustment costs account
on average for up to 0.5% of revenue at the wholesale level, but only 0.1% of
revenue at the retail level; (c) overall, 54.1% of the incomplete exchange rate
pass-through is due to local non-traded costs; 33.7% to markup adjustment; and
12.2% to the existence of price adjustment costs.
Week 6, PAPER CLUSTER
2: Inflation targeting in emerging-market countries
2.1
Nicoletta
Batini and Douglas Laxton, “Under what conditions can inflation targeting be
adopted?
The
experience of emerging markets”
http://www.bcentral.cl/estudios/documentos-trabajo/pdf/dtbc406.pdf
While
there have been numerous studies of inflation targeting in industrial
countries, there has been much less analysis of the effects of inflation
targeting in emerging market countries. Based on a new and detailed survey of
31 central banks, this paper shows that inflation targeting in emerging-market
countries brings significant benefits to the countries that adopt it relative
to other strategies, such as money or exchange rate targeting. Indeed, by
comparing the performance of the inflation-targeting countries with a sample of
countries that pursue other regimes we show that there are significant
improvements in anchoring both inflation and inflation expectations with no
adverse effects on output. In addition, under inflation targeting interest
rates, exchange rates, and international reserves are less volatile, and the
risk of currency crises relative to money or exchange rate targets is smaller.
Interestingly, IT seems to outperform exchange rate pegs—even when only
successful pegs are chosen in comparison. The survey evidence indicates that it
is unnecessary for countries to meet a stringent set of institutional,
technical, and economic “preconditions” for the successful adoption of
inflation targeting.
2.2
Michael
Hanson and Kwanghee Nam, “Inflation
Targeting in an Emerging Market: the Case of
Korea” http://repec.wesleyan.edu/pdf/mshanson/2005007_hanson.pdf
To evaluate the effectiveness of targeting
monetary policy strategies in a small open economy, we develop a dynamic
optimizing model calibrated to recent Korean data. We then explore the
consequences of alternative specifications of the loss function for society and
the central bank, with particular focus on exchange rate volatility. Policy
simulations include variations on inflation targeting, nominal income growth
targeting and exchange rate targeting. Our results indicate that inflation targeting
remains the most preferred policy regime, even when an explicit motive for
exchange rate smoothing is introduced. In this case, the optimal inflation
targeting and nominal income growth targeting policies are characterized by a
“conservative” central bank that places greater weight on both the primary
target variable and on the exchange rate than in society’s objective function.
However, the optimal policy reacts to changes in degree of exchange rate
pass-though in a non-linear fashion, complicating the robustness of inflation
targeting recommendations for emerging markets.
2.3
Gilberto A. Libanio, “’Good governance’ in monetary policy and the
negative real effects of
inflation targeting in developing economies” (Dec. 2005)
http://www.cedeplar.ufmg.br/pesquisas/td/TD%20277.pdf
This paper analyzes the
growth effects of inflation targeting regimes in emerging market economies. In
particular, it focuses on the case of three Latin American economies where the
inflation targeting framework has been implemented, namely Brazil, Chile and
Mexico. It is argued that not only monetary policy is procyclical under
inflation targeting, but also that it is likely to react in an asymmetric way
to fluctuations in economic activity and exchange rates (too ‘tight’ during
recessions, not so ‘loose’ during expansions). Such pattern may generate a
downward bias in aggregate demand, with negative long-run real effects on output
growth and employment. Our results suggest that monetary policy is procyclical
in Brazil and Chile, and countercyclical in Mexico. Also, they suggest that
monetary policy has reacted asymmetrically to economic activity in the three
countries. The main economic policy implication of this study is that central
banks should consider more seriously the effects of monetary policy on output
and employment.
2.4
Saade
Chami, Selim Elekdag, Todd Schneider, and Nabil Ben Ltaifa. “Can
a Rule-Based Monetary
Policy Framework Work in a Developing
Country? The Case of Yemen”
http://www.imf.org/external/pubs/ft/wp/2007/wp0706.pdf
Monetary policy in Yemen is largely
rudimentary and ad hoc in nature. The Central Bank of Yemen’s (CBY) approach
has been based on discretionary targeting of broad money without any clear
target to anchor inflation expectations. This paper argues in favor of a new
formal monetary policy framework for Yemen emphasizing a proactive and
rule-based approach with a greater direct focus on price stability in the
context of a flexible management of the exchange rate. Although, as in many
developing countries, institutional capacity is a concern, adopting a more
formal framework could impel the kind of changes that are required to strengthen
the ability of the CBY in achieving low and stable rates of inflation over the medium
term.
2.5
Mendoza, Alfonso, “Is there room for foreign exchange interventions
under an inflation
targeting framework? Evidence from Mexico and Turkey”
http://www-wds.worldbank.org/servlet/WDSContentServer/WDSP/IB/2004/06/10/000009486_20040610155908/Rendered/PDF/wps3288mexico.pdf
The
salient characteristics of emerging market economies coupled with the
increasing adoption of inflation targeting in these countries has stimulated
much debate about the role of the exchange rate in inflation targeting regimes.
The authors aim at shedding more light on this issue by investigating whether
central bank foreign exchange interventions have had any impact on the
volatility of the exchange rate in Mexico and Turkey since the adoption of the
floating regime. To this end, their study, using daily data on foreign exchange
intervention, employs an Exponential GARCH framework. Empirical results suggest
that both the amount and frequency of foreign exchange interventions have
decreased the volatility of the exchange rates in these countries. The author’s
findings corroborate the notion that if foreign exchange interventions are
carried out with finesse and sensibly -- that is, not to defend a particular
exchange rate -- they could play a useful role in containing the adverse
effects of temporary exchange rate shocks on inflation and financial stability.
2.6
Valpy Fitzgerald, “Monetary Models and Inflation
Targeting in Emerging Market Economies”
http://www.economics.ox.ac.uk/Research/wp/pdf/paper189.pdf
This paper extends and modifies the Keynesian critique of
inflation targeting with reference to stabilisation policy in emerging market
economies. The IMF `basic monetary programming framework` for developing
countries uses government borrowing and the exchange rate as policy instruments
in order to achieve specific inflation and balance of payments targets. This
paper first adapts this standard model in order to include short-term capital
flows and the floating exchange rate arising from financial liberalisation. In
this way, the macroeconomic consequences of the current Fund focus on inflation
targeting and the use of a single monetary policy instrument (the interest
rate, combined with rigid fiscal and reserve `rules`) in emerging market
economies can be demonstrated. Second, the paper encompasses the structuralist
critique of the negative effect of inflation targeting on capacity utilisation
and trade competitiveness, leading to an argument for counter-cyclical monetary
policy in response to external shocks. An alternative model is constructed
within a comparable macroeconomic framework to that of the IMF in order to
permit the shortcomings of inflation targeting to be rigorously demonstrated. A
macroeconomic stabilisation policy based on real exchange rate targeting, bank
credit regulation and an active fiscal stance is shown to be more effective in
supporting growth and investment.
2.7
Ruy Lama Juan Pablo Medina. “Simple Monetary Policy
Rules for Developing Countries.” (2004).
http://repec.org/esLATM04/up.16600.1082059384.pdf
This paper evaluates the performance of simple monetary
policy rules in a calibrated model for the Chilean economy. The monetary
regimes considered are: exchange rate peg, money peg, inflation targeting, non-tradable
inflation targeting, and a Taylor rule. We develop a small open economy model
with tradable and non-tradable goods, monopolistic competition and staggered
prices a la Calvo. Business cycles fluctuations in the economy are driven by
three types of shocks: foreign interest rate, productivity, and government
expenditure. In this environment, the role of monetary policy is to offset as
much as possible the distortions in the economy, namely staggered prices and
monopolistic competition. We ranked the rules according to their ablity to
smooth consumption and leisure of the representative household. The welfare
analysis suggests that, depending on the source of the shock, it is optimal to
stabilize either the price of the tradable goods or the non-tradable goods.
Rules with these targets are welfare superior to other monetary regimes, such
as CPI inflation targeting or money peg. Our analysis tends to support some
exchange rate intervention in order to achieve an efficient allocation of
resources.
2.8 Mackowiak,
Bartosz. How Much of
the Macroeconomic Variation in Eastern Europe Is
Attributable to External Shocks?
Comparative Economic Studies, September 2006, 48(3), pp.
523-44.
Also available more readily as: http://ideas.repec.org/p/hum/wpaper/sfb649dp2005-061.html
We
decompose by origin the sources of the variation in real aggregate output and
aggregate price level in the Czech Republic, Hungary and Poland. We find that a
sizable fraction of the variation is attributable to external shocks, especially
so for aggregate price level. We show that euroarea interest rate shocks can
account for a significant fraction of the external spillover effects. We
conclude that theoretical models of advanced transition economies and policy
rules for these economies should feature a prominent role for external shocks.
Week
7, PAPER CLUSTER
#3: Monetary policy and financial stability: Causes and effects
3.1 Álvaro
Almeida, “40 Years of
Monetary Targets and Financial Crises in 20 OECD Countries”
http://www.fep.up.pt/investigacao/workingpapers/wp128.pdf
This paper examines differences in the stability of the
foreign exchange, money, and stock markets, associated with the use of
alternative monetary policy targets, based on data from a panel of 20 OECD
countries, for the period 1961-2000. The main conclusion of the paper is that
the choice of monetary policy target will significantly affect stability in
financial markets. The use of inflation targets reduces the likelihood of
crises in the foreign exchange and money markets (relative to any other
monetary policy framework), suggesting that a central bank concerned with
financial stability should adopt this framework. Results also suggest that
exchange rate targeting frameworks tend to have higher likelihood of foreign
exchange and money market crises, but multilateral exchange rate arrangements
have lower likelihood of crises than unilateral pegs. The paper also includes a
complete description of the monetary policy targets used in the countries
analysed.
3.2 Q. Farooq
Akram and Øyvind Eitrheim, “Flexible inflation targeting and
financial stability: Is it
enough to
stabilise inflation and output?”
http://www.norges-bank.no/upload/import/publikasjoner/arbeidsnotater/pdf/arb-2006-07.pdf
We investigate empirically whether a central bank can
promote financial stability by stabilising inflation and output, and whether
additional stabilisation of asset prices and credit growth would enhance
financial stability, in particular. We employ an econometric model of the
Norwegian economy to investigate the performance of simple interest rate rules
that allow a response to asset prices and credit growth, in addition to
inflation and output. We find that output stability also promotes financial
stability, while inflation stability is achieved at the expense of both output
and financial stability. A stabilisation of house prices, equity prices and/or
credit growth enhances stability in both inflation and output, but not
financial stability. By contrast, stabilisation of the nominal exchange rate
induces excess volatility in general.
3.3 Vasco
Curdia, 2007. "Monetary policy
under sudden stops," Staff Reports 278, Federal Reserve
Bank of New York. http://www.newyorkfed.org/research/staff_reports/sr278.pdf
This paper proposes a model to investigate the effects of monetary
policy in an emerging market economy that experiences a sudden stop of capital
inflows. The model features credit frictions, debt denominated in foreign
currency, imported inputs, and households that have access to the international
capital market only indirectly, through their ownership of leveraged firms. The
sudden stop is modeled as a change in the perceptions of foreign lenders that
brings about an increase in the cost of borrowing. I show that the higher the
elasticity of foreign demand, the lower the contraction in output - leading, at
the extreme, to the possibility of an expansion, depending on policy. A second
result is that the recession is most severe in a fixed exchange rate regime.
Taylor rules that react to inflation and output are more stabilizing. A
comparison of alternative rules shows that low commitment to inflation
stabilization allows for less contraction in output and even expansion but at
the cost of much stronger contraction in capital inflows and higher interest
rates. Credibility is also shown to have an important role, with low
credibility and the risk of loose policy implying increased trade-offs,
stronger contraction of the economy, and higher interest rates.
3.4 Martın Uribe and Vivian Z.
Yue, “Country Spreads and Emerging Countries: Who Drives Whom?”
(Oct. 2003). http://www.sf.frb.org/economics/conferences/0406/Uribe.pdf
A number of studies have stressed the role of
movements in US interest rates and country spreads in driving business cycles
in emerging market economies. At the same time, country spreads have been found
to respond to changes in both the US interest rate and domestic conditions in
emerging markets. These intricate interrelationships leave open a number of
fundamental questions: Do country spreads drive business cycles in emerging
countries or vice versa, or both? Do US interest rates affect emerging countries
directly or primarily through their effect on country spreads? This paper
addresses these and other related questions using a methodology that combines
empirical and theoretical elements. The main findings are: (1) US interest rate
shocks explain about 20 percent of movements in aggregate activity in emerging
market economies at business-cycle frequency. (2) Country spread shocks explain
about 12 percent of business-cycle movements in emerging economies. (3) About
60 percent of movements in country spreads are explained by country-spread
shocks. (4) In response to an increase in US interest rates, country spreads
first fall and then display a large, delayed overshooting; (5) US-interest-rate
shocks affect domestic variables mostly through their effects on country
spreads. (6) The fact that country spreads respond to business conditions in
emerging economies significantly exacerbates aggregate volatility in these countries.
(7) The US-interest-rate shocks and country-spread shocks identified in this paper
are plausible in the sense that they imply similar business cycles in the
context of an empirical VAR model as they do in the context of a theoretical
dynamic general equilibrium model of an emerging market economy.
3.5 Marco
Arena, Carmen Reinhart, Francisco Vázquez, “The
Lending Channel in Emerging
Economics: Are Foreign Banks
Different?” NBER Working Paper No. 12340 (June 2006). {access
through Aladin}
This paper assembles a dataset
comprising 1,565 banks in 20 Asian and Latin American countries during
1989-2001 and compares the response of the volume of loans, deposits, and
bank-specific interest rates on loans and deposits, to various measures of
monetary conditions, across domestic and foreign banks. It also looks for
systematic differences in the behavior of domestic and foreign banks during
periods of financial distress and tranquil times. Using differences in bank
ownership as a proxy for financial constraints on banks, the paper finds weak
evidence that foreign banks have a lower sensitivity of credit to monetary
conditions relative to their domestic competitors, with the differences driven
by banks with lower asset liquidity and/or capitalization. At the same time,
the lending and deposit rates of foreign banks tend to be smoother during
periods of financial distress, albeit the differences with domestic banks do
not appear to be strong. These results provide weak support to the existence of
supply-side effects in credit markets and suggest that foreign bank entry in
emerging economies may have contributed somewhat to stability in credit
markets.
3.6 Elif? (has a micro/IO dimension) Simon Gilchrist
and Jae Sim. “Investment during the Korean
Financial
Crisis: A Structural Econometric Analysis.” NBER Working Paper No. 13315 (Aug.
2007). {access through Aladin}
This paper uses firm-level panel data to analyze the role
of financial factors in determining investment outcomes during the Korean
financial crisis. Our identification strategy exploits the presence of
foreign-denominated debt to measure shocks to the financial position of firms
following the devaluation that occurred during the crisis period. Structural
parameter estimates imply that financial factors may account for 50% to 80% of
the overall drop in investment observed during this episode. Our estimates also
imply that foreign-denominated debt had relatively little effect on aggregate
investment spending. Counterfactual experiments suggest sizeable contractions
in investment through this mechanism for economies that are more heavily
dependent on foreign-denominated debt however.
WEEK
9, PAPER CLUSTER 4: Exchange-rate issues
4.1
Égert, Balázs Halpern, László. “Equilibrium
exchange rates in Central and Eastern Europe: A
meta-regression analysis.”
http://ideas.repec.org/p/hhs/bofitp/2005_004.html
This paper analyses the ever-growing literature on
equilibrium exchange rates in the new EU member states of Central and Eastern
Europe in a quantitative manner using meta-regression analysis. The results
indicate that the real misalignments reported in the literature are
systematically influenced, inter alia, by the underlying theoretical concepts
(Balassa-Samuelson effect, Behavioural Equilibrium Exchange Rate, Fundamental
Equilibrium Exchange Rate) and by the econometric estimation methods. The
important implication of these findings is that a systematic analysis is needed
in terms of both alternative economic and econometric specifications to assess
equilibrium exchange rates.
4.2
Meissner, C.M. and N. Oomes. “Why Do Countries Peg the Way They
Peg? The Determinants of
Anchor Currency Choice”
http://www.econ.cam.ac.uk/dae/repec/cam/pdf/cwpe0643.pdf
Conditional on choosing a pegged exchange rate regime,
what determines the currency to which countries peg or “anchor” their exchange
rate? This paper aims to answer this question using a panel multinomial logit
framework, covering more than 100 countries for the period 1980-1998. We find
that trade network externalities are a key determinant of anchor currency
choice, implying that there are multiple steady states for the distribution of
anchor currencies in the international monetary system. Other factors found to
be related to anchor currency choice include the symmetry of output
co-movement, the currency denomination of debt, and legal or colonial origins.
4.3 Etienne
B. Yehoue. “On
the Pattern of Currency Blocs in Africa.” 2005
http://www.imf.org/external/pubs/ft/wp/2005/wp0545.pdf
This paper seeks to elucidate the debate over currency
union in Africa. The paper examines whether empirical investigation points to the
gradual emergence of currency blocs. Based on the historical data on inflation,
trade, and the co-movements of prices and outputs, I argue that the emergence
of large-scale currency blocs in Africa will
follow a gradual path and that this dynamic does not lead to the emergence of a
single continental currency at this time. Rather, the pattern which emerges
seems to suggest three blocs: one in West Africa, a second
around South Africa, and a third in Central Africa. Although little evidence is found
supporting the emergence of a single African currency at this time, the
emergence of an African currency union is not necessarily precluded, since the
ultimate decision to surrender a nation's monetary policy to a supranational
institution is not made based solely on economic considerations. I then address
the issue of a possible anchor for the union, were it to emerge and opt for an
anchorage. I find -- based on the trade criterion -- that the euro seems to be
a good choice.
4.4 David Fielding & Kalvinder Shields. “Economic
Integration in West Africa: Does the CFA Make a
Difference?”
(2003). http://www.le.ac.uk/economics/research/RePEc/lec/leecon/dp03-8.pdf
In this paper we use data from 17 African nations in order
to investigate the hypothesis that monetary union – represented in this case by
the CFA Franc Zone – augments the extent of macroeconomic integration in
developing countries. The paper covers a number of dimensions of integration
including the volume of bilateral trade, real exchange rate volatility and the
magnitude of cross-country business cycle correlation.
4.5
Chudik, Alexander, and Mongardini,
Johannes (2007). “In Search of Equilibrium: Estimating
Equilibrium Real Exchange Rates in
Sub-Saharan African Countries.” IMF Working Paper
WP/07/90.
http://www.imf.org/external/pubs/ft/wp/2007/wp0790.pdf
This paper presents
a methodology to estimate equilibrium real exchange rates (ERER) for Sub-Saharan
African (SSA) countries using both single-country and panel estimation techniques.
The limited data set hinders single-country estimation for most countries in
the sample, but panel estimates are statistically and economically significant,
and generally robust to different estimation techniques. The results replicate
well the historical experience for a number of countries in the sample. Panel
techniques can also be used to derive out of sample estimates for countries
with a more limited data set.
WEEK 10, PAPER CLUSTER 5: Commodity prices and monetary/IF
policies
5.1
Clinton,
Kevin. “Commodity-Sensitive Currencies and Inflation Targeting.” 2001
http://www.bankofcanada.ca/en/res/wp/2001/wp01-3.pdf
Two aspects of the recent monetary history of Canada,
Australia, and New Zealand stand out: the sensitivity of their dollars to
prices of resource-based commodities, and inflation
targeting. This paper explores various aspects of these
phenomena. It uses standard empirical models, and an investigation of the
different approaches to inflation targeting
in the three countries—including a case study of the 1998 international financial
crisis—to assess how well a floating currency serves a resource-rich economy,
and how monetary policy ought to be conducted during periods of turbulence in
commodity and currency markets. The broad swings and cycles in the Canadian,
Australian, and New Zealand dollars are found to have been helpful to
macroeconomic stability. It appears that the most
effective monetary policy approach focuses on domestic inflation
control over the medium term. In a crisis of confidence in the financial
markets, of the kind that sporadically affected the Canadian dollar in the
first half of the 1990s, a case can be made for short-term monetary actions to
stabilize expectations. Apart from crisis situations, as long as a credible
low-inflation policy is followed, monetary policy does not
have to be concerned with the exchange rate per se.
5.2
Fiorella de Fiore & Giovanni Lombardo & Viktors
Stebunovs. “Oil Price Shocks, Monetary Policy
Rules
and Welfare.” 2006
http://www.bank-banque-canada.ca/en/conference_papers/commodity_price2006/fiore.pdf
Sudden and protracted oil-price
increases are generally accompanied by economic contractions and high
inflation. How should monetary policy react to oil-price
shocks in order to minimize such adverse macroeconomic effects? We build a DSGE
model characterized by two oil-importing countries and
one oil-exporting
country. Oil-importing countries use oil for consumption and as input in
production. The oil-exporting country consumes imported
goods and produces oil. We calibrate the model and
evaluate the performance of simple Taylor-type interest rate rules, on the
basis of a micro-founded welfare metric. We search for rules that i) maximize
welfare to a second order of approximation, ii) satisfy the zero-lower-bound
for the nominal interest rate and iii) produce either a Nash or a cooperative
equilibrium. We show that the optimal reaction of monetary policy is strongly influenced by
the presence of energy taxes. For calibrated values of energy taxes, we find
that monetary policy should partially accommodate oil-price increases. The optimal
interest rate rule is inertial, it reacts strongly and positively to inflation
and output deviations from the steady state, while it reacts negatively to
deviations of the real price of oil from its steady-state value
5.3
Juan Pablo Medina and Claudio Soto. “Oil Shocks and Monetary
Policy in an Estimated DSGE
Model for a
Small Open Economy"
http://www.bank-banque-canada.ca/en/conference_papers/commodity_price2006/medina.pdf
This paper analyzes the effects of oil-price shocks
from a general equilibrium standpoint. We develop a dynamic stochastic general
equilibrium (DSGE) model, estimated by Bayesian methods for the Chilean
economy. The model explicitly includes oil in the consumption basket and also
in the technology used by domestic firms. With the estimated model we simulate
how monetary policy and other variables would respond to an oil-price shock
under the policy rule that best describes the behavior of the Central Bank of
Chile (CBC). We also simulate the counterfactual responses in a flexible prices
and wages equilibrium, and under alternative monetary frameworks. We show that
a 13% increase in the real price of oil leads to a fall in output of about 0.5%
and an increase in inflation of about 0.4%. The contractionary effect of the
oil shock is mainly due to the endogenous tightening of the monetary policy.
5.4
Uwe Böwer & André Geis & Adalbert Winkler. 2007. “Commodity
price fluctuations and their
impact
on monetary and fiscal policies in Western and Central Africa.”
http://www.ecb.europa.eu/pub/pdf/scpops/ecbocp60.pdf
Commodity prices play an important role in economic
developments in most of the 24 Western and Central African (WCA) countries
covered in this paper. It is confirmed that in the light of rising commodity
prices between 1999 and 2005, net oil exporters recorded strong growth rates
while net oil-importing countries – albeit benefiting from increases in their
major non-oil commodity export prices – displayed somewhat lower growth. For
most WCA economies, inflation rates appear less affected by commodity price
changes and more determined by exchange rate regimes as well as monetary and
fiscal policies. While pass-through effects from international to domestic
energy prices were significant, notably in oil-importing countries,
second-round effects on overall prices seem limited. Governments of oil-rich
countries reacted prudently to windfall revenues, partly running sizable fiscal
surpluses. A favourable supply response to rising spending as well as sterilisation
efforts and increasing money demand also helped to dampen inflationary
pressures. However, substantial excess reserves of commercial banks reflect
challenges in financial sector developments and the effectiveness of monetary
policy in many WCA countries. Given currently widely used fixed exchange rate
regimes, fiscal policy will continue to carry the main burden of macroeconomic
adjustment and of sustaining non-inflationary growth, which remains the key
policy challenge facing WCA authorities.
5.5
Varangis, Panos, Elton Thigpen, and Sudhakar Satyanarayan,
“The use of New York cotton
futures contracts to hedge cotton price risk in developing countries”
Cotton exports account for a significant share of
commodity exports for some developing countries, especially in West Africa and
Central Asia. In these countries, dependency on cotton for export revenues has
increased in the past 20 years. These countries therefore have a high exposure
to cotton price volatility. Cotton-producing developing countries and economies
in transition make little use of hedging mechanisms to reduce risk from the
volatility of cotton export revenues. Countries in Francophone West Africa use
forward sales to hedge but only for a small share of the crop. These countries
could use cotton futures and options contracts to hedge against short- to
medium-term price volatility, making cotton export revenues more predictable.
Cotton futures and options contracts could also make cotton-related commercial
transactions more flexible. (Futures could be sold when there are no buyers in
the physical market, for example.) In West Africa, futures and options could
complement the existing system of forward sales. The authors examine the
feasibility of using New York cotton futures and options contracts as hedging
instruments. They base their analysis on a portfolio selection problem in which
the hedger selects the optimal proportions of unhedged and hedged output to
minimize risk. The results suggest that despite the existence of relatively high
basis risk (that is, a relatively low correlation between spot and future
prices), hedging reduces cotton price volatility by 30 to 70 percent. Moreover,
for all varieties of cotton examined, the hedge ratio (the percentage of
exports hedged) was below one. Using a hedge ratio of one (naive hedge), at
times, increases rather than decreases risk. The results also show that
hedging, while reducing risk, also reduces expected returns. Attitudes toward
risk that is, the degree of risk aversion - determine how much of this
risk-return tradeoff is acceptable. For a risk-averse agent, the main benefit
of hedging lies in risk reduction rather than in the potential for increased
returns.
WEEK
11, PAPER CLUSTER 6: Miscellaneous
interesting issues {OR select a paper of your choice}
6.1
David Fielding,
“How Does Monetary Policy
Affect the Poor? Evidence from the West African
Economic
and Monetary Union”
http://www.le.ac.uk/economics/research/RePEc/lec/leecon/dp03-11.pdf
The West African Economic and Monetary
Union (UEMOA) has a history of monetary stability and low inflation.
Nevertheless, there is substantial variation in relative prices within some
UEMOA countries, in particular in the price of food relative to other elements
of the retail price index (IHPC). Using monthly time-series data for cities
within the region, we analyze the impact of changes in monetary policy instruments
on the relative prices of components of the IHPC. We are then able to explore
how the burden of monetary policy innovations is likely to be shared between
the rich and poor.
6.2
Jian
Yang, Cheng Hsiao, Qi Li, Zijun Wang. “The emerging market crisis and stock
market
linkages: further evidence,” Journal of Applied Econometrics, Sep/Oct 2006. Vol. 21, Iss. 6; p.
727
This
study examines the long-run price relationship and the dynamic price
transmission among the USA, Germany, and four major Eastern European emerging
stock markets, with particular attention to the impact of the 1998 Russian
financial crisis. The results show that both the long-run price relationship
and the dynamic price transmission were strengthened among these markets after
the crisis. The influence of Germany became noticeable on all the Eastern
European markets only after the crisis but not before the crisis. We also
conduct a rolling generalized VAR analysis to confirm the robustness of the
main findings. [PUB
6.3 Fabio
Canova. “The transmission of US shocks to Latin America,” Journal of Applied
Econometrics. 2005. Vol. 20, Iss. 2; p. 229
(23 pages)
I study whether and how US shocks are transmitted to eight
Latin American countries. US shocks are identified using sign restrictions and
treated as exogenous with respect to Latin American economies. Posterior
estimates for individual and average effects are constructed. US monetary
shocks produce significant fluctuations in Latin America, but real demand and
supply shocks do not. Floaters and currency boarders display similar output but
different inflation and interest rate responses. The financial channel plays a
crucial role in the transmission. US disturbances explain important portions of
the variability of Latin American macro-variables, producing continental
cyclical fluctuations and, in two episodes, destabilizing nominal exchange rate
effects. Policy implications are discussed.
6.3
Tor
Jacobson, Per Jansson, Anders Vredin, Anders Warne. “Monetary policy analysis
and
inflation targeting in a small open economy: A VAR
approach,” Journal of Applied
Econometrics.
Jul/Aug 2001. Vol. 16, Iss. 4; p. 487
Empirical
monetary policy research has increased in the last decade, possibly because
deregulation and explicit monetary targets have made monetary
policy issues more interesting. In particular, within the inflation targeting
framework it has been argued that inflation forecasts can be used as optimal
intermediate targets for monetary policy, and the development of
empirical models that have good forecasting properties is therefore important.
It is shown that a VAR model with long-run restrictions, justified by economic
theory, is useful for both forecasting inflation and for analyzing other issues
that are central to the conduct of monetary policy.
6.4
Dedola,
Luca; Lippi, Francesco. “The Monetary Transmission Mechanism:
Evidence from the
Industries of Five OECD
Countries,” European Economic Review,
vol. 49, no. 6, August 2005, pp.
1543-69.
This paper studies the monetary transmission mechanism using
disaggregated industry data from five industrialized countries. Our goal is to
document the cross-industry heterogeneity of monetary policy effects and relate it
to industry characteristics suggested by monetary transmission theories. Sizable
and significant cross-industry differences in the effects of monetary
policy are found. Such differences swamp the hardly detectable cross-country
variability. Sectoral output responses to monetary policy shocks are
systematically related to the industry output durability, financing
requirements, borrowing capacity and firm size. These findings are consistent
with a quantitatively non-negligible role of financial frictions in the monetary
transmission.
6.5
Francis Nathan Okurut. “Access to credit by the
poor in South Africa: Evidence from Household
Survey
Data 1995 and 2000” (2006). http://ideas.repec.org/p/sza/wpaper/wpapers27.html
This
study specifically investigated the factors that influenced access by the poor
and Blacks to credit in the segmented financial sector in South Africa,
using income and expenditure survey data from 1995 and 2000. The study sheds
light on the extent of financial sector deepening through household
participation especially among the poor and Blacks, in the context of the fight
against poverty. In this study, three types of credit were identified. Formal
credit was defined to include debts from commercial banks (including mortgage
finance and car loans), semi-formal credit included consumption credit (for
household assets such as furniture and open accounts in retail stores), and
informal credit specifically referred to debts from relatives and friends. Multinomial
logit models and Heckman probit models with sample selection were used for
analytical work. The results suggest that the poor and Blacks have limited
access to the formal and semi-formal financial sectors. At the national level,
access to bank credit is positively and significantly influenced by age, being
male, household size, education level, household per capita expenditure and
race (being Coloured, Indian or White). Being poor has a negative and significant
effect on formal credit access.
6.6
Burnside,
Craig; Fanizza, Domenico. “Hiccups for
HIPCs? Implications of Debt Relief for Fiscal
Sustainability and Monetary
Policy,” B.E. Journals in Macroeconomics:
Contributions to
Macroeconomics, vol.
5, no. 1, 2005, pp. 1-37.
In this
paper we discuss fiscal and monetary policy issues facing heavily-indebted poor
countries (HIPCs) who receive debt reduction via the enhanced HIPC initiative.
This debt relief program is distinguished from previous ones by its conditionality:
freed resources must be used for poverty reduction. We argue that (i) this
conditionality severely limits the extent to which the initiative provides
significant debt relief; (ii) depending on the response of monetary policy to
an increase in social spending there could be a short-run increase in inflation
in HIPC countries and (iii) the keys to long-run fiscal sustainability in the
HIPCs are significant fiscal reforms by their governments, and the
effectiveness of their poverty reduction programs in raising growth.