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131. International Coordination of Macroeconomic Policies: Still Alive in the New Millennium?

Author:
Joseph E. Gagnon, Dale W. Henderson, Brian M. Doyle, and Laurence H. Meyer
Publication Date:
04-2002
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
In this paper we provide two building blocks for an analysis of international policy coordination: (1) a survey of models of policy coordination, and (2) an account of experience with policy coordination among the G-7 countries and within Europe since the breakdown of the Bretton Woods System. Using these building blocks, we investigate the correspondence between the models and experience and attempt to draw lessons for both the modelers and the practitioners. We find that the correspondence is close enough that the models help in analyzing several instances of actual policy coordination, but that the correspondence could be even closer. As for lessons for modelers, we suggest that they devote more attention to the analysis of information exchange, a key feature of practical policy coordination; to the coordination of different types of policies; to the ramifications of political divisions within countries; and to the implications of market irrationality and speculative bubbles. As for lessons for policy makers, we suggest that they give more consideration to the choice of their ultimate objectives, in particular to whether the current account should always be close to balance; to achieving better internal policies; and to the greater use of fiscal policy as a stabilization tool.
Topic:
International Relations, Economics, Globalization, and International Trade and Finance
Political Geography:
Europe

132. Financial Centers and the Geography of Capital Flows

Author:
Francis E. Warnock and Chad Cleaver
Publication Date:
04-2002
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
We examine an assumption common in empirical work on bilateral portfolio capital flows that the countries the flows are attributed to are also the countries of the security's issuer, seller, or ultimate buyer. We do this by estimating U.S. investors' holdings of debt and equities in over 40 countries and, for the same countries, foreign investors' holdings of U.S. debt and equities. A comparison of our estimates with data from benchmark surveys provides insight into U.S. data on international debt and equity transactions. We find that, contrary to the common assumption, the data do not track the location of U.S. investment or the location of investors in U.S. assets very well. Because the U.S. portfolio flow data collection system was designed to measure cross-border transactions with foreign counterparties who are often intermediaries, the majority of the flows are attributed to financial centers. By aggregating our country-level estimates, we find that U.S. data accurately portray net inflows into U.S. equities and net outflows into foreign bonds. However, the data substantially overcount net inflows into U.S. bonds and may undercount net outflows into foreign equities. We conclude with a discussion of the implications of our findings for research on capital flows.
Topic:
International Relations, Economics, and International Trade and Finance
Political Geography:
United States

133. Regional Influences on U.S. Monetary Policy: Some Implications for Europe

Author:
Ellen E. Meade and D. Nathan Sheets
Publication Date:
02-2002
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
This paper looks at the monetary policy decisions of the U.S. Federal Reserve and asks whether those decisions have been influenced solely by national concerns, or whether regional factors have played a role. All of the Federal Reserve's policymakers have some regional identity, i.e., either their positions explicitly carry some regional affiliation or their region of origin is a factor that must be considered in the selection process. This research is relevant for the Fed, and it may also be relevant for Europe's fledgling central bank in Frankfurt. Critics have asserted that ECB policymakers have an incentive to base policy on national developments and respond to national political pressures. We find that Fed policymakers do take into account developments in regional unemployment when deciding monetary policy, and that these regional developments are more important for central bankers at the hub than in the spokes. These findings are robust to a variety of different specifications of the voting equation.
Topic:
Economics and International Trade and Finance
Political Geography:
United States and Europe

134. Identifying VARs Based on High Frequency Futures Data

Author:
Jonathan H. Wright, Jon Faust, and Eric Swanson
Publication Date:
02-2002
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
Using the prices of federal funds futures contracts, we measure the impact of the surprise component of Federal Reserve policy decisions on the expected future trajectory of interest rates. We show how this information can be used to identify the effects of a monetary policy shock in a standard monetary policy VAR. This constitutes an alternative approach to identification that is quite different, and, we would argue, more plausible, than the conventional short-run restrictions. We find that the usual recursive identification of the model is rejected, but we nevertheless agree with the literature's conclusion that only a small fraction of the variance of output can be attributed to monetary policy shocks.
Topic:
Economics, Emerging Markets, and International Trade and Finance
Political Geography:
United States

135. Inflation Targeting and Nominal Income Growth Targeting: When and Why Are They Suboptimal?

Author:
Dale W. Henderson and Jinill Kim
Publication Date:
02-2002
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
We derive optimal monetary stabilization rules and compare them to simple rules under both full and partial information. The nominal interest rate is the instrument of monetary policy. Special attention is devoted to inflation targeting and nominal-income-growth targeting. We use an optimizing-agent model of a closed economy which features monopolistic competition in both product and labor markets. A stabilization problem exists because there are one-period nominal contracts, either for wages alone or for both wages and prices, and three shocks that are unknown when contracts are signed. In order to highlight basic theoretical results, we deliberately keep our model simple enough that we can obtain exact solutions. Optimal rules maximize the expected utility of the representative agent subject to the information set of the policymaker. A key result, possibly surprising at first, is that even with monopolistic competition, the optimal full information policy makes the economy mimic the hypothetical equilibrium with flexible prices and wages. We explain why strict versions of inflation targeting, nominal income growth targeting, and other such simple rules are suboptimal under both full and partial information and derive flexible versions that are optimal under certain partial information assumptions. Nominal income growth targeting dominates inflation targeting for plausible parameter values.
Topic:
Economics, Emerging Markets, and International Trade and Finance
Political Geography:
United States

136. On the Sequencing of Projects, Reputation Building, and Relationship Finance

Author:
David C. Smith, Steven Ongena, and Dominik Egli
Publication Date:
02-2002
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
We study the decision an entrepreneur faces in financing multiple projects and show that relationship financing will arise endogenously in an environment where strategic defaults are likely, even when firms have access to arm's-length financing. Relationship financing allows an entrepreneur to build a private reputation for repayment that reduces the cost of financing. However, in an environment where the risk of strategic default is low, the benefits from reputation building are outweighed by holdup rents extractable by the incumbent lender. Entrepreneurs then choose to finance projects from single or multiple arm's-length lenders.
Topic:
International Relations, Economics, and International Trade and Finance
Political Geography:
United States

137. An Empirical Comparison of Bundesbank and ECB Monetary Policy Rules

Author:
John H. Rogers, Jonathan H. Wright, and Jon Faust
Publication Date:
08-2001
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
We estimate a monetary policy reaction function for the Bundesbank and use it as a benchmark to assess the monetary policy of the ECB since the launch of the euro in January 1999. We find that euro interest rates are low relative to this benchmark. We consider several possible reasons for this, including the divergence between core and headline inflation, inflation having turned out to be higher than could have been foreseen by the ECB and the possibility that the ECB is focussing only on macroeconomic conditions in a subset of member countries. We argue that these potential explanations cannot account for the difference between recent interest rates and our estimated Bundesbank benchmark. Our results suggest that the reaction function of the ECB features a high weight on the output gap relative to the weight on inflation, compared to the Bundesbank.
Topic:
Development, Economics, and International Trade and Finance
Political Geography:
United States

138. Monetary Policy and Exchange Rate Pass-Through

Author:
Jane Ihrig and Joseph E. Gagon
Publication Date:
07-2001
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
The pass-through of exchange rate changes into domestic inflation appears to have declined in many countries since the 1980s. We develop a theoretical model that attributes the change in the rate of pass-through to increased emphasis on inflation stabilization by many central banks. This hypothesis is tested on twenty industrial countries between 1971 and 2003. We find widespread evidence of a robust and statistically significant link between estimated rates of pass-through and inflation variability. We also find evidence that observed monetary policy behavior may be a factor in the declining rate of pass-through.
Topic:
Development, Economics, and International Trade and Finance
Political Geography:
United States

139. Permanent and Transitory Components of Business Cycles: Their Relative Importance and Dynamic Relationship

Author:
Chang-Jin Kim, Jeremy Piger, and Richard Startz
Publication Date:
05-2001
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
This paper investigates the relationship between permanent and transitory components of U.S. recessions in an empirical model allowing for business cycle asymmetry. Using a common stochastic trend representation for real GNP and consumption, we divide real GNP into permanent and transitory components, the dynamics of which are different in booms vs. recessions. We find evidence of substantial asymmetries in postwar recessions, and that both the permanent and transitory component have contributed to these recessions. We also allow for the timing of switches from boom to recession for the permanent component to be correlated with switches from boom to recession in the transitory component. The parameter estimates suggest a specific pattern of recessions: switches in the permanent component lead switches in the transitory component both when entering and leaving recessions.
Topic:
Development, Economics, and International Trade and Finance
Political Geography:
United States and Mexico

140. The Use of Cyclical Indicators in Estimating the Output Gap in Japan

Author:
Jane Haltmaier
Publication Date:
04-2001
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
The paper uses capital and labor utilization rates to derive estimates of the Japanese output gap and potential output. Two techniques are used. The first uses the cyclical indicators to adjust potential output estimates derived from a Hodrick-Prescott filter over the most recent period when such estimates are generally considered to be unreliable. The second estimates equilibrium levels of the cyclical indicators and uses an Okun's Law-type relationship to derive output gaps and potential output. The second method is also applied to the components of potential output to derive a third estimate. These methods suggest that the current Japanese output gap is considerably larger than a simple Hodrick-Prescott filter would suggest.
Topic:
Economics, Emerging Markets, and International Trade and Finance
Political Geography:
United States and Japan