• Selected
• Entire List

Abstract:
This paper reviews recent research on central bank independence (CBI). After we have distinguished between independence and conservativeness, the literature on optimal inflation contracts is discussed, followed by research in which the inflationary bias is endogenised. Finally, the various challenges that have been raised against previous empirical findings on CBI are reviewed. We conclude that the negative relationship between CBI and inflation is quite robust.

Abstract:
This paper introduces a parameter for central bank independence in a monetary policy game with a conservative central banker. It tries to explain the optimal degree of central bank independence and conservativeness by four economic and political determinants, both theoretically and empirically. There appears to be a trade off between central bank independence and conservativeness. Then, by comparing the optimal degree of conservativeness and independence with the actual degree of independence, we want to identify the optimal degree of conservativeness for the countries participating in EMU.

Abstract:
The paper builds a simplified model describing the economy of a currency union with decentralised national fiscal policy, where the main features characterising the policy-making are similar to those in EMU. National governments choose the size of deficit taking into account the two main rules of the Stability and Growth Pact on public finance. Unlike previous literature the asymmetric working of those rules is explicitly modelled in order to identify its impact on the Nash equilibrium of deficits arising from a game of strategic interaction between fiscal authorities in the union.

Stability and Growth Pact, EMU, asymmetric fiscal rules, decentralised fiscal policy

Abstract:
The Paper builds a simplified model describing the economy of a currency union with decentralized national fiscal policy, where the main features characterizing the policy-making are similar to those in EMU. National governments choose the size of deficit taking into account the two main rules of the Stability and Growth Pact on public finance. Unlike previous literature, the asymmetric working of those rules is explicitly modeled in order to identify its impact on the Nash equilibrium of deficits arising from a game of strategic interaction between fiscal authorities in the union.

Stability and growth pact, EMU, asymmetric fiscal rules, decentralized fiscal policy

Abstract:
The literature has documented an international risk sharing puzzle: there seem to be substantial unexploited gains from international risk sharing. In this paper we analyze the relative contributions of the intertemporal and the cross-sectional smoothing channel to this puzzle. We find that the unexploited gains from intertemporal smoothing are large (2.8% for the representative G7 country during 1956-1992). By contrast, the gains from cross-sectional smoothing, once complete intertemporal smoothing has been achieved, seem to be small. Furthermore, we find that intertemporal gains are easier to achieve than cross-sectional gains: their implementation causes less incentive problems (moral hazard and default) and they can to a large extent be realized through existing financial assets. We conclude that instead of a general international risk sharing puzzle, we face an intertemporal smoothing puzzle.

international risk sharing, incentive constraints, welfare gains

Abstract:
The literature has documented an international risk sharing puzzle: there seem to be substantial unexploited gains from international risk sharing. In this paper we analyze the relative contributions of the intertemporal and the cross-sectional smoothing channel to this puzzle. We find that the unexploited gains from intertemporal smoothing are large (2.8% for the representative G7 country during 1956-1992). By contrast, the gains from cross-sectional smoothing, once complete intertemporal smoothing has been achieved, seem to be small. Furthermore, we find that intertemporal gains are easier to achieve than cross-sectional gains: their implementation causes less incentive problems (moral hazard and default) and they can to a large extent be realized through existing financial assets. We conclude that instead of a general international risk sharing puzzle, we face an intertemporal smoothing puzzle.

international risk sharing, incentive constraints, welfare gains

Abstract:
Banking regulation has proven to be inadequate to guard systemic stability in the recent financial crisis. Central banks have provided liquidity and ministries of finance have set up rescue programmes to restore confidence and stability. Using a model of a systemic bank suffering from liquidity shocks, we find that the unregulated bank keeps too much liquidity and takes excessive risk compared to the social optimum. A Lender of Last Resort can alleviate the liquidity problem, but induces moral hazard. Therefore, we introduce a fiscal authority that is able to bail out the bank by injecting capital. This authority faces a trade-off: when it imposes strict bailout conditions, investment increases but moral hazard ensues. Milder bailout conditions reduce excessive risk taking at the expense of investment. This resembles the current situation on financial markets, in which banks take less risk but also provide less credit to the economy.

Bank Regulation, Lender of Last Resort, Liquidity, Capital, Bailout

Abstract:
Banking regulation has proven to be inadequate to guard systemic stability in the recent financial crisis. Central banks have provided liquidity and ministries of finance have set up rescue programmes to restore confidence and stability. Using a model of a systemic bank suffering from liquidity shocks, we find that the unregulated bank keeps too much liquidity and takes excessive risk compared to the social optimum. A Lender of Last Resort can alleviate the liquidity problem, but induces moral hazard. Therefore, we introduce a fiscal authority that is able to bail out the bank by injecting capital. This authority faces a trade-off: when it imposes strict bailout conditions, investment increases but moral hazard ensues. Milder bailout conditions reduce excessive risk taking at the expense of investment. This resembles the current situation on financial markets, in which banks take less risk but also provide less credit to the economy.

Bank Regulation, Lender of Last Resort, Liquidity, Capital, Bailout

Abstract:
Banking regulation has proven to be inadequate to guard systemic stability in the recent financial crisis. Central banks have provided liquidity and ministries of finance have set up rescue programmes to restore confidence and stability. Using a model of a systemic bank suffering from liquidity shocks, we find that the unregulated bank keeps too much liquidity and takes excessive risk compared to the social optimum. A Lender of Last Resort can alleviate the liquidity problem, but induces moral hazard. Therefore, we introduce a fiscal authority that is able to bail out the bank by injecting capital. This authority faces a trade-off: when it imposes strict bailout conditions, investment increases but moral hazard ensues. Milder bailout conditions reduce excessive risk taking at the expense of investment. This resembles the current situation on financial markets, in which banks take less risk but also provide less credit to the economy.

Bailout, Bank Regulation, Capital, Lender of Last Resort, Liquidity

Abstract:
Should central banks increase their degree of transparency any further? We show that there is likely to be an optimal intermediate degree of central bank transparency. Up to this optimum more transparency is desirable: it improves the quality of private sector inflation forecasts. But beyond the optimum people might: (1) start to attach too much weight to the conditionality of their forecasts, and/or (2) get confused by the large and increasing amount of information they receive. This deteriorates the (perceived) quality of private sector inflation forecasts. Inflation then is set in a more backward looking manner resulting in higher inflation persistence. By using a panel data set on the transparency of 100 central banks we find empirical support for an optimal intermediate degree of transparency at which inflation persistence is minimized. Our results indicate that while there are central banks that would benefit from further transparency increases, some might already have reached the limit.

central bank transparency, inflation persistence, monetary policy

Abstract:
Should central banks increase their degree of transparency any further? We show that there is likely to be an optimal intermediate degree of central bank transparency. Up to this optimum more transparency is desirable: it improves the quality of private sector inflation forecasts. But beyond the optimum people might: (1) start to attach too much weight to the conditionality of their forecasts, and/or (2) get confused by the large and increasing amount of information they receive. This deteriorates the (perceived) quality of private sector inflation forecasts. Inflation then is set in a more backward looking manner resulting in higher inflation persistence. By using a panel data set on the transparency of 100 central banks we find empirical support for an optimal intermediate degree of transparency at which inflation persistence is minimized. Our results indicate that while there are central banks that would benefit from further transparency increases, some might already have reached the limit.

central bank transparency, monetary policy, inflation persistence

Abstract:
We provide an up-to-date overview of the literature on the desirability of central bank transparency from an economic viewpoint. Since the move towards more transparency, a lot of research on its effects has been carried out. First, we show how the theoretical literature has evolved, by looking into branches inspired by Cukierman and Meltzer (1986) and by investigating several, more recent, research strands (e.g. coordination and learning). Then, we summarize the empirical literature which has been growing more recently. Last, we discuss whether: i) the empirical research resolves all theoretical question marks, ii) how the findings of the literature match the actual practice of central banks, and iii) where there is scope for more research.

Central bank transparency, monetary policy, survey

Abstract:
We provide an up-to-date overview of the literature on the desirability of central bank transparency from an economic viewpoint. Since the move towards more transparency, a lot of research on its effects has been carried out. First, we show how the theoretical literature has evolved, by looking into branches inspired by Cukierman and Meltzer (1986) and by investigating several, more recent, research strands (e.g. coordination and learning). Then, we summarize the empirical literature which has been growing more recently. Last, we discuss whether:
- the empirical research resolves all theoretical question marks,
- how the findings of the literature match the actual practice of central banks, and
- where there is scope for more research.

central bank transparency, monetary policy, survey

Abstract:
This paper examines the effect of monetary policy on the exchange rate during currency crises. Using data for a number of crisis episodes between 1986 and 2004, we find strong evidence that raising the interest rate: (i) has larger adverse balance sheet effects and is therefore less effective in countries with high domestic corporate short-term debt; (ii) is more credible and therefore more effective in countries with high-quality institutions; iii) is more credible and therefore more effective in countries with high external debt; and (iv) is less effective in countries with high capital account openness. We predict that monetary policy would have had the conventional supportive effect on the exchange rate during five of the crisis episodes in our sample, while it would have had the perverse effect during seven other episodes. For four episodes, we predict a statistically insignificant effect. Our results support the idea that the effect of monetary policy depends on its impact on fundamentals, as well as its credibility, as suggested in the recent theoretical literature.They also provide an explanation for the mixed findings in the empirical literature.

currency crisis, institutions, monetary policy, short-term debt, external debt, capital account openness

Abstract:
Central banks have become increasingly transparent during the last decade. One of the main benefits of transparency predicted by theoretical models is that it enhances the credibility, reputation, and flexibility of monetary policy, which suggests that increased transparency should result in lower nominal interest rates. This paper exploits a detailed transparency data set to investigate this relationship for eight major central banks. It appears that for all central banks, the level of interest rates is affected by the degree of central bank transparency. In particular, the majority of the improvements in transparency are associated with significant effects on interest rates, controlling for economic conditions. In most of these cases, interest rates are lower, often by around 50 basis points, although in some instances transparency appears to have had a detrimental effect on interest rates.

Central bank transparency, monetary policy, interest rates

Abstract:
Central banks have become increasingly transparent during the last decade. One of the main benefits of transparency predicted by theoretical models is that it enhances the credibility, reputation, and flexibility of monetary policy, which suggests that increased transparency should result in lower nominal interest rates. This paper exploits a detailed transparency data set to investigate this relationship for eight major central banks. It appears that for all central banks, the level of interest rates is affected by the degree of central bank transparency. In particular, the majority of the improvements in transparency are associated with significant effects on interest rates, controlling for economic conditions. In most of these cases, interest rates are lower, often by around 50 basis points, although in some instances transparency appears to have had a detrimental effect on interest rates.

central bank transparency, monetary policy, interest rates

Abstract:
In this paper, we incorporate the term structure of interest rates in a standard inflation forecast targeting framework. Learning about the transmission process of monetary policy is introduced by having heterogeneous agents - i.e., the central bank and private agents - who have different information sets about the future sequence of short-term interest rates. We analyse inflation forecast targeting in two environments. One in which the central bank has perfect knowledge, in the sense that it understands and observes the process by which private sector interest rate expectations are generated, and one in which the central bank has imperfect knowledge and has to learn the private sector forecasting rule for short-term interest rates. In the case of imperfect knowledge, the central bank has to learn about private sector interest rate expectations, as the latter affect the impact of monetary policy through the expectations theory of the term structure of interest rates. Here, following Evans and Honkapohja (2001), the learning scheme we investigate is that of least-squares learning (recursive OLS) using the Kalman filter. We find that optimal monetary policy under learning is a policy that separates estimation and control. Therefore, this model suggests that the practical relevance of the breakdown of the separation principle and the need for experimentation in policy may be limited.

Information, term structure of interest rates, least squares, optimization, inflation, forecasting, learning, rational expectations, Kalman filter

Abstract:
The Stability and Growth Pact has been under fire ever since it was born. But is the Pact a flawed fiscal rule? Against established criteria for an ideal fiscal rule, its design and compliance mechanisms show strengths and weaknesses. The latter tend to reflect trade-offs typical of supra-national arrangements. In the end, only a higher degree of fiscal integration would remove the inflexibility inherent in the recourse to predefined budgetary rules. No alternative solution put forward in the literature appears clearly superior. This does not mean that the original Pact of 1997 could not be improved. The debate on the SGP has shown that any reform should aim at overcoming the excessive uniformity of the rules, improving their transparency, correcting pro-cyclicality and strengthening enforcement. The reform of the Pact agreed in 2005 moves in this direction but leaves open a number of issues.

Fiscal policy, fiscal rules, economic and monetary union, Stability and Growth Pact

Abstract:
The Stability and Growth Pact has been under fire ever since it was born. But is the Pact a flawed fiscal rule? Against established criteria for an ideal fiscal rule, its design and compliance mechanisms show strengths and weaknesses. The latter tend to reflect tradeoffs typical of supra-national arrangements. In the end, only a higher degree of fiscal integration would remove the inflexibility inherent in the recourse to predefined budgetary rules. No alternative solution put forward in the literature appears clearly superior. This does not mean that the original Pact of 1997 could not be improved. The debate on the SGP has shown that any reform should aim at overcoming the excessive uniformity of the rules, improving their transparency, correcting pro-cyclicality and strengthening enforcement. The reform of the Pact agreed in 2005 moves in this direction but leaves open a number of issues.

EMS, fiscal policy, fiscal rules, Economic and Monetary Union, Stability and Growth Pact

Abstract:
This paper studies how the exposure of a country's corporate sector to interest rate and exchange rate changes affects the probability of a currency crisis. To analyze this question, we present a model that defines currency crisis as situations in which the costs of maintaining a fixed exchange rate exceed the costs of abandonment. The results show that a higher exposure to interest rate changes increases the probability of crisis through an increased need for output loss compensation and an increased efficacy of monetary policy in stimulating output. A higher exposure to exchange rate changes also increases the need for output loss compensation. However, it lowers the efficacy of monetary policy in stimulating output through the adverse balance sheet effects of exchange rate depreciation. As a result, its effects on the probability of crisis is ambiguous.

currency, financial crisis, monetary policy, foreign debt, balance sheets, short term debt

Abstract:
The implications of uncertain policy preferences for the targeting and contracting approaches to monetary policy are investigated. It is shown that, in the presence of uncertain preferences, a linear incentive contract in the sense of Walsh performs better than an explicit inflation target as proposed by Svensson. The reason is that an inflation target produces a higher variance of inflation. It is also shown that it is optimal to offer a linear inflation contract that does not depend on the degree of preference uncertainty.

Abstract:
In this paper we incorporate the term structure of interest rates in a standard inflation forecast targeting framework. We find that under flexible inflation targeting and uncertainty in the degree of persistence in the economy, allowing for active learning possibilities has effects on the optimal interest rate rule followed by the central bank. For a wide range of possible initial beliefs about the unknown parameter, the dynamically optimal rule is in general more activist, in the sense of responding aggressively to the state of the economy, than the myopic rule for small to moderate deviations of the state variable from its target. On the other hand, for large deviations, the optimal policy is less activist than the myopic and the certainty equivalence policies.

Learning, rational expectations, separation principle, term structure of interest rates

Abstract:
In this paper we incorporate the term structure of interest rates in a standard inflation forecast targeting framework. We find that under flexible inflation targeting and uncertainty in the degree of persistence in the economy, allowing for active learning possibilities has effects on the optimal interest rate rule followed by the central bank. For a wide range of possible initial beliefs about the unknown parameter, the dynamically optimal rule is in general more activist, in the sense of responding aggressively to the state of the economy, than the myopic rule for small to moderate deviations of the state variable from its target. On the other hand, for large deviations, the optimal policy is less activist than the myopic and the certainty equivalence policies.

Learning, Rational Expectations, Separation Principle, Term Structure of Interest Rates

Abstract:
The paper focuses on labor and product market deregulations, as fundamental elements in the passage from an investment to an innovation-based economy. The approach undertaken is prominently empirical. After a very brief description of the regulatory levels on the two sides of the Atlantic, we take two cornerstone theoretical models: one developed by Robert Gordon (1997), the other developed by Blanchard and Giavazzi (2003) and we observe how well their theoretical predictions are supported by hard data. We conclude with an independent study on the accuracy of the IMD competitiveness index in predicting the overall economic performance of countries close to the technological frontier.

Employment, unemployment, wages, growth, regulation, productivity, IMD competitiveness index

Abstract:
The paper focuses on labor and product market deregulations, as fundamental elements in the passage from an investment to an innovation-based economy. The approach undertaken is prominently empirical. After a very brief description of the regulatory levels on the two sides of the Atlantic, we take two cornerstone theoretical models: one developed by Robert Gordon (1997), the other developed by Blanchard and Giavazzi (2003) and we observe how well their theoretical predictions are supported by hard data. We conclude with an independent study on the accuracy of the IMD competitiveness index in predicting the overall economic performance of countries close to the technological frontier.

employment, unemployment, wages, growth, regulation, productivity, IMD

Abstract:
This paper examines the effect of monetary policy on the exchange rate during currency crises. Using data for a number of crisis episodes between 1986 and 2004, we find strong evidence that raising the interest rate: (i) has larger adverse balance sheet effects and is therefore less effective in countries with high domestic corporate short-term debt; (ii) is more credible and therefore more effective in countries with high-quality institutions; iii) is more credible and therefore more effective in countries with high external debt; and (iv) is less effective in countries with high capital account openness. We predict that monetary policy would have had the conventional supportive effect on the exchange rate during five of the crisis episodes in our sample, while it would have had the perverse effect during seven other episodes. For four episodes, we predict a statistically insignificant effect. Our results support the idea that the effect of monetary policy depends on its impact on fundamentals, as well as its credibility, as suggested in the recent theoretical literature. They also provide an explanation for the mixed findings in the empirical literature.

Currency Crises, Institutions, Monetary Policy, Short-Term Debt, External Debt, Capital Account Openness

Abstract:
Central banks have become more and more transparent about their monetary policy making process. In the central bank transparency literature the distinction between actual and perceived central bank transparency is often lacking. However, as perceptions are crucial for the actions of economic agents this distinction matters. A discrepancy between actual and perceived transparency may exist because of incomplete or incorrect transparency knowledge and other (psychological) factors. Even financial experts, the most important channel through which the central bank can influence the economy, might suffer from misaligned perceptions. We investigate the mismatch between actual and perceived transparency and its relevance by analyzing data of a Dutch household survey on the European Central Bank's transparency. To benefit from higher transparency perceptions the European Central Bank might feel tempted to stress its transparency strengths, but hide its transparency weaknesses.

behavioural economics, CentERpanel, central bank transparency, perceptions, survey

Abstract:
Central banks have become more and more transparent about their monetary policy making process. In the central bank transparency literature the distinction between actual and perceived central bank transparency is often lacking. However, as perceptions are crucial for the actions of economic agents this distinction matters. A discrepancy between actual and perceived transparency may exist because of incomplete or incorrect transparency knowledge and other (psychological) factors. Even financial experts, the most important channel through which the central bank can influence the economy, might suffer from misaligned perceptions. We investigate the mismatch between actual and perceived transparency and its relevance by analyzing data of a Dutch household survey on the European Central Bank's transparency. To benefit from higher transparency perceptions the European Central Bank might feel tempted to stress its transparency strengths, but hide its transparency weaknesses.

Central bank transparency, Perceptions, Survey, CentERpanel, Behavioral Economics

Abstract:
This paper starts with a discussion of the various aspects of accountability of central banks. On the basis of this discussion we construct an indicator for accountability for 16 central banks, including the European Central Bank. It is shown that the degree of accountability differs considerably and that the ECB has a rather low score. The indicator is used to examine the relationship between central bank independence and accountability. It is concluded that although there appears to be a negative relationship between independence and accountability, this certainly does not imply that a central bank cannot be both independent and accountable.

Central banks, democratic accountability, independence, indicators, comparison, European Central Bank

Abstract:
Recent cross-country studies on the globalization and output-inflation tradeoff correlation find openness has no significant effect on OECD countries. Those studies assume parameter constancy across countries. In this paper, we argue that this assumption does not hold for major industrialized countries. Using individual time series analysis, we find the effect of openness on the output-inflation trade off differ in sign and size across countries. In contrast to previous cross-country studies, we find globalization has significantly changed some major industrialized countries’ output inflation tradeoff. This has important implications for future theoretical and empirical research.

openness, output-inflation tradeoff, Phillips curve, time inconsistency theory

Abstract:
Recent cross-country studies on the globalization and output-inflation tradeoff correlation find openness has no significant effect on OECD countries. Those studies assume parameter constancy across countries. In this paper, we argue that this assumption does not hold for major industrialized countries. Using individual time series analysis, we find the effect of openness on the output-inflation trade off differ in sign and size across countries. In contrast to previous cross-country studies, we find globalization has significantly changed some major industrialized countries’ output inflation tradeoff. This has important implications for future theoretical and empirical research.

openness, output-inflation tradeoff, Phillips curve, time inconsistency theory

Abstract:
The Stability and Growth Pact is under fire. Problems have appeared in sticking to the rules. Proposals to reform the Pact or ditch it altogether abound. But is the Pact a flawed fiscal rule? Against established criteria for an ideal fiscal rule, its design and compliance mechanisms fare reasonably well. Where weaknesses are found, they tend to reflect trade-offs typical of supra-national arrangements. In the end, only a higher degree of fiscal integration would remove the inflexibility inherent in the recourse to predefined budgetary rules. This does not mean that the EU fiscal rules cannot be improved. Given the existing degree of political integration in EMU, however, internal adjustment rather than attempting to redesign the rules from scratch appears a more suitable way to bring about progress. Redefining the medium term budgetary target, improving transparency, tackling the pro-cyclical fiscal bias in good times, moving towards non-partisan application of the rules and improving transparency in the data can achieve both stronger discipline and higher flexibility.

Fiscal policy, fiscal rules, economic and monetary union, stability and growth pact

Abstract:
In this paper we incorporate the term structure of interest rates in a standard inflation forecast targeting framework. We find that under flexible inflation targeting and uncertainty in the degree of persistence in the economy, allowing for active learning possibilities has effects on the optimal interest rate rule followed by the central bank. For a wide range of possible initial beliefs about the unknown parameter, the dynamically optimal rule is in general more activist, in the sense of responding aggressively to the state of the economy, than the myopic rule for small to moderate deviations of the state variable from its target. On the other hand, for large deviations, the optimal policy is less activist than the myopic and the certainty equivalence policies.

Learning, Rational Expectations, Separation Principle, Term Structure of Interest Rates

Abstract:
Central bank transparency has become the topic of a lively public and academic debate on monetary policy. Unfortunately, it has been complicated by the fact that transparency is a qualitative concept that is hard to measure. This Paper proposes a comprehensive index for central bank transparency that comprises the political, economic, procedural, policy and operational aspects of central banking. The index is compiled for nine major central banks. It is based on an analysis of information disclosure practices and reveals a rich variety in the degree of central bank transparency.

Central banking, monetary policy, independence, accountability, transparency

Abstract:
In this paper we investigate central bank accountability by looking at the effect of transparency in a simple monetary policy game with an overriding mechanism. Monetary policy is transparent if there is little uncertainty about the central banker's preferences for inflation stabilization relative to output stabilization. Transparency enhances the central bank's accountability. The paper shows that transparency leads to a lower expected rate of inflation and less stabilization of supply shocks.

Accountability, central banks, monetary policy, transparency

Abstract:
This paper develops a theory of central bank accountability. Two aspects of accountability are considered. The first one is transparency of actual monetary policy, the second aspect is the question of who bears final responsibility for monetary policy. Monetary policy is transparent if there is little uncertainty about the central bankers preferences. Transparency enhances the central bank's accountability. Another way to make the central bank accountable is to shift final responsibility for monetary policy in the direction of the government. This can be achieved by making the cost of overriding the central bank lower. The paper shows that accountability through transparency leads to a lower expected rate of inflation and less stabilization of supply shocks. Accountability through shifting final responsibility in the direction of the government leads to higher inflationary expectations and more stabilization of supply shocks.

Abstract:
This Paper analyses the tax competition and tax exporting effect of financial integration. On the one hand, financial integration increases capital mobility and thus the incentive for countries to compete for capital. On the other hand, financial integration increases foreign ownership of firms and capital and allows for exportation of source taxes. Both effects have contrary implications for capital taxes. Allowing for imperfectly mobile capital, our analysis suggests that currently the tax exportation effect is dominating, which implies excessive capital taxation. From studying the benchmark of full financial integration we find that capital taxes are likely to increase from current levels. We further examine the tax exportation effect empirically and find that is significant as well as quantitatively important for the US.

Tax competition, capital mobility, cross-ownership

Abstract:
There is a broad consensus in the literature that costs of information processing and acquisition may generate costly disagreements in expectations among economic agents, and that central banks may play a central role in reducing such dispersion in expectations. This paper analyses empirically whether enhanced central bank transparency lowers dispersion among professional forecasters of key economic variables, using a large set of proxies for central bank transparency in 12 advanced economies. It finds evidence for a significant and sizeable effect of central bank transparency on forecast dispersion, be it by means of announcing a quantified inflation objective, other forms of communication, or by publishing central banks’ inflation and output forecasts. However, there also appear to be limits to central bank transparency, with decreasing marginal returns to enhancing (economic) transparency, and given our findings that disagreement among inflation expectations in the general public is not affected by the various central bank transparency measures analyzed in this paper.

central bank communication, central banking, disagreement, forecasting, inflation targeting, monetary policy, survey expectations, transparency

Abstract:
There is a broad consensus in the literature that costs of information processing and acquisition may generate costly disagreements in expectations among economic agents, and that central banks may play a central role in reducing such dispersion in expectations. This paper analyses empirically whether enhanced central bank transparency lowers dispersion among professional forecasters of key economic variables, using a large set of proxies for central bank transparency in 12 advanced economies. It finds evidence for a significant and sizeable effect of central bank transparency on forecast dispersion, be it by means of announcing a quantified inflation objective, other forms of communication, or by publishing central banks’ inflation and output forecasts. However, there also appear to be limits to central bank transparency, with decreasing marginal returns to enhancing (economic) transparency, and given our findings that disagreement among inflation expectations in the general public is not affected by the various central bank transparency measures analyzed in this paper.

central banking, transparency, disagreement, survey expectations, monetary policy, inflation targeting, central bank communication, forecasting

Abstract:
The translation of legal independence into actual independence is primarily determined by the rule of law. Inspired by the economic growth literature, where the role of institutions already is incorporated, we introduce Institutional Quality Indicators that can be used as reasonable proxies for the rule of law in a country. This idea can be seen as an important extension of the existing empirical research about the relationship between inflation and the institutional design of monetary institutions. With the rule of law factor we will get a better expression of effective central bank independence. Transition economies like former socialist economies in Europe are interesting candidates for the examination of the relationship between the rate of inflation, central bank reforms and the transition process. Legal Transition Indicators will be used as proxy for the rule of law in these countries. The liberalization process seems to be an important condition for the effectiveness of legal central bank independence. With the Cumulative Liberalization Index we incorporate the liberalization process into our analysis.

Central banks, legal independence, transition economies, inflation, reform

Abstract:
In this Paper we present a model that combines the second-generation trade-off between costs of maintenance and abandonment with possible balance-sheet problems in the corporate sector. We show how debt levels can move a small economy from a fixed exchange rate to a floating exchange rate equilibrium or vice versa, simply by altering the trade-off faced by the monetary authorities. Even if the monetary authorities still have a substantial amount of foreign reserves available to guarantee the fixed value of the currency, they might choose not to and abandon the fixed exchange rate regime. Although it is often argued that first- and second-generation literature have not been able to explain the crisis in East Asia (1997-98), our model suggests that adding corporate balance sheet positions to second-generation models could substantially improve the explanatory power of these models in the case of the Asian crisis.

Financial crises, monetary policy, financial fragility, currency crises, Asian crisis

Abstract:
This paper studies how the exposure of a country’s corporate sector to interest rate and exchange rate changes affects the probability of a currency crisis. To analyze this question, we present a model that defines currency crises as situations in which the costs of maintaining a fixed exchange rate exceed the costs of abandonment. The results show that a higher exposure to interest rate changes increases the probability of crisis through an increased need for output loss compensation and an increased efficacy of monetary policy in stimulating output. A higher exposure to exchange rate changes also increases the need for output loss compensation. However, it lowers the efficacy of monetary policy in stimulating output through the adverse balance sheet effects of exchange rate depreciation. As a result, its effect on the probability
of crisis is ambiguous.

Currency Crises, Monetary Policy, Short-Term Debt, Foreign Debt, Corporate Balance Sheets

Abstract:
Central banks around the world have a reputation for being secretive about their operations and market assessments. It is sometimes argued that central banks need flexibility and therefore cannot be fully transparent. We find that this explanation does not carry through in a forward-looking New Keynesian framework, where transparency about the central bank's forecasting procedures improves output stabilization. We also show that higher transparency increases optimal conservatism, as the benefits from higher transparency in terms of output stabilization are greater the more conservative is the central bank.

Abstract:
Some central banks have a reputation for being secretive. A justification for this behaviour that we find in the literature is that being transparent about operations and beliefs hinders the central bank in achieving the best outcome. In other words, a central bank needs flexibility and, therefore, cannot be fully transparent. Using a forward-looking New-Keynesian model, we find exactly the opposite. A central bank that is conservative improves output stabilization by being transparent about the procedures it uses to assess the economy and, especially, about the forecast errors it makes. Under certain conditions, transparency by a conservative central bank also improves interest rate stabilization. We also find that higher transparency makes it optimal for the central bank to be more conservative as the benefits from higher transparency in terms of output stabilization are greater the more conservative the central bank is.

Monetary policy, central bank, information processing, expectation formation

Abstract:
In a simple macromodel with forward-looking expectations, this Paper looks into disclosure policy when a central bank has private information on future shocks. The main result is that advance disclosure of forecasts of future shocks does not improve welfare, and in some cases is not desirable as it impairs stabilization of current inflation and/or output. This result holds when there is no credibility problem or the central bank's preference is common knowledge. When there is uncertainty about the central bank's preference shock, and this uncertainty is not resolved in the subsequent period, advance disclosure does not matter for current outcomes. The reason lies in the strong dependence of one-period-ahead private sector inflation forecasts on central bank actions, which induces the central bank to focus exclusively on price stability in subsequent periods. Another implication of the model is that, in contrast to forecasts of current period shocks emphasized by the literature, forecasts of future shocks may not be revealed to the public by current policy choices because the central bank refrains from responding to its own forecasts.

Forward-looking expectations, private information, central bank forecasts, central bank disclosure, central bank transparency

Abstract:
In this Paper, we incorporate the term structure of interest rates in a standard inflation forecast targeting framework. Learning about the transmission process of monetary policy is introduced by having heterogeneous agents - i.e., the central bank and private agents - who have different information sets about the future sequence of short-term interest rates. We analyse inflation forecast targeting in two environments. One in which the central bank has perfect knowledge, in the sense that it understands and observes the process by which private sector interest rate expectations are generated, and one in which the central bank has imperfect knowledge and has to learn the private sector forecasting rule for short-term interest rates. In the case of imperfect knowledge, the central bank has to learn about private sector interest rate expectations, as the latter affect the impact of monetary policy through the expectations theory of the term structure of interest rates. Here following Evans and Honkapohja (2001), the learning scheme we investigate is that of least-squares learning (recursive OLS) using the Kalman filter. We find that optimal monetary policy under learning is a policy that separates estimation and control. Therefore, this model suggests that the practical relevance of the breakdown of the separation principle and the need for experimentation in policy may be limited.

Learning, rational expectations, separation principle, Kalman filter, term structure of interest rates

Abstract:
This Paper analyses the optimal degree of flexibility under a Lucas type convex Phillipscurve. As a benchmark, we first analyse optimal monetary policy with a linear Phillipscurve and persistent cost-push shocks. As in Svensson (1997a), a central banker who possesses private information and who inherits society's preferences will engage in too much output stabilisation; because of which welfare will be improved by appointing an individual who is less flexible. Moreover, we are able to investigate the determinants of the optimal degree of flexibility and contrast them with results obtained in a situation where the central banker has an output target which exceeds its potential. If the central banker has no private information under a linear Lucas type Phillipscurve, it will be optimal to abstain from output stabilisation entirely. Next, we extend the symmetric information case by assuming the Phillipscurve is convex. In this respect, it is shown that even under strict inflation targeting, the optimal conditional inflation forecast will be state-dependent. This is because the central bank can to some extent predict the slope of the Phillipscurve. Furthermore, if the degree of flexibility is zero, monetary policy will be subject to a deflationary bias which will exceed the bias obtained in a model where the expected slope of the Phillipscurve is constant. We also show that the long run average rate of inflation will be strictly increasing in the degree of flexibility. This is because both demand uncertainty and persistent supply shocks will, on average, cause output to fall below potential. A central bank with an output target equal to potential will try to prevent this but because of the lack of an information asymmetry its attempts will only increase the expected rate of inflation. Therefore some degree of flexibility will be socially optimal in this model because it will render the deflationary bias obtained under strict inflation targeting less severe.

Convex Phillipscurve, uncertainty, optimal degree of central bank flexibility

Abstract:
The main aim of structural policy is to decrease the regional disparities within the European Union (EU). In 2004 ten new member countries joined the EU, and it is expected that this enlargement will cause strong regional disparities within the Union. For this reason the distribution of financial support by structural policy will undergo drastic changes. In this study we consider two main themes. First, convergence of the current EU Member States is empirically tested for the period 1995-2001, and the effect of the structural funds in this context is identified. Structural funds do indeed appear to have had a positive impact, and poorer countries (like Greece) appear to have caught up with the richer countries. The importance of the structural funds in this respect therefore cannot be neglected. Second, we touch on the problem of moral hazard and the substitution effect. It may be expected that receivers of structural funds in some cases are not really eligible and may therefore use the funds inefficiently. Our first and preliminary results seem to indicate that the less clean countries (or as we measure it, more 'corrupt' countries) of the current EU-15 do not gain less economic growth from the structural funds. The hypothesis that structural funds contributed to fewer interregional disparities within the current 15 European countries cannot be rejected. This may mean the intended plans of channelling a big share of the funds to the candidate countries in 2007-13 will probably contribute to higher economic growth in these countries.

Abstract:
Currency crisis literature offers a broad area of research regarding the causes and impacts of the phenomenon. The literature recently focuses on the appropriate policy measures in the aftermath of a currency crisis; however the studies do not gather around a robust answer regarding the appropriate monetary policy response in defending the domestic currency. This study tries to emphasize the notion that there is no single policy applicable for all currency crises happened and happening in the global world. The approach of the study is presenting empirical evidence by focusing separately on the advanced and emerging economies and proving that the monetary policy response for the emerging economies should be different from the advanced economies, depending mainly on the vulnerabilities of these economies preceding and during the crisis periods. The study includes twenty four economies, in which fifteen of them are emerging and nine of them are advanced, for the crisis periods between 1986 and 2009. The main finding of the study is that the tight monetary policy is effective in the advanced economies and detrimental in the emerging economies. Advanced economies besides having more independent central banking, lower country riskiness and almost no default history; mainly have second generation model weaknesses which cause the increased interest rates to be successful in stabilizing the exchange rates. For the emerging economies the third generation models play a major role together with the first generation models’ vulnerabilities. Thus the major policy implication follows that the policy makers should take into account the economic fragilities during the crisis in defending the currency.

Currency crises, Interest Rate Defense, Monetary Policy

Abstract:
This paper empirically examines the effect of monetary policy on exchange rates during currency crises. We find strong evidence that raising the interest rate: (i) has larger adverse balance sheet effects and is therefore less effective in countries with high domestic corporate short-term debt; (ii) is more credible and therefore more effective in countries with high-quality institutions; (iii) is more credible and therefore more effective in countries with high external debt; and (iv) is less effective in countries with high capital account openness. Our results support the idea that the effect of monetary policy depends on its impact on fundamentals, as well as its credibility, as suggested in the recent theoretical literature.

Abstract:
This paper examines the effect of monetary policy on the exchange rate during currency crises. Using data for a number of crisis episodes between 1986 and 2004, we find strong evidence that raising the interest rate: (i) has larger adverse balance sheet effects and is therefore less effective in countries with high domestic corporate short-term debt; (ii) is more credible and therefore more effective in countries with high-quality institutions; iii) is more credible and therefore more effective in countries with high external debt; and (iv) is less effective in countries with high capital account openness. We predict that monetary policy would have had the conventional supportive effect on the exchange rate during five of the crisis episodes in our sample, while it would have had the perverse effect during seven other episodes. For four episodes, we predict a statistically insignificant effect. Our results support the idea that the effect of monetary policy depends on its impact on fundamentals, as well as its credibility, as suggested in the recent theoretical literature. They also provide an explanation for the mixed findings in the empirical literature.

Capital account openness, currency crises, external debt, institutions, monetary policy, short-term debt

Abstract:
The theoretical argument for central bank independence is based on the idea that even if the government represents people's preferences over inflation and output it has an incentive to renege from prearranged plans to gain a short run boost to output. This incentive leads to higher than desired inflation. One solution to this credibility problem is to give control of monetary policy to an independent central bank that is more averse to inflation than society. Central bank independence thus reduces society's credibility problem but this may be at the expense of less flexible countercyclical monetary policy. The aim of this paper is to find the correct balance between credibility and flexibility, ie the optimal degree of central bank independence.

The first part of the paper sets out an open economy model and identifies some macroeconomic factors that influence the optimal degree of independence. It finds that the optimal degree of independence increases when;

1. the NAIRU is higher, 2. the benefits of unanticipated inflation are greater, 3. society is less inflation-averse, 4. productivity shocks have smaller variance, 5. the real exchange rate has less variability, 6. the economy is less open.

The second part of the paper estimates the relationship between these six factors and measures of central bank independence for 19 industrial countries using a latent variables estimation technique. It finds that, in general, the actual degree of independence is related to these six factors and so the institutional arrangements in most countries are close to the optimum. The main exceptions are Germany and Switzerland - that seem to have an excessively high degree of independence - and Australia, Norway, Sweden and the UK - which have a lower than optimal degree of independence.

Abstract:
A stylised fact of monetary policy making is that central banks do not immediately respond to new information but rather seem to prefer to wait until sufficient 'evidence' to warrant a change has accumulated. However, theoretical models of inflation targeting imply that an optimising central bank should continuously respond to shocks. This paper attempts to explain this stylised fact by introducing a small menu cost which is incurred every time the central bank changes the interest rate. It is shown that this produces a relatively large range of inaction because this cost will induce the central bank to take the option value of the status quo into account. In other words, because action is costly the central bank will have an incentive to wait and see whether or not the economy will move closer to the inflation target of its own accord. Next, the paper analyses the implications for the time series properties of interest rates. In particular, we examine the effect of the interest rate sensitivity of aggregate demand, the slope of the Lucas supply function and the variance of demand shocks on the size of the interest rate step and the expected length of the time period till the next interest rate step. Finally, we analyse the effect of menu costs on inflationary expectations. In this respect we find that the economy will suffer from an inflationary bias if the cost of raising the interest rate exceeds the cost of lowering it.

Abstract:
This paper examines the implications of the expectations theory of the term structure for the implementation of inflation targeting. We show that the term structure weakens the transmission of short-term interest rates to ultimate policy objectives. Therefore, short term interest rates in the central bank's forward looking monetary policy rule need to respond more strongly to the output gap and deviations of inflation from its target. Thus, in general the term structure implies a higher degree of policy activism. Next, we show that both the sensitivity of the term spread to economic fundamentals, and the extent to which the spread predicts future output, are increasing in the duration of the long bond and the degree of structural output persistence. If the central bank becomes relatively less concerned about inflation stabilization the term spread becomes less sensitive to fundamentals, and the spread will be less successful in predicting real economic activity.

Abstract:
This paper considers the optimal frequency of central bank decision making. This frequency affects the central bank's flexibility to respond to economic shocks in a timely fashion and also its credibility to maintain low inflation. Generally, the central bank resets monetary policy less often than the arrival of economic news. By adjusting monetary policy less frequently, the central bank achieves lower inflation at the cost of somewhat higher output variability. Evidence for several key countries (Australia, Germany, Japan, the United Kingdom and the United States) shows that the frequency of actual monetary policy changes is indeed positively related to the inflation rate.

Abstract:
This paper starts with a discussion of the various aspects of accountability of central banks. On the basis of this discussion we construct an indicator for accountability for 16 central banks, including the European Central Bank. It is shown that the degree of accountability differs considerably and that the ECB has a rather low score. The indicator is used to examine the relationship between central bank independence and accountability. It is concluded that although there appears to be a negative relationship between independence and accountability, this certainly does not imply that a central bank cannot be both independent and accountable.

Abstract:
We look at the implications of uncertain monetary policy preferences for the targeting and contracting approach to monetary stability. It turns out that in presence of uncertain preferences a linear incentive contract in the sense of Walsh (1995) performs better in terms of social welfare than an explicit inflation target as proposed by Svensson (1997). The reason is that, although both approaches can get rid of the inflationary bias, the impact of uncertain preferences on the variance of inflation will be considerably higher with an inflation target. We also find that on top of an optimal linear contract or target, a quadratic contract, in the sense of Rogoff's (1985) "weight-conservative" central banker, improves the outcome. In the case of an inflation target, a more conservative banker is needed than with a Walsh contract.