Consumption home bias and exchange rate behavior

This paper studies the response of the nominal exchange rate to monetary shocks in an economy with consumption home bias (CHB). When wages are sticky monetary shocks produce exchange rate dynamics. A liquidity effect and a net foreign asset effect determine the extent of these dynamics. I demonstrate that the exchange rate dynamics generated through these two channels are greater the more consumption is biased towards locally produced goods. I also show the influence of consumption home bias is stronger (weaker) when monetary shocks result in a negative (positive) net foreign asset position.     

Optimal Monetary Policy with Vertical Production and Trade*

This paper explores the optimal monetary policy response to domestic and foreign technology shocks in an open economy with vertical structure of production and trade. We find that any stage‐specific productivity shock in one country may have a transborder spillover effect on the other country via the vertical trade. So when choosing optimal monetary rules, each monetary authority should respond to both home and foreign productivity shocks. Also, the flexible exchange rate cannot replicate the flexible price equilibrium, even under producer currency pricing, due to price stickiness in multiple stages. We also find that the existence of a transborder spillover effect depends on the currencies of price setting. Finally, vertical trade may affect the value of exchange rate flexibility under PCP and LCP setting.     

Tobin's Q channel and monetary policy rules under incomplete exchange rate pass-through

This paper focuses on the role of the Tobin's Q channel in a two-country framework in which exporting firms set their prices on the basis of local currency pricing. Incomplete exchange rate pass-through significantly affects the Tobin's Q channel in each country compared with the case of complete exchange rate pass-through. We explore whether different specifications of monetary policy enhance social welfare. Regardless of the degree of home bias, a monetary policy rule that stabilizes domestic asset prices attains preferable outcomes to several alternative policy rules considered in our analysis. Notably, there are large gains from employing a domestic asset price rule when the home bias is large. A monetary policy rule that stabilizes the asset prices of both countries results in worse outcomes. Our simulation results suggest that stabilizing asset prices is important in an open economy with incomplete exchange rate pass-through.     

Evaluating inflation targeting as a monetary policy objective for India

This study formulates a small open economy model for India with exchange rate as a prominent channel of monetary policy. The model is estimated using the Instrumental Variable-Generalized Methods of Moments (IV-GMM) estimator and evaluated through simulations. This study compares different cases of domestic and CPI inflation targeting, strict and flexible inflation targeting, and simple Taylor type rules. The analysis highlights the unsuitability of simple Taylor-type monetary rules in stabilizing the Indian economy and suggests that discretionary optimization works better in stabilizing this economy. There seems to be a trade-off between output gap stabilization and exchange rate stabilization in flexible domestic inflation targeting and CPI inflation targeting respectively. However, flexible domestic inflation targeting seems a better alternative from an overall macro stabilization perspective in India where financial markets are still not sufficiently integrated to ensure quick transmission of interest rate impulses and existence of rigidities in the economy.     

Monetary Policy Rules for a Small Open Economy

In this paper, the optimal choice of a monetary target is investigated for a small open economy that is subject to foreign monetary policy shocks. In contrast to large parts of the literature, pegging the exchange rate is never the best policy choice for the small open economy in our model. Instead, monetary targeting and, depending on the parameter combination, producer price index targeting come closest to the optimal policy rule in terms of welfare. Generally, the welfare performance of the simple targeting rules under consideration hinge critically on the degree of pass-through in the home economy and in the rest of the world.     

Optimal monetary policy for a small open economy

This paper focuses on the design of monetary policy rules for a small open economy. The model features optimizing behavior, general equilibrium and price stickiness. The real exchange rate is shown to affect the firm's real marginal cost, aggregate supply and aggregate demand. The welfare objective depends on the openness of the economy, and the optimal policy rule differs from that which obtains in a closed economy. The inflation versus output gap stabilization trade-off is caused by the real exchange rate. The implied optimal monetary policy regime is domestic inflation target coupled with controlled floating of the real exchange rate.     

Macroeconomic Effects of Asset‐Price Shocks in a Globalized Financial Market

In this paper, I study a model in which shocks to asset prices affect the real sector of the economy through a credit channel. As financial markets become internationally integrated, the economy becomes less vulnerable to domestic asset‐price shocks, but more vulnerable to foreign asset‐price shocks. To the extent that monetary policy stabilization is feasible and desirable, the globalization of financial markets shifts the focus of monetary policy from domestic asset prices to worldwide asset prices.     

Should Commodity Exporters Peg to the Export Price?

To account for the specific situation of commodity exporters, pegging to export prices (PEP) has been proposed elsewhere as an alternative to other conventional monetary regimes such as an exchange rate peg or inflation targeting. PEP is supposed to deliver automatic accommodation to terms‐of‐trade shocks, while retaining the credibility gain from a nominal anchor. This paper analyzes the PEP proposal in a dynamic general‐equilibrium model and compares it with a standard Taylor rule, consumer price index (CPI)‐level targeting and a nominal exchange rate peg. Judged by the degree of output stabilization, PEP performs very similar to CPI targeting for export demand as well as domestic demand shocks and underperforms in the case of shocks to the export price. The results suggest that PEP is not superior to conventional CPI targeting from a macroeconomic stabilization perspective.     

Equity home bias,incomplete financial markets,and nominal rigidities

Abstract This paper analyzes optimal portfolio decisions in a monetary open‐economy framework. It is found that market completeness and the specific form of nominal rigidities, namely, nominal price vs. nominal wage rigidities, matter for justifying the observed structure of equity holdings. When markets are complete, sticky prices generate a negative correlation between the non‐diversifiable labour income and the profit of domestic firms with respect to the productivity shocks, which explains why households invest little abroad. In contrast, when markets are incomplete, rigidities in goods prices result in a counterfactual ‘super home bias’, because domestic equities provide a good hedge against not only the labour income risk but also the relative price risk. Wage rigidities, however, have the opposite effect. Therefore, nominal rigidities in both goods prices and wage rates are needed to address the empirical composition of gross equity positions under incomplete markets.     

Monetary Policy in the Open Economy Revisited: Price Setting and Exchange-Rate Flexibility

This paper develops a welfare-based model of monetary policy in an open economy. We examine the optimal monetary policy under commitment, focusing on the nature of price adjustment in determining policy. We investigate the implications of these policies for exchange-rate flexibility. The traditional approach maintains that exchange-rate flexibility is desirable in the presence of real country-specific shocks that require adjustment in relative prices. However, in the light of empirical evidence on nominal price response to exchange-rate changes—specifically, that there appears to be a large degree of local-currency pricing (LCP) in industrialized countries—the expenditure-switching role played by nominal exchange rates may be exaggerated in the traditional literature. In the presence of LCP, we find that the optimal monetary policy leads to a fixed exchange rate, even in the presence of country-specific shocks. This is true whether monetary policy is chosen cooperatively or non-cooperatively among countries.     

Optimal monetary policy in a small open economy with inflation and output persistence

We study optimal monetary policy for a small open economy in a model where both inflation and output show persistence. We incorporate habit formation into intertemporal consumption decision and modify the Calvo price setting to include indexation to past inflation. The message conveyed from this study can be viewed as twofold. First, full stabilization of domestic prices or the output gap is not optimal policy. This is because stabilization of the output gap leads to serial correlation in domestic inflation, whereas under full stabilization of domestic prices the output gap displays some serial correlation. It is, however, shown that at the zero inflation steady state, stabilizing domestic prices is equivalent to stabilizing the output gap. Second, in the presence of foreign income shock inflation and the output gap are more stable under flexible CPI inflation targeting than under other alternative policy regimes considered.     

Monetary policy and noise traders: A welfare analysis

This paper studies the choice of monetary policy regime in a small open economy with noise traders in forex markets. We focus on two simple rules: fixed exchange rates and inflation targeting. We contrast the above two rules against optimal policy with commitment under productivity shocks. In general, the presence of noise traders increases the desirability of a fixed exchange rate regime. We also evaluate the welfare impact of Tobin taxes in this milieu. These taxes help unambiguously in the absence of productivity shocks; their welfare impact under productivity shocks depends on the monetary regime in place and trade elasticity between domestic and foreign goods.     

Capital Inflows,Dutch Disease Effects,and Monetary Policy in a Small Open Economy

This paper studies the role of monetary policy in a small open economy that experiences Dutch disease effects as a result of capital inflows, and examines the issue of whether such a policy should seek to address these effects from a welfare perspective. I find that Dutch disease effects occur under a fixed nominal exchange rate regime. However, a monetary policy regime characterized by generalized Taylor interest rate rules featuring either the real exchange rate or the nominal exchange rate avert Dutch disease effects. Welfare results reveal that the optimal rule is a generalized Taylor rule consistent with nominal exchange rate flexibility.     

Optimal Monetary Policy

Optimal monetary policy maximizes the welfare of a representative agent, given frictions in the economic environment. Constructing a model with two sets of frictions—costly price adjustment by imperfectly competitive firms and costly exchange of wealth for goods—we find optimal monetary policy is governed by two familiar principles. First, the average level of the nominal interest rate should be sufficiently low, as suggested by Milton Friedman, that there should be deflation on average. Yet, the Keynesian frictions imply that the optimal nominal interest rate is positive. Second, as various shocks occur to the real and monetary sectors, the price level should be largely stabilized, as suggested by Irving Fisher, albeit around a deflationary trend path. Since expected inflation is roughly constant through time, the nominal interest rate must therefore vary with the Fisherian determinants of the real interest rate. Although the monetary authority has substantial leverage over real activity in our model economy, it chooses real allocations that closely resemble those which would occur if prices were flexible. In our benchmark model, there is some tendency for the monetary authority to smooth nominal and real interest rates.     

Optimal monetary and macroprudential policies: Gains and pitfalls in a model of financial intermediation

We estimate a quantitative general equilibrium model with nominal rigidities and financial intermediation to examine the interaction of monetary and macroprudential stabilization policies. The estimation procedure uses credit spreads to help identify the role of financial shocks amenable to stabilization via monetary or macroprudential instruments. The estimated model implies that monetary policy should not respond strongly to the credit cycle and can only partially insulate the economy from the distortionary effects of financial frictions/shocks. A counter-cyclical macroprudential instrument can enhance welfare, but faces important implementation challenges. In particular, a Ramsey planner who adjusts a leverage tax in an optimal way can largely insulate the economy from shocks to intermediation, but a simple-rule approach must be cautious not to limit credit expansions associated with efficient investment opportunities. These results demonstrate the importance of considering both optimal Ramsey policies and simpler, but more practical, approaches in an empirically grounded model.     

Exchange rates and asymmetric shocks in small open economies

We study the stabilizing properties of exchange rates in five small open economies during to periods of floating exchange rates and inflation targeting. In the cases of Sweden and Canada, the nominal exchange rates behave in a stabilizing manner. Most exchange rate movements emanate from the exchange rate itself and are hence not responses to fundamental shocks. However, these non-fundamental shocks have only negligible effects on output and inflation. Our findings indicate that exchange rates display some stabilizing properties but can mainly be characterized as disconnected from the rest of the economy. We would like to thank Nils Gottfries and participants at seminars at Uppsala University and the Riksbank for helpful advice and useful comments. Post gratefully acknowledges financial support from Handelsbankens forskningsstiftelser.     

Alternative Monetary Policy Rules for Small Open Economies

This paper examines the relative merits of alternative monetary policy rules for a small open economy. Rules considered target: the exchange rate, price level, nominal income, or a monetary aggregate. The standard framework employed in previous comparisons of these rules fails to take account of important features of small open economies. In particular, the standard framework fails to consider the effects on aggregate supply of exchange rate adjustments resulting from adherence to policy rules. Incorporating these effects is shown to weaken the case for targeting nominal income and, more generally, to complicate the ranking of policy rules.     

Optimal Monetary Policy with Price and Wage Rigidities

In this paper, I search for an optimal configuration of parameters for variants of the Taylor rule by using an accurate second‐order welfare‐based method within a fully microfounded dynamic stochastic model, with price and wage rigidities, without capital accumulation. A version of the model with distortionary taxation is also explicitly tested. The model is solved up to second‐order solution. Optimal rules are obtained by maximizing a conditional welfare measure, differently from what has been done in the current literature. Optimal monetary policy functions turn out to be characterized by inflation targeting parameter lower than in empirical studies. In general, the optimal values for monetary policy parameters depend on the degree of nominal rigidities and on the role of fiscal policy. When nominal rigidities are higher, optimal monetary policy becomes more aggressive to inflation. With a tighter fiscal policy, optimal monetary policy turns out to be less aggressive to inflation. Impulse‐response functions based on second‐order model solution show a non‐affine pattern when the economy is hit by shocks of different magnitude .     

Fractionalization and long-run economic growth: webs and direction of association between the economic and the social -- South Africa as a time series case study

In this paper it is considered that the relationship between nominal exchange rate and prices depends on the nature of the shocks impacting the economy. In order to identify the sources of nominal exchange rate and relative price fluctuations we impose long-run restrictions on the dynamics of these variables through a 2-variable and 3-variable SVAR, respectively. This methodology is applied to data on the Spanish economy and find that supply and real demand shocks move nominal exchange rates and relative prices in opposite directions. Nominal shocks, however, move both variables in the same direction. Thus, in this case, only under nominal shocks may exchange rate depreciations fuel inflation.     

中国名义货币状况指数的构建

构建和监测货币状况指数是将汇率纳入货币政策框架中的一种可行方式.文章在系统分析汇率和货币供应量等变量对国内消费者价格水平的价格传递链条的基础上,运用VAR方法来构建了2005年7月人民币汇率制度改革以来的中国名义货币状况指数.研究表明,M1和名义有效汇率在名义MCI中的权重之比为1:1.17,在此基础上构建的名义MCI与消费价格指数走势是高度吻合的.从货币政策立场指示器和对通货膨胀进行监测的角度看,我国央行应关注并定期发布货币状况指数.