Currency substitution,inflation, and welfare

Currency substitution affects the mapping between social welfare and inflation by altering the underlying money demand function and influencing interest rates. In order to explore the essence of this effect, I build a model with working capital under which foreign currency is substituted with the less liquid components of domestic money. The framework closely mimics the actual pattern of currency substitution across varying rates of inflation and enables the study of an additional channel that works through the impact of currency substitution on interest rates. It is found that there is a threshold inflation rate, which turns out to be 44% under baseline calibration, below which currency substitution decreases welfare and vice versa. A practical implication is that, at inflation rates lower (greater) than the threshold, the potential welfare gains from disinflation to a near-zero inflation rate are higher (lower) if there is currency substitution than otherwise.     

Time and place where gold acts as an inflation hedge: An application of long-run and short-run threshold model

This study examines the short-run and long-run inflation hedging effectiveness of gold in the United States and Japan during the period of January 1971 to January 2010. Previous research has shown in the long-run that inflation tends to appropriately increase the price of gold in the U.S., leading to gold's popularity as an asset in portfolios to reduce the risk against sudden inflation. However, gold is only partially effective in hedging against inflation in Japan. This research found that the rigidity between the price of gold and the consumer price index affects the inflation hedging ability of gold in the long-run. The gold price is characterized by market disequilibrium induced by the price rigidity, causing the price of gold to be unable to response to changes in the CPI. To explore the inflation hedging ability of gold in the short-run, this study further examines the price rigidity in low and high momentum regime. It is found during the low momentum regimes that, gold return is unable to hedge against inflation in either the U.S. or Japan. However, during high momentum regimes, gold return is able to hedge against inflation in the U.S., while the price rigidity in Japan causes the price of gold to not fully hedge against inflation in the short-run.     

Exchange market reform,inflation, and fiscal deficits

This paper examines the effects of exchange market reform on inflation and quasifiscal deficits in developing countries. The first part presents the conceptual framework, which identifies a variety of implicit taxes and subsidies that must be taken into account (in addition to implicit taxes on exports, as emphasized by Pinto (1991)) in assessing the fiscal and inflationary effects of exchange market reform. A formula that attempts to capture explicitly these taxes and subsidies is derived. The second part applies the formula to six countries (Guyana, India, Jamaica, Kenya, Sierra Leone, and Sri Lanka). The results suggest that exchange market reform may lead to a significant reduction in reliance on the inflation tax.     

Time-varying inflation persistence in the Euro area

This paper investigates how inflation persistence in the Euro area has evolved between 1991 and 2006. Employing an ARMA(1,11) model with time-varying autoregressive parameter, we find that inflation persistence has fallen markedly since the third stage of the EMU began in January 1999 and inflation no longer exhibits unit-root behaviour.     

Sticky prices and moderate inflation

Recent evidence shows that there is great heterogeneity in the price setting frequency across sectors, and that those changing prices frequently do so even under low inflation. What happens to price setting strategies of sticky price goods under moderate inflation? We built a dataset of monthly newspaper and magazine prices for Colombia, for the period 1960–2005, an exceptional example of prolonged moderate inflation. Within this macroeconomic scenario, and the novel database, we study the frequency of price adjustment, the relative importance of time- and state-dependent theories, and their evolution as inflation declined from moderate rates to single digits.     

Macroeconomic relevance of credit channels: Evidence from an emerging economy under inflation targeting

This article presents a contribution to the empirical literature concerning credit channels in emerging economies. Based on data from 2002 to 2009, three sets of GMM models are considered in this article for analyzing the macroeconomic relevance of the credit channels in Brazil: (i) the first set analyzes the effects of shocks on economic variables which are essential for credit supply; (ii) the second set considers the effects of the same variables used in the previous case on credit spread; and (iii) the third set takes into account the effects of changes in the credit market conditions on the product. In addition, with the intention of showing the effects of shocks on the variables which are relevant in the GMM models for credit supply, spread, and product, a VAR analysis is made. Finally, with the objective of testing the results, a GMM system model is built. The findings denote that the effects of economic shocks on credit supply and on credit spread are in accordance with the credit channel theory. In particular, it is observed that shocks on the interest rate are not transmitted directly to the economy but through the credit channels.     

New Keynesian Phillips Curve and inflation dynamics in Australia

The New Keynesian Phillips Curve (NKPC) was developed as a response to the New Classical critique that Keynesian macroeconomics lacked micro-foundations. The NKPC provides theoretical micro-foundations that attempt to explain, inter alia, nominal rigidities and, explicitly price stickiness. This paper investigates the validity of the NKPC for Australia. In contrast to the findings for the USA and Euro area, we find that neither the output gap nor marginal cost appears to be a key driving force variable across different set of instruments and estimators (GMM and 2SLS) over the sample period from 1959 to 2009. The flattening of the NKPC along with significant presence of price stickiness is also found in the data. In particular, the reduced form coefficients and implied estimates from the structural parameters of the model support the view that inflation dynamics are forward looking while the role of lagged inflation is also statistically important only after 1980s. However, we claim that the forward looking baseline NKPC contrary to the hybrid NKPC is stable and better explains inflation dynamics for the Australian economy.     

Dichotomy between macroprudential policy and monetary policy on credit and inflation

This paper compares macroprudential policy and monetary policy using a simple New Keynesian model with credit. Macroprudential policy is effective in stabilizing credit with limited impact on inflation. Monetary policy stabilizes inflation, but is ‘too blunt’ for credit stabilization.     

Inside the bank lending channel

This paper tests cross-sectional differences in the effectiveness of the bank lending channel. The results, derived from a comprehensive sample of Italian banks, suggest that heterogeneity in the monetary policy pass-through exists. After a monetary tightening the decrease in lending is lower for well-capitalized banks that are perceived as less risky by the market and are better able to raise uninsured deposits. Liquid banks can protect their loan portfolio against monetary tightening simply by drawing down cash and securities. The presence of internal capital markets in bank holding companies also contributes to insulate monetary shocks. Bank size is never relevant.     

How do banks set interest rates?

This paper studies cross-sectional differences in banks interest rates. It adds to the literature in two ways. First, it analyzes systematically the micro and macroeconomic factors that influence the price-setting behaviour of banks. Second, by using banks’ prices (rather than quantities) it provides an alternative way of disentangling loan supply from loan demand shift in the “bank lending channel” literature. The results suggest that heterogeneity in the banking rates pass-through - depending on liquidity, capitalization and relationship lending - exists only in the short run.     

New models of trader beliefs and their application for explaining financial bubbles

One challenging and exigent problem in behavior finance is how to establish verifiable models describing the appearance and burst of price bubbles. Current results are enhanced in this paper through a series of improvement as follows: new models are proposed for describing the return and dividend processes, especially the trader's behavior with the adaptive expectation belief and the bounded rational expectation belief, respectively; with these models, we establish dynamical systems in terms of the price-to-earnings ratio and the forecast-to-earnings ratio; the detailed solution and asymptotic analysis of these equations provide new, elaborate and quantitative explanations for both the formation and disappearance of different price bubbles; inspired by the herd behavior framework, a new random belief evolutionary mechanism is devised to model the belief change between two beliefs; a specific genetic algorithm is designed to efficiently estimate model parameters; simulation and empirical studies are carried out to illustrate the application of new methods. Both theoretical and empirical results sufficiently show the reasonability, practicality, efficiency and robustness of our new models and methods for properly explaining the appearance and burst of different kinds of price bubbles.     

Optimal monetary policy and economic growth

A question at the center of many analyses of optimal monetary policy is, why do central banks never implement the Friedman rule? To the list of answers to this question, we add neoclassical production (specifically, the Tobin effect) as one possible explanation. To that end, we study an overlapping generations economy with capital where limited communication and stochastic relocation create an endogenous transactions role for fiat money. We assume a production function with a knowledge externality (Romer style) that nests economies with endogenous growth (AK form) and those with no long-run growth (the Diamond model). The Tobin effect is shown to be always operative. Under CRRA preferences, a mild degree of social increasing returns is sufficient (but not necessary) for some positive inflation to dominate zero inflation and for the Friedman rule to be sub-optimal, irrespective of the degree of risk aversion.     

Do central banks affect Tobin's q?

Previous work has documented inflation effects on Tobin's q in the long run. This paper examines whether the FED's different policies and chairmen tenure have an impact on Tobin's q, after a modified stylized AD-AS model shows that central banks affect q. We do find changing responses of q depending on the pre-Volcker and post-Volcker periods.     

Search, money, and inflation under private information

I study monetary exchange and inflation when buyers have private information about their willingness to pay for certain goods. Introducing imperfect information in the Lagos-Wright [A unified framework for monetary theory and policy analysis, J. Polit. Economy 113(3) (2005) 463-484] economy shows that the existence of monetary equilibrium is a more robust feature of the environment. In general, my model has a monetary steady state in which only a proportion of the agents hold money. Agents who do not hold money cannot participate in trade in the decentralized market. The proportion of agents holding money is endogenous and depends (negatively) on the level of expected inflation. As in Lagos and Wright's model, in equilibrium there is a positive welfare cost of expected inflation, but the origins of this cost are very different.     

On the dynamics of international inflation

We investigate the dynamic properties of inflation in 20 OECD countries with a novel approach based on the autocorrelation function. We find evidence in favor of long memory and nonlinearity. Linear autoregressive models are shown to be misspecified.     

Self-insurance vs. self-financing: A welfare analysis of the persistence of shocks

We study the welfare cost of market incompleteness in a generalized Bewley model where idiosyncratic risk takes the form of entrepreneurial productivity shocks. Market incompleteness in our framework has two dimensions. First, in the Bewley tradition, only a limited set of instruments for consumption smoothing is available. Second, entrepreneurs? capital rental is subject to collateral constraints. As is well known, it is harder to self-insure against more persistent shocks, and the welfare cost of missing consumption insurance increases with shock persistence. On the other hand, with collateral constraints, an increase in shock persistence leads to better allocation of production factors through entrepreneurs? self-financing, and the welfare cost of imperfect capital rental markets decreases with shock persistence. The overall welfare cost of market incompleteness can be increasing, decreasing, or even non-monotone in shock persistence, depending on the relative strengths of its two components—the cost of missing insurance and the cost of imperfect capital markets.     

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.