Monetary aggregate versus interest rate rules

This paper analyzes the issue regarding whether the central bank should stabilize the interest rate, a monetary aggregate, or some combination thereof, in the context of a model with rational expectations and with permanent and temporary aggregate supply, IS, and LM disturbances. Monetary policy has a role due to the assumption that the monetary authority uses information on the current interest rate while wage setters do not. The analysis confirms Poole (1970) for the case of temporary IS and LM shocks, and provides several additional results when disturbances are permanent and when they affect supply.     

The relative importance of demand and supply shocks some international evidence

In this paper the contribution of demand and supply shocks of the fluctuation of output and employment is analyzed using quarterly data for four countries (USA, UK, FRG and Switzerland) covering the period 1966 to 1988 in a long run restricted VAR framework for employment, output, the interest rate and inflation. For the USA output and employment fluctuations seem to be dominated by supply shocks in theshort and long run, whereas interest and price level variations are dominated by demand shocks. The result obtained with German and Swiss data are, however, different with two respects: The contribution of demand shocks to output and employment fluctuations are substantial up to a time horizon of eight quarters and price level variations, are at least in the short run, dominated by supply disturbances. Finally, the analysis of the UK data shows the US pattern of results for employment and the price level, but demand shocks are important for output up to four quarters and interest rate movements are dominated by supply shocks.     

Compatibility between monetary and fiscal policy under EMU

The debate over the Stability and Growth Pact (SGP) as a part of European Monetary Union, has highlighted the need to assess the extent to which fiscal policies of union members should be constrained as a pre-requisite for price stability within the union. In this paper, we develop a two country open economy model, where each country has overlapping generations of finitely lived consumers who supply labour to imperfectly competitive firms which can only change their prices infrequently. We examine the case where the two countries have formed a monetary union, but where the fiscal authorities remain independent. We show that the fiscal response required to ensure stability of the real debt stock is greater when consumers are not infinitely lived. In principle, this allows for some compensating behaviour between governments, but we show that the scope for compensation is limited. The monetary authority can abandon its active targeting of inflation to stabilise the debt of at most one fiscal authority, and any other combination of policies will either result in price level indeterminacy and/or indefinite transfers of wealth between the two economies. Finally, in a series of simulations we show that fiscal shocks have limited impact on output and inflation provided the fiscal authorities meet the (weak) requirements of fiscal solvency. However, when monetary policy is forced to abandon its active targeting of inflation, then fiscal shocks have a much greater impact on both output and inflation.     

Supply shocks and the interdependence of macroeconomic stability under flexible exchange rates

This paper analyzes the effects of a change in the monetary policy of a large economy on the macroeconomic stability of a small open economy with high dependence on imported intermediate goods. The analysis is carried out using the Taylor framework where the money supply rule is specified by the degree of monetary accommodation of price shocks. A supply shock to the large country is transmitted as both demand and supply shocks to the small country. A shift toward less monetary accommodation by the large country is shown to increase both price and output instability in the small country through the supply side linkage, while it may enhance price or output stability through the demand side linkage. Simulation results for Germany and Japan suggest that the supply side effect on price stability is important and that the effect on output stability depends crucially on the importance of trade in goods between the large country and the country in question.     

Financial constraints and the balance sheet channel: a re-interpretation

Aggregate demand models extending IS/LM fixed price framework yield an enhancement mechanism of the traditional monetary transmission mechanism, the credit channel, which, according to the credit view, works through the ‘balance sheet channel’ and the ‘bank lending channel’. In this paper the augmented IS/LM model is modified assuming that investments may be financed by both internal and external sources of funds. The inclusion of internal funds in the augmented IS/LM fixed price model suggests a different interpretation of the ‘balance sheet channel’ as an enhancement mechanism amplifying monetary policy effects through the quantity rather than the cost of borrowing. Thus, changes in borrowers’ net worth over the cycle can amplify and propagate output fluctuations directly rather than indirectly as in the traditional interpretation of the balance sheet channel. The empirical analysis of the monetary transmission mechanism for Italy in the last decade accords with the interpretation of the balance sheet channel proposed in this paper.     

Demand Shift across US Industries and the Stabilizing Function of Nominal Wage and Price Flexibility.

Nominal wage and price adjustments in response to demand shocks are likely to determine industrial output variability. The direction of this relationship is complicated, however, by demand and supply factors. The empirical investigation across a sample of private industries in the United States produces the following evidence. Price flexibility moderates the response of the output supplied to a given shift in industrial demand. Similarly, nominal wage flexibility moderates, although insignificantly, the output response to a given shift in industrial demand. The size of industrial demand shifts dominates, however, supply-side constraints in differentiating output fluctuations across industries. While price flexibility moderates shifts in industrial demand in response to aggregate demand shocks, these shifts are larger the higher the nominal wage flexibility across industries. The combined supply and demand effects differentiate the stabilizing function of nominal wage and price flexibility. Nominal wage flexibility increases output fluctuations in response to aggregate demand shocks. In contrast, output fluctuations are smaller the larger the price adjustment to demand shocks across industries. Given the endogeneity of price flexibility, it is necessary to control for variation in demand variability in order to reveal the stabilizing effect of price flexibility on output across industries.     

The Economic Effects of North Sea Oil on the Manufacturing Sector

This paper analyses the economic effects of the oil and gas sector (energy booms) on manufacturing output in two energy producing countries: Norway and the UK. In particular, I investigate whether there is evidence of a 'Dutch disease', that is whether energy booms have had adverse effects on manufactures. In addition to energy booms, three other types of structural disturbances are identified; demand, supply and oil price shocks. The different disturbances are identified by imposing dynamic restrictions on a vector autoregressive model. Overall, there is only weak evidence of a Dutch disease in the UK, whereas manufacturing output in Norway has actually benefited from energy discoveries and higher oil prices     

The asymmetric effects of oil shocks on output growth: A Markov–Switching analysis for the G-7 countries

Oil shocks are generally acknowledged to have important effects on both economic activity and macroeconomic policy. The aim of this paper is to investigate how oil price shocks affect the growth rate of output of a subset of developed countries by comparing alternative regime switching models. Different Markov–Switching (MS) regime autoregressive models are, therefore, specified and estimated. In a successive step, univariate MS models are extended in order to verify if the inclusion of asymmetric oil shocks as an exogenous variable improves the ability of each specification to identify the different phases of the business cycle for each country under scrutiny. Following the wide literature on this topic, seven different definitions of oil shocks which are able to describe oil price changes, asymmetric transformations of oil price changes, oil price volatility, and oil supply conditions are considered.     

Joint Adjustment of House Prices, Stock Prices and Output Towards Short‐run Equilibrium

A dynamic IS‐LM model including houses and stocks as additional assets will be analysed in this paper. Providing also housing services, a major consumption item for most households, houses create an additional link between the monetary and the real sector, distinct from the traditional wealth effect channel. We analyse the adjustment path of output, house prices and stock prices after policy shocks within a rational expectation setup. Depending crucially on the elasticity of housing services demand, different reaction patterns of asset prices will emerge. The results are contrasted with relevant empirical findings, particularly Lastrapes (Journal of Housing Economics, 11 (2002), pp. 40–74), leading to the identification of plausible elasticity ranges. The analysis sheds new light on the ongoing discussion about demand effects from changing real estate wealth and about determinants of house price fluctuations.     

The asymmetric effects of monetary shocks: the case of Turkey

This paper examines whether there is an asymmetry in the effects of positive versus negative and small versus big money supply shocks, and whether the effects of the shocks on output and prices vary over the business cycles in the case of Turkey. Negative shocks to money are found to have greater output and smaller price effects compared to the effects of positive shocks, irrespective of the initial state of the economy. It is also found that monetary shocks of different size affect output growth and inflation rates proportionately. These findings can be interpreted as evidence for the view that the short run aggragate supply curve is convex in such a country like Turkey.     

Foreign output and price shocks and macroeconomic activity in Korea

This paper examines the effects of foreign output and price shocks on output and the price level in Korea. The framework is a nine variable VAR model which includes output, price level, interest rate, real exchange rate, money supply, government expenditures, government debt, and foreign output and price variables. Foreign output and price effects are evaluated through computation of variance decompositions and impulse response functions. The variance decompositions indicate significant effects of foreign output on domestic output and significant effects of foreign prices on domestic output and the price level. The impulse response functions indicate positive short-run effects of foreign output on domestic output but insignificant effects on the price level while foreign price shocks have significant negative effects on output and significant positive effects on the price level for approximately two years. The results indicate the importance of including foreign shock variables when modeling the Korean economy.     

The contemporaneous correlation between price shocks and output shocks

Until the 1990s, prices were believed to be procyclical. Several researchers have since presented evidence of counter-cyclical prices. This evidence proved robust, but its interpretation has varied. Some have argued that the contemporaneous correlation between output and prices reflects both the source of the current shock and the adjustment process from short-run to long-run equilibrium; the adjustment to the long run imparts a bias towards a negative price-output correlation. The issue of dynamics is addressed by estimating price shocks and output shocks. The sign of the correlation between these shocks does not reveal anything about the relative importance or frequency of demand versus supply shocks; however, some understanding is gained from the time-series of the product of the shocks. In periods when the product is negative, supply shocks must have been either relatively large or relatively important. In periods when the product is positive, demand shocks must have been either relatively large or relatively important. The data suggest that the economies of the USA, Canada and the UK were buffeted by both demand and supply shocks in about equal portions.     

The sectorial impact of commodity price shocks in Australia

This study reports that commodity price shocks predominantly affect the mining, construction and manufacturing industries in Australia. However, the financial and insurance sectors are found to be relatively unaffected. Mining industry profits and nominal output substantially increase in response to commodity price shocks. Construction output is also found to increase significantly, especially in response to a bulk commodity shock, as a result of increased demand for resource related construction. Increased demand for construction has a positive spillover effect to the parts of the manufacturing industry that supply the construction sector with intermediate inputs, such as the non-metallic mineral sub-industry. In contrast, other manufacturing sub-industries with only tenuous links to the resources sector such as textiles, clothing and other manufacturing, are relatively unresponsive to commodity price shocks.     

The effects of macroeconomic factors on South African agriculture

Significant research efforts have been devoted to understanding the effects of macroeconomic factors on the agriculture sector. Analysing the sources of volatility in the industry is critical for designing appropriate policies to stabilize agricultural markets, reduce poverty and increase economic growth. Agriculture is a competitive sector with prices that are more flexible than those in nonagricultural sectors. This article uses annual data over the 1957–2004 period and a vector error-correction model in investigating the dynamic effects of exchange rates, money supply and other macroeconomic variables on the agricultural sector in South Africa. Overall, real exchange rates, interest rates, inflation and money supply (M3) shocks have significant and persistent impacts on agricultural output, prices received by farmers and farm input prices. M3 and interest rate shocks tend to put agriculture in a cost-price squeeze. Agricultural price movements are a source of macroeconomic instability in the country. Real exchange rate shocks shift relative prices in favour of agriculture in the long-run, thereby, boosting farm incomes and accelerating poverty reduction in the country.     

Materials price increases and aggregate adjustment in an open economy: A Stochastic Approach

This paper develops a stochastic macroequilibrium frameworks to analyze the differing implications of alternative types of input price disturbances. The distinctions between expected and unexpected, permanent and transitory, nominal and real disturbances are considered. The introduction of input disturbances involves a more elaborate modelling of the supply side of the economy. Both constant returns to scale and decreasing returns to scale technologies are considered. The analysis highlights the sensitivity of the macroeconomic impacts of input price shocks to their specific type. The analytical results obtained are not unambiguous and are supplemented with numerical simulations.     

Nominal GDP targeting for developing countries

Interest in nominal GDP (NGDP) targeting has come in the context of large advanced economies. Developing countries are better suited for it, however, in light of big supply shocks and terms of trade shocks, such as monsoon rains and oil import price shocks in the case of India. Under annual inflation targeting (IT), the full impact of adverse supply shocks is felt as lost real GDP. NGDP targeting automatically accommodates such shocks, while retaining the advantage of anchoring expectations. We derive the condition under which NGDP targeting would dominate other regimes such as annual IT, to achieve objectives of output and price stability. We estimate key parameters for the case of India and conclude that the condition may indeed hold.     

Oil prices and economic downturns: the case of Spain

We address the macroeconomic effects of an oil price shock in Spain. We apply a vector autoregression model (VAR) analysis to quarterly data for the Spanish economy since 1986, to elucidate the effects of variations in the oil price on the economy, considering the three main causes of disruptions in the oil markets: oil supply shocks, oil demand shocks and oil-specific (precautionary) demand shocks. We conclude that the effects in Spain strongly depend on the type of shock: the consumer price index (CPI) has mainly been influenced by oil demand shocks; output has only reacted to oil supply shocks; and monetary policy has mainly reacted after precautionary shocks. Second-round effects caused by the behaviour of nominal wages have not been found. Additionally, we discuss two facts: the ability of firms to increase markups in a context of rising demand and the procyclical role of monetary policy when faced with oil demand shocks.     

Oil Prices, Terms of Trade Shocks, and Macroeconomic Fluctuations in Saudi Arabia

The article investigates the sources of macroeconomic fluctuations in Saudi Arabia using structural vector autoregression methods and pays particular attention to oil prices and changes in terms of trade. Using a macroeconomic model tailored to the Saudi Arabian economy, the authors identify terms of trade, supply, balance of payments, aggregate demand, and monetary shocks. The results show that the Saudi Arabian price level, real exchange rate, and to a lesser extent output is vulnerable to terms of trade shocks. Moreover, Saudi Arabian terms of trade are driven by output, trade balance, and aggregate demand shocks. To stabilize output and the real exchange rate, Saudi Arabia ought to continue diversifying its production base and aim for a stable nominal oil price. (JEL E32 , Q43 , C22 )     

A Note on Inflation Targeting

The authors present a pedagogical graphical exposition to illustrate the stabilizing effect of price target zones. Based on a textbook AD-AS apparatus, they find that authorities' commitment to defend a price target zone will affect the public's inflation expectations and, in turn, reduce actual inflation. They also find that, when the economy experiences supply shocks, the announcement that the monetary authorities intend to defend a price target zone will reduce the variability of domestic prices but raise the variability of domestic output relative to a free-price regime. However, when the economy experiences demand shocks, a price target zone tends to lower the variability of both domestic prices and out-put relative to a free-price regime.     

Exchange rate,price, and output inter-relationships in Ghana: evidence from vector autoregressions

This paper explores the dynamic inter-relationships among the currency exchange rate, consumer price inflation, and real output growth, as well as the roles of money and interest rates in output and price determination. Time series data and vector autoregression models are used. Results suggest that there are significant inter-relationships between the exchange rate and inflation, monetary shocks matter only when explaining money itself and the price level, and interest rate-dependent monetary policies in the absence of financial modernization are ineffective