External monetary shocks and monetary integration: Evidence from the Bulgarian currency board

Starting July the 1st 1997, Bulgaria adopted a Currency Board (CB) monetary system. This paper aims at investigating if the adoption of the CB monetary system, which involves the cost of losing monetary autonomy, has provided a relatively better (with respect to other CEEC) monetary integration of Bulgaria with the European Monetary Union (EMU). Since Bulgarian monetary variables are endogenous under a CB, we focus on the ECB and FED interest rates as the main sources on monetary volatility. First, we find that ECB shocks are more rapidly absorbed and have less significant impact of domestic variables, with respect to other external monetary shocks (FED rate changes). Second, the responses of Bulgarian variables following changes in the ECB interest rate present lower persistence and significance, with respect to what the previous literature emphasized for other CEEC with monetary autonomy. This latter result still holds when accounting for different sources of cross-country heterogeneity outlined in the literature, thus supporting that the adoption of the CB may have worked as a rather good device in terms of integration of Bulgaria into the EMU.     

Identifying monetary policy shocks with changes in open market operations

In this paper, we reexamine the effects of monetary policy shocks by exploiting the information contained in open market operations. A sticky price model is developed where money is the counterpart of securities deposited at the central bank. The model's solution reveals that a rise in central bank holdings of open market securities can be interpreted as a monetary expansion. Estimates of vector autoregressions for US data are further provided showing that reactions to an unanticipated rise in open market securities are consistent with common priors about a monetary expansion, i.e., a decline in the federal funds rate, a rise in output, and inertia in price responses. Compared to federal funds rate shocks, prices do not exhibit a puzzling behavior and a larger fraction of the GDP forecast error variance can be attributed to open market shocks. However, the explanatory power of the latter has decreased since federal funds rate targets have been announced.     

Liquidity risk, economic development, and the effects of monetary policy

Empirical evidence indicates that monetary policy is not super-neutral in many countries. In particular, in high inflation economies, inflation is negatively related to economic activity. By comparison, inflation may be positively correlated with output in low inflation countries. We present a neoclassical growth model with money in which the incidence of liquidity risk is inversely related to aggregate capital formation. Interestingly, there may be multiple monetary steady-states where the effects of monetary policy vary. In poor economies, the financial system is highly distorted and higher rates of money growth are associated with less capital formation. In contrast, in advanced economies, a Tobin effect is observed. Since inflation exacerbates distortions from a coordination failure in the low-capital steady-state, individuals become much more exposed to liquidity risk. Consequently, optimal monetary policy depends on the level of development.     

Interacting nominal and real labour market rigidities

The note analyses interactions between nominal wage stickiness and costly employment adjustment under rule-based and optimal monetary policy. Policy regimes affect and optimal policy lowers the welfare cost of rigidities. No quantitatively important second-best interaction between both rigidities is found.     

Real and nominal effects of monetary policy shocks

Abstract.  We employ the identification scheme of Kahn, Kandel and Sarig (2002) to analyse the impact of Canadian monetary policy on ex ante real interest rates and inflationary expectations. First, we decompose nominal interest rates into ex ante real rates and inflationary expectations using the methodology of Blanchard and Quah (1989) . Then we estimate a recursive VAR model with innovations in a monetary aggregate and the overnight target interest rate as alternative measures of monetary policy shocks. We find that a negative policy shock raises both nominal and ex ante real interest rates, lowers inflationary expectations and real industrial output, and appreciates the Canadian dollar.     

Social status, human capital formation and super-neutrality in a two-sector monetary economy

In this paper, we study how social status affects the impact of monetary policy on the long-run growth rate in a two-sector monetary economy with human capital accumulation, and find that the super-neutrality of money, with regard to the growth rate of the economy depends on the formation of human capital. In an economy with Lucas-type human capital formation, money is super-neutral; however, for an economy in which both physical and human capital are used as inputs for human capital accumulation, the money growth rate will have a positive effect on the long-run economic growth rate. The existence, uniqueness and saddle-path stability of balanced-growth equilibrium are also examined.     

Market concentration, macroeconomic uncertainty and monetary policy

This paper studies the effect of market structure and macroeconomic uncertainty on the transmission of monetary policy. We motivate our analysis with a simple model which predicts that: (1) investment and production in more concentrated sectors are more affected by demand shocks and (2) high uncertainty makes investment and production more sensitive to demand shocks. The empirical analysis estimates the effect of monetary shocks on sectoral output for different sectors in the US using a structural vector autoregressive (VAR) approach. The results are generally consistent with the theoretical predictions.     

Unions, monetary shocks and the labour market cycle

This paper provides a new growth model by considering strategic behaviour in the supply of labour. Workers form a labour union with the aim of manipulating wages for their own benefit. We analyse the implications on labour market dynamics at business cycle frequencies of getting away from the price-taking assumption. A calibrated monetary version of the union model does quite a reasonable job in replicating the dynamic features of labour market variables observed in post-war U.S. data.     

Forward-looking monetary policy and anticipated shocks to inflation

This paper extends a standard New Keynesian model to describe the effects of anticipated shocks to inflation and forward-looking monetary policy. Using the data generated from this modified model suggests that overlooking these two factors in the standard Cholesky structural vector autoregressive identification scheme will generate a price puzzle. Furthermore, this paper demonstrates that failing to account for these two factors may result in significant estimates of two other explanations of the price puzzle—the cost channel of transmission of monetary policy and indeterminacy due to violation of the Taylor principle—even though neither features in the data generating process.     

Endogenous monetary commitment

We develop an asynchronous framework in which each player can optimally select the frequency of his moves based on cost-benefit considerations. To demonstrate how such ability to commit can alleviate coordination problems, we apply the framework to monetary policy.     

A small estimated euro area model with rational expectations and nominal rigidities

We estimate a small model of the euro area to be used for evaluating alternative monetary policy strategies. Starting with the relationship between output and inflation we compare the fit of the nominal wage contracting model due to Taylor (J. Political Econom. 88 (1980) 1) and the relative real wage contracting model proposed by Buiter and Jewitt (The Manchester School 49 (1981) 211; reprinted in Buiter (Ed.), Macroeconomic Theory and Stabilization Policy, Manchester University Press, Manchester, 1989) and estimated with U.S. data by Fuhrer and Moore (Quart. J. Econom. 110 (1995) 127). While Fuhrer and Moore reject nominal contracts in favor of relative contracts, which induce more inflation persistence, we find that both specifications fit euro area data reasonably well. When considering France, Germany and Italy separately, however, we find that nominal contracts fit German data better, while the relative contracting model does well with respect to formerly high inflation countries such as France and Italy. We close the model by estimating an aggregate demand relationship and investigate the implications of nominal versus relative contracts for the inflation-output variability tradeoff when monetary policy follows Taylor's rule.     

Fiscal and Monetary Policies in a Transactions‐Based Endogenous Growth Model with Imperfect Competition

This paper's model is capable of explaining the empirical evidence on the mixed growth‐rate effects of fiscal and monetary policies and a nonlinear inflation–growth relation. When monopoly power in the product market is strong/weak, an increase in the money growth rate or the income tax rate promotes/reduces the output growth rate through lowering/raising the equilibrium gross markup and increasing/reducing the net rate of return on capital. The fact that money can generate a positive growth rate effect allows for the appearance of a nonlinear inflation–growth relation. Such a nonlinear relation cannot be caused by changes in the income tax rate.     

Non-neutral responses to money supply shocks when consumption and leisure are Pareto substitutes

Summary. To a greater extent than is often stressed in existing literature, preference assumptions affect responses to money shocks in equilibrium monetary models. Temporary money shocks can have persistent real effects if the marginal utility of leisure is a decreasing function of consumption, where leisure is measured as time endowment less market labor effort, and consumption refers to market produced goods. This condition is an empirically supported implication of home production models. Though not theoretically necessary for supporting the existence of short run real effects, the presence of distortionary taxes and endogenous productivity can have significant quantitative effects on responses to temporary money supply shocks. Received: August 21, 1996; revised version: February 3, 1997     

The financial accelerator and monetary policy rules

Comparing Bernanke et al.’s (1999) financial accelerator model to a comparable model without an operational financial accelerator mechanism, we find that financial acceleration is reduced when monetary policy reacts to the output gap and when firm-specific volatility rises.     

Asset prices,nominal rigidities,and monetary policy

Should monetary policy respond to asset prices? This paper analyzes this question from the vantage point of equilibrium determinacy. A central bank responding to asset prices is indirectly responding to firm profits. In a model with sticky prices, increases in inflation tend to lower firm profits so that a central bank responding to share prices implicitly weakens its overall response to inflation. This is the novel source of equilibrium indeterminacy highlighted in the paper.     

Rule-of-thumb behaviour and monetary policy

We investigate the implications of rule-of-thumb behaviour by consumers or price setters for optimal monetary policy and simple interest rate rules. This behaviour leads to endogenous persistence in output and inflation and alters the policymaker's welfare objective. Our main finding is that highly inertial policy is optimal regardless of what fraction of agents occasionally follow a rule of thumb. We also find that a first-difference version of Taylor's (Carnegie-Rochester Conf. Ser. Public Policy 39 (1993) 195-214) rule generally has desirable properties. By contrast, the coefficients in other optimised simple rules tend to be extremely sensitive with respect to the fraction of rule-of-thumb behaviour.     

Welfare cost of inflation in a stochastic balanced growth model

There is a large and growing literature on the welfare cost of inflation. However, work in this area tend to find moderate estimates of welfare gains. In this paper we reexamine welfare costs of inflation within a stochastic general equilibrium balanced growth model paying a particular attention to recursive utility, portfolio balance effects, and monetary volatility and monetary policy uncertainty. Our numerical analysis shows that a monetary policy that brings down inflation to the optimum level can have substantial welfare effects. Portfolio adjustment effects seem to be the dominant factor behind the welfare gains.     

Time consistent monetary policy with endogenous price rigidity

I characterize time consistent equilibrium in an economy with price rigidity and an optimizing monetary authority operating under discretion. Firms have the option to increase their frequency of price change, at a cost, in response to higher inflation. Previous studies, which assume a constant degree of price rigidity across inflation regimes, find two time consistent equilibria—one with low inflation, the other with high inflation. In contrast, when price rigidity is endogenous, the high inflation equilibrium ceases to exist. Hence, time consistent equilibrium is unique. This result depends on two features of the analysis: (1) a plausible quantitative specification of the fixed cost of price change, and (2) the presence of an arbitrarily small cost of inflation that is independent of price rigidity.     

Inflation dynamics and the cost channel of monetary transmission

Evidence from vector autoregressions indicates that the impact of interest rate shocks on macroeconomic aggregates can substantially be affected by the so-called cost channel of monetary transmission. In this paper, we apply a structural approach to examine the relevance of the cost channel for inflation dynamics in G7 countries. Since firms’ costs of working capital increase with interest rates, we augment a (hybrid) New Keynesian Phillips curve by including the short-run nominal interest rate. We find significant and varying direct interest rate effects for the majority of countries, including member countries of the EMU. Simulations further demonstrate that the estimated interest rate coefficients can substantially affect inflation responses to monetary policy shocks, and can even lead to inverse inflation responses, when the cost channel is - relative to the demand channel - sufficiently strong.     

Firm-specific capital, nominal rigidities, and the Taylor principle

In the presence of firm-specific capital the Taylor principle can generate multiple equilibria. Sveen and Weinke [New perspectives on capital, sticky prices, and the Taylor principle, J. Econ. Theory 123 (2005) 21-39] obtain that result in the context of a Calvo-style sticky price model. One potential criticism is that the price stickiness which is needed for our theoretical result to be relevant from a practical point of view is somewhat to the high part of available empirical estimates. In the present paper we show that if nominal wages are not fully flexible (which is an uncontroversial empirical fact) then the Taylor principle fails already for some minor degree of price stickiness. We use our model to explain the consequences of both nominal rigidities for the desirability of alternative interest rate rules.