how important is fiscal policy cooperation in a currency union abstract by constructing a dynamic stochastic general equilibrium model which assumes a currency union consisting of two countries with nontradables we study the importance of fiscal policy cooperation as shown in the previous studies we find that the role of fiscal policy is important in maximizing social welfare however we have a contrary result for fiscal policy cooperation while the previous studies highlight that fiscal policy cooperation has a nontrivial effect in maximizing social welfare we show that fiscal policy cooperation has no benefits regardless of the share of nontradables self oriented fiscal policy can replicate social welfare under the cooperative setting

sticky prices and monetary policy evidence from disaggregated us data this paper disentangles fluctuations in disaggregated prices due to macroeconomic and sectoral conditions using a factor augmented vector autoregression estimated on a large data set on the basis of this estimation we establish eight facts 1 macroeconomic shocks explain only about 15 of sectoral inflation fluctuations 2 the persistence of sectoral inflation is driven by macroeconomic factors 3 while disaggregated prices respond quickly to sector specific shocks their responses to aggregate shocks are small on impact and larger thereafter 4 most prices respond with a significant delay to identified monetary policy shocks and show little evidence of a price puzzle contrary to existing studies based on traditional vars 5 categories in which consumer prices fall the most following a monetary policy shock tend to be those in which quantities consumed fall the least 6 the observed dispersion in the reaction of producer prices is relatively well explained by the degree of market power 7 prices in sectors with volatile idiosyncratic shocks react rapidly to aggregate monetary policy shocks 8 the sector specific components of prices and quantities move in opposite directions

a monetary policy strategy in good and bad times lessons from the recent past we evaluate the ecb s monetary policy strategy against some of the underlying economic features of the eurozone in normal times and during the financial crisis we show that in the years preceding the crisis the ecb s emphasis on monetary indicators and deliberate avoidance of excessive activism were justified by the underlying macroeconomic conditions that the ecb faced in the eurozone and contributed to avoid more volatile patterns of inflation and economic activity after the collapse of financial intermediation in late 2008 the strategy of the ecb was to adopt several non standard policy measures according to our quantitative evaluation of the impact of the main non standard policies decided in october 2008 and in may 2009 which notably did not include entering commitments regarding the future path of the policy rate such measures have significantly contributed to preserving price stability and forestalling a more disruptive collapse of the macroeconomy stephan fahr roberto motto massimo rostagno frank smets and oreste tristani

optimal monetary policy responses to relative price changes abstract an optimizing model with a flexible price sector and a sticky price sector is presented to analyze the effects of relative price changes on inflation fluctuations the relative price of the flexible price good represents a shift parameter of the new keynesian phillips curve the optimal monetary policy is to target sticky price inflation rather than a broad inflation measure although stabilizing the relative price around its efficient value is one of the appropriate goals of the central bank stabilizing sticky price inflation is sufficient for achieving this goal an optimal monetary policy for a small open economy is also discussed

product replacement bias in inflation and its consequences for monetary policy the paper examines a new keynesian model with product entry and exit and with two types of households households consume different product baskets and therefore face different inflation rates the statistical bureau used in the model measures aggregate inflation but observes product entry with a probabilistic delay consequently measured inflation suffers from product replacement bias with respect to aggregate inflation measured inflation is less volatile but more persistent than aggregate inflation and the correlation between aggregate inflation and aggregate output is lower than the correlation between measured inflation and measured output when monetary policy responds to measured variables it stabilizes aggregate inflation insufficiently nevertheless under discretionary monetary policy responding to measured variables improves welfare

monetary policy and the relative price of durable goods abstract in a structural vector autoregressive model of the us the response of the relative price of durables to a monetary policy contraction is either flat or mildly positive it significantly falls only if narrowly defined as the ratio between new house and nondurables prices these findings are rationalized via the estimation of two sector new keynesian nk models durables prices are estimated to be as sticky as those of nondurables leading to a flat relative price response to a monetary policy shock conversely house prices are estimated to be almost flexible such results survive several robustness checks and a three sector extension of the nk model these findings have implications for building nk models with durable and nondurable goods and for the conduct of monetary policy

inflation targeting rules and welfare in an asymmetric currency area abstract this paper studies the effect on monetary policy of differing degrees of competition and differing degrees of nominal rigidity between the members of a monetary union in particular we assess the welfare loss brought about by the use of a simple interest rate rule that does not take into account such structural differences our results show that ceteris paribus to maximize welfare the central bank should react more strongly to inflation pressure generated by the more competitive economies our work extends the results of benigno benigno p 2004 optimal monetary policy in a currency area journal of international economics 63 293 320 by showing that if the degree of competition differs between countries the optimal rule could involve placing a greater weight on the more flexible countries our study suggests that the size of the welfare losses generated by failure to take account of these asymmetries depends crucially on the actual combination of the various asymmetries as a consequence we show that if the optimal weights are chosen under incomplete information regarding the extent and type of asymmetries the resulting level of welfare could be lower than that produced by the symmetric rule

optimal monetary policy in a currency area abstract this paper investigates how monetary policy should be conducted in a two region general equilibrium model with monopolistic competition and price stickiness this framework delivers a simple welfare criterion based on the utility of the consumers that can be used to evaluate monetary policy in a currency area if the two regions share the same degree of nominal rigidity the terms of trade are completely insulated from monetary policy and the optimal outcome is obtained by targeting a weighted average of the regional inflation rates these weights coincide with the economic sizes of the region if the degrees of rigidity are different the optimal plan implies a high degree of inertia in the inflation rate but an inflation targeting policy in which higher weight is given to the inflation in the region with higher degree of nominal rigidity is nearly optimal

commodity trade and international risk sharing how much do financial markets matter abstract this paper evaluates the social gains from international risk sharing in some simple general equilibrium models with output uncertainty a simulation model calibrated to selected moments of u s and japanese data estimates the incremental loss from a ban on international portfolio diversification to be on the order of 0 20 percent of output per year even the theoretical gains from asset trade may disappear under alternative sets of assumptions on preferences and technology the paper argues that the small magnitude of potential trade gains may help explain the apparently inconsistent findings of empirical studies on the degree of international capital mobility

capital market imperfections and the theory of optimum currency areas this paper studies how within and cross country capital market imperfections affect the welfare effects of forming a currency union the analysis considers a bank only world where intermediaries compete in cournot fashion and monitoring and state verification are costly the first part determines the credit market equilibrium and the optimal number of banks prior to joining the union the second part discusses the benefits from joining a currency union a competition effect is identified and related to the added monitoring costs that banks may incur when operating outside their home country through an argument akin to the brander krugman reciprocal dumping model of bilateral trade however in our framework whether joining a union raises welfare of the home country is ambiguous it depends on the relative strength of investment creation and intermediation diversion effects

nominal price rigidity money supply endogeneity and business cycles abstract this paper investigates the ability of nominal price rigidity to explain the co movement of inflation with the cyclical component of output observed in the post war u s data a dynamic general equilibrium model is constructed with the introduction of monopolistic competition and nominal price rigidity in a standard real business cycle model allowing for an endogenous money supply rule it is then demonstrated that sticky price models can explain the observed associations between movements in inflation and output much better than flexible price models this result depends little on whether money supply is assumed to be endogenous or not

inflation measurement and the ecb s pursuit of price stability a first assessment as part of its monetary policy strategy announced in 1998 the ecb provided a quantitative definition of its price stability objective as an annual rate of increase in the harmonized index of consumer prices hicp of below 2 0 percent this paper takes a measurement perspective in evaluating the ecb s quest for price stability during the first years of monetary we consider the following questions first what is the hicp designed to measure and how accurate is it in terms of its stated objective second how accurate are the traditional exclusion type measures of core inflation derived from the hicp and more importantly is there evidence that less traditional measures of core inflation might be useful to the ecb and third is there any sense in which the ecb s definition of price stability in terms of a 2 0 percent limit on hicp inflation can be said to be too low from a measurement perspective we conclude that the conceptual underpinnings of the hicp remain sufficiently vague that it is difficult to compare with other indexes or come to any hard conclusions about its accuracy it is possible that the hicp is as susceptible to the biases that are known to affect other measures of inflation at the consumer or household level and if forced to quantify potential bias a point estimate of 1 0 percent strikes us as reasonable potential bias of this magnitude in conjunction with the inherent noisiness of the headline number and the well known aversion of central bankers to deflation argues for a modest upward redefinition of the rate of hicp inflation consistent with price stability finally we show that the ecb would be well served by increasing their use of nontraditional core inflation measures

new directions for stochastic open economy models the paper develops a simple stochastic new open economy macroeconomic model based on sticky nominal wages explicit solution of the wage setting problem under uncertainty allows one to analyze the effects of the monetary regime on welfare expected output and the expected terms of trade despite the potential interplay between imperfections due to sticky wages and monopoly the optimal monetary policy rule has a closed form solution to motivate our model we show that observed correlations between terms of trade and exchange rates are more consistent with our traditional assumptions about nominal rigidities than with a popular alternative based on local currency pricing 2000 elsevier science b v all rights reserved

optimal monetary policy with international trade in intermediate inputs abstract this paper examines optimal monetary policy in a two country new keynesian model with international trade in intermediate inputs we derive the loss function of a cooperative monetary policymaker and find that the optimal monetary policy must target intermediate goods price inflation rates final goods price inflation rates final goods output gaps and relative price gaps we use the welfare loss under the optimal monetary policy as a benchmark to evaluate the welfare implications of three taylor type monetary policy rules a main finding is that the degree of price stickiness at the stage of intermediate goods production is a key factor to determine which policy rule should be followed specifically when the degree of price stickiness at the stage of intermediate goods production is high the policymaker should follow intermediate goods ppi based taylor rule whereas cpi based taylor rule should be followed when the degree of price stickiness at the stage of intermediate goods production is intermediate or low

do the ecb and the fed really need to cooperate optimal monetary policy in a two country world abstract a two country model with monopolistic competition and price stickiness is employed to investigate the implications for macroeconomic stability and the welfare properties of three international policy arrangements a cooperative b non cooperative and c monetary union i characterize the conditions under which there is scope for policy cooperation and quantify the costs of non cooperation and monetary union the non cooperative equilibrium may be suboptimal because of terms of trade spillover effects while monetary union may be suboptimal because of the sluggishness of relative prices both the costs of policy competition and of a monetary union are sensitive to the values assumed for the intertemporal and international demand elasticity and the degree of openness of the economy independently of the calibration scenario adopted the ecb has little to gain by coordinating with the fed

monetary policy natural resources and federal redistribution can monetary policy shocks induce redistribution across natural resource rich and poor states within a federation we conjecture that resource rich states are capital intensive hence their investment is more responsive to changes in monetary policy consequently contractionary monetary policy shocks e g increases in the interest rate may induce redistribution from resource poor states to resource rich ones via an equalizing federal transfer scheme because investment is reduced more strongly in the latter we test these hypotheses using a panel of u s states covering several decades and find that 1 resource rich states are significantly and persistently more capital intensive 2 contractionary monetary policy shocks induce a relative drop increase in investment federal transfers in resource rich states over the course of four years 3 these patterns are driven by resource induced differences in the capital share in the economy we estimate that a one standard deviation contractionary monetary shock induces within the first year federal redistribution of approximately 2 5 billion from the resource poor to the resource rich states representing about 11 of the total average annual federal transfers received by the latter states

the aggregate implications of regional business cycles during the last recession and its aftermath aggregate price growth and aggregate nominal wage growth remained robust despite the high rate of unemployment we document that u s states with weaker labor markets experienced lower price growth lower nominal wage growth and lower real wage growth during the great recession given that reliable measures of local prices do not exist we create our own state price indices using scanner data from the nielsen retail scanner database the main innovation of the paper is the development of an econometric procedure that combines cross region data with aggregate time series data to infer the underlying shocks driving both aggregate and regional business cycles applying our procedure to the great recession we find that a combination of both demand and supply shocks are necessary to account for the joint dynamics of aggregate prices wages and employment during the 2007 2012 period in contrast we find that only demand shocks are needed to explain the cross region variation the results suggest that only using cross region variation to explain aggregate fluctuations is insufficient when shocks do not have a substantive regional component

optimal monetary policy in the euro area in the presence of heterogeneity abstract this paper examines the optimal design of monetary policy in the european monetary union in the presence of structural asymmetries across union member countries it derives analytically an optimal interest rate rule under commitment and studies the dependence of its coefficients on the parameters of the structural model of each economy the central bank s preferences for inflation and output stabilization as shown in its loss function and the relative size of each country based on a two country forward looking general equilibrium model which is estimated for two euro area countries germany and france we show that there are gains to be achieved by the ecb taking into account the heterogeneity of economic structures this finding appears to be robust under alternative weights given by the central bank to the stabilization of the target variables although the implementation of the proposed rule involves difficulties relating to data and estimation constraints as well as risks of accommodating structural divergences it is important that the ecb takes into consideration national characteristics in formulating its monetary policy especially in view of more countries joining the european monetary union in the future however as monetary and financial integration advances the welfare benefits of monetary policy responding to individual countries variables may become less significant

inflation targeting and exchange rate pass through this paper analyzes how endogenous imperfect exchange rate pass through affects inflation targeting optimal monetary policies in a new keynesian small open economy the paper shows that an inverse relation exists between the pass through and the insulation of the economy from foreign and monetary policy shocks and that imperfect pass through tends to decrease the variability of the terms of trade furthermore with cpi inflation targeting in the short run delayed pass through constrains monetary policy more than incomplete pass through and interest rate smoothing amplifies this effect when the pass through decreases the variability in economic activity tends to rise and the trade off between the stabilization of cpi inflation and output worsens in direct relation to how strictly the central bank is targeting cpi inflation in contrast with domestic inflation targeting optimal monetary policy is not constrained and opposite results occur consequently imperfect pass through favors the choice of domestic to cpi inflation targeting

fiscal and monetary rules for a currency union abstract this paper addresses the optimal joint conduct of fiscal and monetary policy in a two country model of a currency union with staggered price setting and distortionary taxes a tractable linear quadratic approximation permits a representation of the optimal policy plan in terms of targeting rules in the optimal equilibrium monetary policy should achieve aggregate price stability following a flexible inflation targeting rule fiscal policy should stabilize idiosyncratic shocks allowing for permanent variations of government debt but should abstain from creating inflationary expectations at the union level simple policy rules can approximate the optimal commitment benchmark through a mix of strict inflation targeting and flexible budget rules conversely the welfare costs of balanced budget rules are at least one order of magnitude higher than conventional estimates of the costs of business cycle fluctuactions

global versus local shocks in micro price dynamics a number of recent papers point to the importance of distinguishing between the price reaction to macro and micro shocks we emphasize instead the importance of distinguishing between global and local shocks we exploit a panel of 276 micro price levels collected on a semi annual frequency over two decades in 59 countries around the world that enables us to distinguish between different types global and local of macro and micro shocks we find that global macro and micro shocks are always associated with a slower response of prices than the respective local shocks focusing on structural monetary macro shocks we show that prices reach their long run value much slower in response to a global macro shock as compared to the time it takes for prices to reach their long run value in response to a local macro shock

welfare and macroeconomic interdependence we develop a baseline model of monetary and fiscal transmission in interdependent economies the welfare effects of expansionary policies are related to monopolistic supply in production and monopoly power of a country in trade an unanticipated exchange rate depreciation can be beggar thyself rather than beggar thy neighbor as gains in domestic output are offset by deteriorating terms of trade smaller and more open economies are more prone to suffer from inflationary shocks larger economies benefit from moderate demand led expansions but may be worse off if policy makers attempt to close the output gap fiscal shocks are generally beggar thy neighbor in the long run in the short run they raise domestic demand at given terms of trade thus reducing the welfare benefits from monetary expansions analytical tractability makes our model uniquely suitable as a starting point to approach the recent new open economy macroeconomic literature

the exchange rate in a dynamic optimizing business cycle model with nominal rigidities a quantitative investigation this paper studies a quantitative dynamic optimizing business cycle model of a small open economy with staggered price and wage setting the model exhibits exchange rate overshooting in response to money supply shocks the predicted variability of the nominal and especially of the real exchange rate is noticeably higher than in standard real business cycle models with flexible prices and wages a positive domestic money supply shock is predicted to lower the domestic interest rate raise gdp and trigger a depreciation of both the nominal and real exchange rate increases in domestic productivity and in the world interest rate are also predicted to induce a nominal and real exchange rate depreciation 2001 elsevier science b v all rights reserved

the transmission of monetary policy in a multisector economy this article constructs and estimates a sticky price dynamic stochastic general equilibrium model with heterogeneous production sectors firms in different sectors vary in their price rigidity production technology and the combination of material and investment inputs in particular firms buy inputs from all sectors using the actual input output matrix and capital flow table of the u s economy by relaxing the standard assumption of symmetry this model allows idiosyncratic sectoral dynamics in response to monetary policy shocks the model is estimated by the generalized method of moments using sectoral and aggregate u s time series

inflation targeting what inflation rate to target abstract in an economy with nominal rigidities in both an intermediate good sector and a finished good sector and thus with a natural distinction between cpi and ppi inflation rates a benevolent central bank faces a tradeoff between stabilizing the two measures of inflation a final output gap and unique to our model a real marginal cost gap in the intermediate sector so that optimal monetary policy is second best we discuss how to implement the optimal policy with minimal information requirement and evaluate the robustness of these simple rules when the central bank may not know the exact sources of shocks or nominal rigidities a main finding is that a simple hybrid rule under which the short term interest rate responds to cpi inflation and ppi inflation results in a welfare level close to the optimum whereas policy rules that ignore ppi inflation or ppi sector shocks can result in significant welfare losses

does exchange rate variability matter for welfare a quantitative investigation of stabilization policies abstract this paper studies what degree of exchange rate stabilization is optimal for several types of open economies this is accomplished through a quantitative evaluation of optimal monetary policy rules in a two country sticky price model first a calibrated benchmark model with incomplete asset markets supports past conclusions from simpler models emphasizing inflation stabilization rather than exchange rate stabilization it also highlights that the utility gains from optimal stabilization policy are small second while an economy extended to include consumer habits implies greater sensitivity by households to consumption variability it has only minor effects on the benchmark conclusions and benefits finally these conclusions are altered under an alternative environment where international asset markets exhibit asymmetry in the form of original sin such countries can benefit from policies that aggressively stabilize the exchange rate with utility gains larger than the previous cases

the dynamics of a small open economy in response to monetary fiscal and productivity shocks abstract this paper evaluates empirically the relative importance of monetary and fiscal versus technology shocks in an open economy characterized by perfect international capital mobility the variance covariance matrix of these shocks is estimated a stochastic model is used to perform numerical simulations the results show that persistent shocks to productivity can reproduce several empirical regularities including the puzzling high correlation between national saving and investment remarkably well and that monetary and fiscal shocks play a minor role

exchange rate economics is always and everywhere controversial abstractthis article reviews the major developments in the recent literature on exchange rate economics it is argued that the link between the exchange rate and economic fundamentals is breaking new ground evidence indicates that alternative analytical frameworks such as the new open economy macroeconomics and exchange rate arrangements such as the euro have their theoretical and analytical elegance but are proving empirically very difficult to implement the role of methodological advances and alternative fundamental instruments such as world commodity prices is also highlighted

large scale bond purchases in a currency union with segmentation in the market for government debt abstract the literature on large scale purchases of government debt emphasises the importance of bond market segmentation along the maturity dimension for their transmission this study investigates how another form of segmentation that we observe the segmentation of government bond markets across countries can be exploited by the central bank of a currency union in which fiscal coordination is not attainable it is shown first that under general conditions government bond purchases which lower bond yields have first order effects on demand and hence inflation through a fiscal channel even in the absence of heterogeneity in investment opportunities the total effect on aggregate demand can be broken down into an income from debt issuance effect and a primary surplus effect as a result the central bank is able to use government bond purchases to control the terms of trade and achieve asymmetric degrees of stimulus across the members of the currency union without a transfer of resources if there is cross country segmentation in bond markets and home bias in government spending the paper characterises the welfare optimising mix of conventional interest rate policy and bond purchases in this scenario and gives an upper bound on the welfare benefits from using the additional tool

real exchange rate dynamics revisited a case with financial market imperfections abstract in this paper we investigate the relationship between real exchange rate dynamics and financial market imperfections for this purpose we first construct a new open economy macroeconomics noem model that incorporates staggered loan contracts as a simple form of the financial market imperfections our model with such a financial market friction replicates persistent volatile and realistic hump shaped responses of real exchange rates which have been thought very difficult to materialize in standard noem models remarkably these realistic responses can materialize even with both supply and demand shocks such as cost push loan rate and monetary policy shocks this implies that the financial market development is a key element for understanding real exchange rate dynamics

contract length heterogeneity and the persistence of monetary shocks in a dynamic generalized taylor economy we develop the generalized taylor economy gte in which there are many sectors with overlapping contracts of different lengths in economies with the same average contract length monetary shocks will be more persistent when longer contracts are present using the bils klenow distribution of contract lengths we find that the corresponding gte tracks the u s data well when we choose a gte with the same distribution of completed contract lengths as the calvo the economies behave in a similar manner

on the relevance of exchange rate regimes for stabilization policy this paper assesses the relevance of the exchange rate regime for stabilization policy using both fiscal and monetary policy we conclude that the exchange rate regime is irrelevant this is the case independently of the severity of price rigidities independently of asymmetries across countries in shocks and transmission mechanisms the only relevant conditions are on the mobility of labor and financial assets the results can be summarized with the claim that every currency area is an optimal currency area however with labor mobility or tradable state contingent assets additional policy instruments would be required to establish the irrelevance result

optimal monetary and macroprudential policy in a currency union abstract the financial crisis proved strikingly that financial frictions play a crucial role for system risk and policymakers have overlooked financial stability the obvious candidate for addressing financial stability is macroprudential policy in this paper we study the optimal ramsey monetary and macroprudential policy mix in a currency union in the case of different kinds of aggregate and idiosyncratic shocks the monetary and macroprudential instruments are modeled as independent tools with a union wide macroprudential tool full stabilization on the aggregate level is possible but welfare losses due to fluctuations in relative variables prevail with country specific macroprudential tools full stabilization of shocks is always possible but as a rule not optimal evaluating the performance of different policy regimes shows that the additional welfare gains from having country specific macroprudential tools are small and vanish as the ability of the central bank to commit decreases

monetary policy and stock prices in an open economy this paper studies monetary policy in a two country perpetual youth model where agents can invest their wealth in both stock and bond markets in our economy the foreign country is financially dominant in the sense that it hosts the only active equity market where all agents also residents of the home country can trade stocks of listed foreign firms we show that contrary to what happens in a closed economy the central bank in the economy endowed with an active stock market should grant a dedicated response to movements in stock prices driven only by local productivity shocks moreover we show that the other central bank should also optimally respond to stock price movements in the other economy as they affect the budget constraint of domestic residents optimal monetary policy pursuing price stability requires dedicated response to stock price dynamics driven by productivity shocks in addition to what implied by the simple existence of the terms of trade channel of policy transmission determinacy of rational expectations equilibria and approximation of the optimal policy by simple monetary rules are also investigated

has the inflation process changed does it change inflation has been low in many countries for at least a decade but have inflation processes changed in ways that would help make low inflation permanent using both aggregate and disaggregated inflation data we find that the means of inflation processes have become smaller over the past two decades and that allowing for these changes in the mean their persistence has not declined much changes in monetary policy frameworks and recessions appear to have contributed to a reduction in the mean of inflation but do not appear to have a meaningful impact on persistence and there is some evidence that the shifts in inflation expectations are the proximate cause of the changes in the mean of inflation these findings suggest that policy makers should focus on maintaining credibility and carefully monitoring inflation expectations for any indication that they are rising stephen g cecchetti and guy debelle

the need for international policy coordination what s old what s new what s yet to come the first generation of policy coordination models was introduced some 25 years ago it provided a rationale for policy coordination but the gains from coordination were generally thought to be small now a new generation of policy coordination models is emerging incorporating monopolistic competition and nominal inertia here we examine macroeconomic interdependence and the scope for policy coordination in a tractable second generation model with two countries and multiple sectors initial calibration of the model suggests that second generation models may have more scope for policy coordination than did the first d 2004 elsevier b v all rights reserved

sectoral phillips curves and the aggregate phillips curve sector level phillips curves are estimated in french data there is considerable heterogeneity across sectors with vastly different estimates of the backward looking component of inflation and the duration of nominal rigidities a multi sector model of inflation dynamics is calibrated on the basis of these sectoral estimates aggregate inflation simulated on the basis of heterogeneous sectors displays comparable dynamics to actual data a comparison is drawn between the policy trade offs implied by a phillips curve based on macroeconomic estimates vs one based on a model with heterogeneous sectors the difference is sizeable

home biased expectations and macroeconomic imbalances in a monetary union abstract under monetary union economic dynamics may diverge across countries due to regional inflation differentials and a pro cyclical real interest rate channel yet stability is generally ensured through endogenous adjustment of the real exchange rate the speed of adjustment depends inter alia on the way agents form expectations we propose a model in which agents expectations are largely based on domestic variables and less so on foreign variables we show that such home bias in expectations strengthens the real interest rate channel and causes country specific shocks to generate larger and more prolonged macroeconomic imbalances

downward wage rigidities and optimal monetary policy in a monetary union this paper analyses the implications of heterogeneity in the type of downward wage rigidity nominal or real for optimal monetary policy in a monetary union with asymmetric wage adjustment costs indexation in one region of the union reduces optimal grease inflation in the presence of common productivity shocks large common shocks may have sizeable and persistent effects on the intra union terms of trade whereby the region characterized by downward real wage rigidity adjusts with a persistent loss of competitiveness in response to asymmetric productivity shocks there is no role for grease inflation because relative price changes facilitating the real wage changes dominate the adjustment mechanism

micro based estimates of heterogeneous pricing rules the united states vs the euro area this paper presents us and euro area estimates for a fully heterogeneous model in which there is a continuum of firms setting prices with a constant probability of adjustment which may differ from firm to firm the estimated model accurately matches the empirical distribution function of individual price durations for the us and the euro area incorporating these micro based pricing rules into a dsge model we find that nominal shocks have a greater real impact in the fully heterogeneous economy than in the standard calvo model we also find that nominal and real shocks bring about a reallocation of resources among sectors monetary policy is found to have a greater real impact in the euro area than in the united states

the immediate challenges for the european central bank immediate challenges for the ecb issues in formulating a single monetary policy this paper discusses a number of issues that the newly constituted board of the ecb will face early on conducting a european monetary policy will be very different from living under the protective umbrella of the bundesbank we discuss voting on the ecb board and argue that the ability to communicate with the public will be critical for the success of the new institution we also ask how a single monetary policy a common change in the interest rate controlled by the ecb is transmitted to the economy of each member country we show that the monetary process differs significantly inside emu initially at least the cost of a disinflation episode could fall disproportionately on a few member countries those with both a financial structure that spreads a monetary contraction widely and a wage price structure that is relatively inflexible this process moreover is sure to evolve in part as a result of financial industry restructuring already under way but in part accentuated by the common money furthermore as the lucas principle suggests the wage price process itself will adapt to the changing focus of european monetary policy rudi dornbusch carlo favero and francesco giavazzi

optimal monetary and fiscal policy in a currency union we lay out a tractable model for the analysis of optimal monetary and fiscal policy in a currency union the monetary authority sets a common interest rate for the union whereas fiscal policy is implemented at the country level through the choice of government spending in the presence of country specific shocks and nominal rigidities the policy mix that is optimal from the viewpoint of the union as a whole requires that inflation be stabilized at the union level by the common central bank whereas fiscal policy has a country specific stabilization role one beyond the efficient provision of public goods

eurosystem monetary targeting lessons from u s data abstract using a small empirical model of inflation output and money estimated on u s data we compare the relative performance of monetary targeting and inflation targeting the results show monetary targeting to be quite inefficient yielding both higher inflation and output variability this is true even with a nonstochastic money demand formulation our results are also robust to using a p model of inflation therefore in these popular frameworks there is no support for the prominent role given to money growth in the eurosystem s monetary policy strategy

understanding the dynamic effects of government spending on foreign trade abstract using vector autoregressions on u s time series the present paper documents the effects of fiscal policy on foreign trade an increase in government spending significantly depreciates the nominal exchange rate appreciates the terms of trade and increases net exports exposed to the same spending shock a new keynesian general equilibrium model is shown to match qualitatively the response of relative prices the response of net exports in contrast depends on the intra and intertemporal elasticities of substitution and the degree of home bias in private spending an accommodating monetary policy dampens but does not alter the response of net exports

incomplete exchange rate pass through and simple monetary policy rules abstract this paper investigates the performance of various monetary policy rules in an open economy with incomplete exchange rate pass through implementing monetary policy through an exchange rate augmented policy rule does not improve social welfare compared to using an optimized taylor rule irrespective of the degree of pass through a direct exchange rate response improves welfare only if the other reaction coefficients on inflation and output are sub optimal however an indirect exchange rate response through a policy reaction to consumer price index cpi inflation rather than to domestic inflation is welfare enhancing this result is independent of whether society values domestic or cpi inflation stabilization

monetary and fiscal policies interaction in monetary unions in this paper the literature on the interaction between monetary and fiscal policies in a monetary union is surveyed by adopting the concept of symbiosis as a starting point the paper highlights the importance of uncertainty policy makers preferences and targets then the role of commitment to policy rules and coordination is addressed the analysis also focuses on the importance of the data considered for the generation of the policy mix as a final step the paper discusses the main results in the literature on public debt management in a monetary union all the reported theoretical results are then adopted to retrieve policy and institutional implications for the european monetary union

technological change sectoral shifts and the distribution of earnings a human capital model the paper studies the long run effect of technological change on a heterogeneous labour market the innovation s impact on the allocation of workers between industries and on the distribution of earnings depends critically on how the technical change alters skill requirements skill using inventions which raise productivity and skill requirements increase inequality and tend to shift labour out of the innovating sector skill neutral inventions cause neither changes in inequality nor in general sectoral shifts skill saving inventions reduce inequality and tend to shift labour towards the innovating sector only a skill neutral invention can lead to a pareto improvement

smoothed interest rate setting by central banks and staggered loan contracts i investigate a new source of economic stickiness namely staggered loan interest rate contracts under monopolistic competition this study introduces this mechanism into a standard new keynesian model simulations show that a response to a financial shock is greatly amplified by the staggered loan contracts although a response to a productivity cost push or monetary policy shock is not much affected i derive an approximated loss function and analyse optimal monetary policy unlike other models the function includes a quadratic loss of the first order difference in loan rates thus central banks have an incentive to smooth the policy rate

the new open economy macroeconomics a survey since the 1995 publication of obsteld and rogoff s redux model there has been an outpouring of research on open economy dynamic general equilibrium models that incorporate imperfect competition and nominal rigidities this paper offers an interim survey of this recent literature 2001 elsevier science b v all rights reserved

exchange rate determination under interest rate rules we propose a theory of exchange rate determination under interest rate rules in a two country model we first show that simple interest rate feedback rules can determine a unique and stable equilibrium without any explicit reaction to the nominal exchange rate we characterize how the behavior of the exchange rate and of the terms of trade depends in a critical way on the monetary regime chosen though not necessarily on monetary shocks we give a simple account of exchange rate volatility in terms of monetary policy rules we provide an explanation of the relation between nominal exchange rate volatility and macroeconomic variability in terms of the monetary regime adopted by monetary authorities

asymmetric labor market institutions in the emu and the volatility of inflation and unemployment differentials how does the asymmetry of labor market institutions affect the adjustment of a currency union to shocks to answer this question this paper sets up a dynamic currency union model with monopolistic competition and sticky prices hiring frictions and real wage rigidities in our analysis we focus on the differentials in inflation and unemployment between countries as they directly reflect how the currency union responds to shocks we highlight the following three results first we show that it is important to distinguish between different labor market rigidities as they have opposite effects on inflation and unemployment differentials second we find that asymmetries in labor market structures tend to increase the volatility of both inflation and unemployment differentials finally we show that it is important to take into account the interaction between different types of labor market rigidities overall our results suggest that asymmetries in labor market structures worsen the adjustment of a currency union to shocks

the optimal rate of inflation with trending relative prices relative price trends mean that monetary policy cannot stabilize the nominal prices of all consumption categories if prices are sticky monetary policy must then trade off distortions within different categories more weight should be placed on stabilizing prices for which adjustment entails greater distortions with exogenous price stickiness a simple model calibrated to u s data implies that slight deflation is optimal even absent money demand considerations if price stickiness is endogenous because of fixed costs of adjustment small inflation or small deflation can be optimal depending on whether demand conditions or price adjustment costs vary across sectors

is canada an optimal currency area an inflation targeting perspective we propose a method based on the currency union model of gali and monacelli 2008 to determine whether a region within an existing currency area belongs in the currency union the method involves assessing the predictability of regional inflation rates at medium term horizons we apply the method to the canadian provinces and find that for all but alberta there is little evidence of costs in terms of inflation arising from national monetary policy for alberta the evidence suggests that they are not as well served by the inflation targeting framework and that a more flexible policy environment might improve inflation outcomes

labor immobility and the transmission mechanism of monetary policy in a monetary union abstract it is believed that a common monetary policy in a monetary union will have identical effects on different countries as long as these countries have identical fundamentals we show that when there is specialization in production the terms of trade react to the shock the transmission mechanism of a monetary shock has in this case an additional channel the terms of trade this is the case even if state contingent assets can be traded across countries for a reasonable parametrization the differential on the transmission across countries is quantitatively significant when compared with the effect on the union s aggregates monetary shocks create cycles with higher volatility in poor countries than in richer ones

regional inflation spatial locations and the balassa samuelson effect evidence from japan we empirically analyse regional inflation using data from japan where there is no regulation to impede the free movement of labour capital goods and services across regions in particular our analysis will focus on the geographical location of regions and the productivity known as the balassa samuelson bs effect as explanations for the dynamics of regional inflation based on a spatial model which is consistent with the theoretical specification of the bs we have confirmed that while it is a relatively small country in terms of land area both spatial location and productivity are important determinants of regional inflation

comovements and heterogeneity in the euro area analyzed in a non stationary dynamic factor model this paper establishes stylized facts on comovements and heterogeneity of individual euro area countries output and price developments in the past two decades for this purpose a non stationary structural dynamic factor model is fitted to a large dataset of euro area macroeconomic variables the main results are as follows both common factors and idiosyncratic components are important in explaining individual countries output and price developments in the euro area and are also both very persistent idiosyncratic shocks and adjustments to these shocks are mainly responsible for cross country heterogeneity the asymmetric transmission of common shocks plays a minor role finally there is no strong evidence that some common shocks lead to greater heterogeneity than others copyright 2009 john wiley sons ltd

the inherent benefit of monetary unions abstract if the monetary authority lacks commitment a monetary union can dominate flexible exchange rates with forward looking staggered pricing inertia in the terms of trade induced by a fixed exchange rate is a benefit under discretion since it acts like a commitment device by trading off flexibility in the adjustment of the terms of trade the monetary authority improves on its ability to manage private sector s expectations the higher the incidence of asymmetric inefficient shocks and or the higher the degree of nominal price rigidity the greater the inherent benefit of monetary unions in stark contrast to the traditional optimum currency area theory

what measure of inflation should a central bank target this paper assumes that a central bank commits itself to maintaining an inflation target and then asks what measure of the inflation rate the central bank should use if it wants to maximize economic stability the paper first formalizes this problem and examines its microeconomic foundations it then shows how the weight of a sector in the stability price index depends on the sector s characteristics including size cyclical sensitivity sluggishness of price adjustment and magnitude of sectoral shocks when a numerical illustration of the problem is calibrated to u s data one tentative conclusion is that a central bank that wants to achieve maximum stability of economic activity should use a price index that gives

macroeconomic policy wage setting and employment what difference does the emu make the likely impact of the emu on the variability and level of employment is analysed the major conclusions are 1 although an inflation target regime will constrain monetary policy of a non parti

regional inflation persistence evidence from italy vaona a and ascari g regional inflation persistence evidence from italy regional studies regional patterns of inflation persistence have received attention only at the level of european monetary union member states however economic disparities within european monetary union member states are an equally important policy issue this paper considers a country with a large regional divide italy at a fine level of territorial disaggregation nuts 3 it is shown that economically backward regions display greater inflation persistence moreover higher persistence is linked to a lower degree of competitiveness in the retail sector finally the inflation persistence at the national level does not present any geographical aggregation bias because it equals the mean of inflation persistence of provincial data vaona a et ascari g la continuite de l inflation regionale des preuves provenant de l italie regional studies c est seulement par rapport aux pays membres de la zone euro que la distributio

exchange rate flexibility under the zero lower bound an independent monetary policy and a flexible exchange rate generally help a country in adjusting to macroeconomic shocks but recently in many countries interest rates have been pushed down close to the lower bound limiting the ability of policy makers to accommodate shocks even with flexible exchange rates this paper argues that when the zero bound constraint on nominal interest rates is binding and policy lacks an effective forward guidance mechanism a flexible exchange rate system may be inferior to a single currency area with monetary policy constrained by the zero bound a flexible exchange rate exacerbates the impact of shocks remarkably this may hold true even if only a subset of countries are constrained by the zero bound and other countries optimally adjust their interest rate targets for a regime of multiple currencies to dominate a single currency in a zero bound environment it is necessary to have effective forward guidance in monetary policy

does it matter for equilibrium determinacy what price index the central bank targets what inflation rate should the central bank target we address determinacy issues related to this question in a two sector model in which prices can differ in equilibrium we assume that the degree of nominal price stickiness can vary across the sectors and that labor is immobile the contribution of this paper is to demonstrate that a modified taylor principle holds in this environment if the central bank elects to target sector one and if it responds with a coefficient greater than unity to price movements in this sector then this policy rule will ensure determinacy across all sectors the results of this paper have at least two implications first the equilibrium determinacy criterion does not imply a preference to any particular measure of inflation second since the taylor principle applies at the sectoral level there is no need for a taylor principle at the aggregate level

monetary policy under emu this paper considers a number of issues connected with the implementation of monetary policy in the euro zone these include the techniques of monetary control whether to adopt an explicit inflation target and if so for what index the politics of decision making within the governing council of the european system of central banks the likelihood of there being conflicts of interest between the member countries of the euro zone the interaction of monetary and fiscal policy and the role of the escb in maintaining financial stability copyright 1998 by oxford university press