Monetary Sector Research Articles

A small macroeconometric model of the Philippine economy

This paper describes the ADB Philippine model, a quarterly macroeconometric model for forecasting and policy analysis. The model covers private consumption, investment, government, foreign trade, GDP 3-sector labor and production, prices and monetary sectors. The equilibrium-correction form is used, estimated via the general→specific dynamic specification approach, to ensure the best possible blend of a priori long-run theories with short-run dynamics through a posteriori guidance. Country-specific features are incorporated and special attention is given the government block design to enable variables simulations of the fiscal debt problem, one of the most critical problems of the economy at present.

Money Growth, Output Growth, and Inflation: A Reexamination of the Modern Quantity Theory's Linchpin Prediction

1. IntroductionOver the years, the quantity theory of has been extended and refined. All versions, however, begin with the well-known equation of exchange, MV = PQ, where Q is the level of national output (real gross domestic product, GDP), P is the general price level, V is the velocity of circulation, and M is the quantity of money. To convert this equation--actually an identity--into a theory, one of the four variables contained therein must be specified as functionally dependent on the other three. Monetarists argue that P is the dependent variable (Sprinkel 1971). Specifically, they argue that M is determined by the national monetary authority; that V is determined by a variety of both secular and cyclical factors;1 that changes in V do not consistently offset changes in M; and that Q is determined by capital, labor, and technological advances (Sprinkel 1971).The monetarist theory of inflation is a long-run theory; it does not purport to explain short-run increases in the general price level (Hafer and Wheelock 2001). Monetarists argue that short-run inflation stabilization is not feasible and, therefore, that monetary policy should be confined to inflation concerns over a relatively long horizon.2John Moroney (2002, p. 399) asserts that in the traditional version of the quantity theory, ... a country's long-run inflation rate increases [one-to-one] with its rate. The modern wrinkle is that inflation is mitigated by real GDP growth (emphasis added). This assertion is consistent with the famous dictum of Milton Friedman (1968, p. 18) that ... inflation is always and everywhere a monetary phenomenon, produced in the first instance by an unduly rapid in the quantity of money (emphasis added). Friedman's assertion is not that an increased rate is the sole cause of inflation in the long run--just the most important cause (Friedman and Friedman 1980). An increase in inflation can also be caused by a decrease in the rate of Q (or, theoretically, even an increase in the rate of V), as is easily seen by solving the equation of exchange for P and then taking logs and first differences.After taking logs and first differences,3 Moroney (2002) obtains an estimating equation in which inflation is functionally dependent on the rates of the stock and real GDP:(Formula Omitted. See article image.) where Y is Δ ln P, X is Δ ln M, Z is Δ ln Q, and u is a random disturbance term that includes velocity changes. (Δ is the first difference operator.) The modern quantity theory's model-implied restrictions--which are testable predictions--are that the intercept is zero, the coefficient of the stock rate is plus one, and the coefficient of the rate of real GDP is minus one. Arguably, this joint hypothesis is the linchpin prediction of the modern quantity theory: If the hypothesis is rejected by the data, the theory falls.Using long-run (1980-1993) cross-section data on 81 countries, which he takes from the World Bank's World Development Report 1995, Moroney (2002) tests the joint hypothesis (β0 = 0, β1 = 1, β2 = -1) and incorrectly claims that the hypothesis cannot be rejected at even the 0.01 level of significance.4 As will be shown in the next section, the joint hypothesis is rejected decisively. Fortunately, however, it will also be shown that a modification to Moroney's model specification helps to salvage the most substantive part of the modern quantity theory's implied restrictions.2. Modification to the Quantity Theory SetupIn contrast to the conventional quantity theory setup, in which the economy's real activity is determined entirely outside its monetary sector (Fama 1982; Moroney 2002)--that is, in which no provision is made for the possibility that the monetary authority's actions could have an adverse effect on output5--the present article entertains the possibility that Y and Z are jointly determined. …

A P* MODEL ANALYSIS OF I NFLATION IN PUE RTO RICO

One can analyze and forecast the inflationary potential in the Puerto Rican e c onomy using the “P* model.” Given the nature of the monetary sector in Puerto Rico (PR), the model is put into the conte xt of variables from the m ainland United States (US). The results indicat e a long-run relationship b etween the m o n ey supply (M1) of the US and the pri ce level in PR, between M1 and real productio n in PR, and b etween M1 and the prime rate in PR. The implications for forecasting and p olicy are discu ssed.

Financial Sector Development in the Middle East and North Africa

Based on data collected on a wide range of financial sector indicators, new indices of financial development for countries in the Middle East and North Africa (MENA) are constructed, encompassing six themes: development of the monetary sector and monetary policy, banking sector development, nonbank financial development, regulation and supervision, financial openness, and institutional quality. The paper finds that the degree of financial development varies across the region. Some countries have relatively well-developed banking sectors and regulatory and supervisory regimes. However, across the region, more needs to be done to reinforce the institutional environment and promote nonbank financial sector development. Based on a subset of indicators, the MENA region is found to compare favorably with a few other regions, but it ranks far behind the industrialized countries and East Asia.

TRANSMISSION OF GERMAN MONETARY POLICY IN THE PRE-EURO PERIOD

A small macroeconomic model is constructed to study the transmission of the monetary policy conducted by the Deutsche Bundesbank (DBB) since the middle of the 1970s. For this purpose, quarterly, seasonally unadjusted data for the period from 1975 to 1998 are used; that is, the period until the introduction of the Euro is considered. A vector error correction model is constructed for the German monetary sector based on M3, GNP, an inflation rate, a long-term interest rate, and a short-term rate that represents the policy variable of the DBB. Moreover, import price inflation is included as an exogenous variable to capture foreign effects. An impulse response analysis highlights the effects of changes in the short-term interest rate and shows the interaction of the main variables of the monetary sector.We thank Alexander Benkwitz for helping with the computations and Massimiliano Marcellino, Paulo Rodrigues, Phillipe Andrade, Harald Uhlig, Adrian Pagan, and two anonymous referees for comments. Financial support was provided by the Deutsche Forschungsgemeinschaft, Sonderforschungsbereich 373, and the European Commission under the Training and Mobility of Researchers Programme (contract No. ERBFMRXCT980213). The paper was presented at the EEA meeting and the ESEM in Venice in 2002.

Nominal and Real Disturbances and Money Demand in Chinese Hyperinflation

This article reexamines the dynamics of hyperinflation by allowing variability in the relative price of capital goods in units of consumption goods that reflects interactions between the real and monetary sectors. The theory generates empirically testable implications that suggest expanding the standard Caganian money demand function to include both anticipated inflation and relative price effects in a nonlinear fashion. Employing data from the post–WW II Chinese hyperinflationary episode, the empirical findings suggest that conventional econometric investigations of money demand during hyperinflation overlook important nonlinear interactions between real and monetary activities and, hence, underestimate the welfare costs of hyperinflation.

A model of the monetary sector with and without binding capital requirements

Bank equity is exogenous in the standard deposit-and-loan-expansion multiplier model, so that model is inappropriate for analyzing the interaction between monetary and bank regulatory policies. This paper examines the effect of a binding capital requirement on the loan expansion process. We evaluate how the conflict between the monetary and regulatory authorities evolves when bank equity adjusts to a binding capital requirement. We find that capital requirements are not innocuous for monetary policy. Nevertheless, the monetary authority can assert control over the loan expansion process in the long run, although multiplier values will differ considerably from those in the standard multiplier model.

Monetary Programming for Growth in Tanzania

Economic managers in central banks and finance ministries in emerging market economies have increasingly been faced with the challenge of making and implementing policy decisions by using indirect policy instruments. This has necessitated development of proper programming frameworks as well as proper understanding of the interactions of macro-economic variables. Monetary programming has become such an important framework. This paper attempts to develop a monetary programming framework for Tanzania. Tanzania has become such an important framework for Tanzania. Tanzania has implemented economic reforms since the mid 1980s-moving from a centrally controlled economy to free market economy. The methodology used was econometric estimation of a macro-economic model, built with incorporation of information obtained through surveys. The survey results indicated that the majority of policy makers (90%) showed that they were aware of the way monetary policy is conducted, (60%) of the respondents expressed dissatisfaction with the conduct of monetary policy pointing out conflicting objectives, crowding out of the private sector, and lack of transparency. The econometric framework was characterized by ten equations for the four sectors of the economy namely; output and expenditure; the public sector; the monetary sector; and the external sector. Data for the estimates covered the period 1986 to 1998, which corresponds with the period of economic liberalization. Results of the estimations showed that current consumption is highly determined by disposable income and lagged consumption. There was no evidence though, that consumption was affected by interest rates. Similarly investment is weakly influenced by the interest rate but strongly and positively affected by output and government expenditure. Output is positively influenced by changes in money supply. In the short run output moves in the opposite direction with changes in the real exchange rate. This can be attributed to the fact that when domestic currency depreciates the cost of import dependent activities increases possibly affecting output negatively. Exports are influenced by real output and their own lagged values while imports are influenced by output and their own lagged values. No strong evidence of exchange rate influence is obtained, in support of the argument that the demand for imports is inelastic to movements in the exchange rate. Demand for money is positively influenced by real output and is negatively influenced by inflation. The coefficient of interest rate however is positive contrary to theory. This can be explained by the coincidence of liberalization of interest rates with the rate of growth of money supply, which began to decline due to tight monetary policy. Domestic prices are positively influenced by foreign prices, changes in money supply, the exchange rate and negatively influenced by real output. Domestic interest rates are influenced by both foreign interest rates and money supply. The money supply equation was included in an attempt to establish the relationship between current level of broad money supply and the level of reserve money and its own lagged values. The findings show that the current values of money are mainly related to their lagged values and by the level of current and lagged reserve money. With respect to tax revenue it was found that private consumption is the determinant of tax revenue. This is natural given the recent introduction of VAT and predominance of trade taxes in total revenue. Surprisingly imports are not a significant factor in influencing domestic revenue. The findings of this study provided an important contribution to the understanding of the macroeconomic environment within which monetary policy operates in Tanzania. (Af. J. of Finance and Management: 2003 11 (2): 1-25)

Financial development and productive efficiency: A panel study of developed and developing countries

This paper uses a stochastic production frontier for panel data to investigate the effect of financial development on productive efficiency. Three panels of a number of countries in different stages of development are used along with eight alternative measures of financial development pertaining to the monetary sector, financial intermediaries, and equity markets. The results indicate that in general the more developed the financial intermediaries sector and equity markets, the higher the productive efficiency. In particular, financial deepening reduces productive inefficiency in both developed and developing countries, although the effect is larger in the former.

Monetary Policy and the Cross‐Section of Expected Stock Returns

AbstractAmple evidence shows that size and book‐to‐market equity explain significant cross‐sectional variation in stock returns, whereas beta explains little or none of the variation. Recent studies also demonstrate that proxies for monetary stringency increase the explained variation in stock returns. We reexamine a three‐factor model that includes beta, size, and book‐to‐market equity, while allowing monetary conditions to influence the relations between these risk factors and average stock returns. We find that ex‐ante proxies for monetary stringency significantly influence the relations between stock returns and all three risk factors. Additionally, all three variables are found to contribute significantly to explaining cross‐sectional returns in a three‐factor model that includes the monetary sector.

Kalecki on money and finance

It is argued that Kalecki had a greater appreciation of the role of the monetary sector than has been generally recognized, and that Kalecki presented ideas which can be seen as now embedded in the structuralist post Keynesian analysis of endogenous money and in the circuitist approach. Six key features of Kalecki's monetary analysis are identified. The paper outlines Kalecki's dismissal of the ‘Pigou effect’ and the ‘Keynes effect’, and then discussion the relationship between the ‘principle of increasing risk’ and the nature of the supply of credit. It discusses interest determination in Kalecki's writings and the manner in which he distinguished different types of money.

Optimal Monetary Policy

Optimal monetary policy maximizes the welfare of a representative agent, given frictions in the economic environment. Constructing a model with two broad sets of frictions — costly price adjustment by imperfectly competitive firms and costly exchange of wealth for goods — we find optimal monetary policy is governed by two familar principles. ; First, the average level of the nominal interest rate should be sufficiently low, as suggested by Milton Friedman, that there should be deflation on average. Yet, the Keynesian frictions imply that the optimal nominal interest rate is positive. ; Second, as various shocks occur to the real and monetary sectors, the price level should be largely stabilized, as suggested by Irving Fisher, albeit around a deflationary trend path. (In modern language, there is only small “base drift” for the price level path as various shocks arise). Since expected inflation is roughly constant through time, the nominal interest rate must therefore vary with the Fisherian determinants of the real interest rate, i.e., with expected growth or contraction of real economic activity. ; Although the monetary authority has substantial leverage over real activity in our model economy, it chooses real allocations that closely resemble those that would occur if prices were flexible. In our benchmark model, we also find some tendency for the monetary authority to smooth nominal and real interest rates.

The Transmission of German Monetary Policy in the Pre-Euro Period

A small macroeconomic model is constructed to study the transmission of the monetary policy conducted by the Deutsche Bundesbank (DBB) since the middle of the 1970s. For this purpose quarterly, seasonally unadjusted data for the period from 1975 to 1998 are used, that is, the period until the introduction of the Euro is considered. A vector error correction model is constructed for the German monetary sector based on M3, GNP, an inflation rate, a long-term interest rate and a short-term rate which represents the policy variable of the DBB. Moreover, import price inflation is included as an exogenous variable to capture foreign effects. An impulse response analysis highlights the effects of changes in the short-term interest rate and shows the interaction of the main variables of the monetary sector.

Optimal Monetary Policy

Optimal monetary policy maximizes the welfare of a representative agent, given frictions in the economic environment. Constructing a model with two sets of frictions -- costly price adjustment by imperfectly competitive firms and costly exchange of wealth for goods -- we find optimal monetary policy is governed by two familiar principles. First, the average level of the nominal interest rate should be sufficiently low, as suggested by Milton Friedman, that there should be deflation on average. Yet, the Keynesian frictions imply that the optimal nominal interest rate is positive. Second, as various shocks occur to the real and monetary sectors, the price level should be largely stabilized, as suggested by Irving Fisher, albeit around a deflationary trend path. Since expected inflation is roughly constant through time, the nominal interest rate must therefore vary with the Fisherian determinants of the real interest rate. Although the monetary authority has substantial leverage over real activity in our model economy, it chooses real allocations that closely resemble those which would occur if prices were flexible. In our benchmark model, there is some tendency for the monetary authority to smooth nominal and real interest rates.

Stock returns during the German hyperinflation

We examine the relationship between stock returns and inflation during the German hyperinflation period. As Cagan (1956) argues, hyperinflation is close to a pure monetary phenomenon, the monetary sector is almost isolated from the real sector of the economy. We can thus study the impact of inflation on common stock returns directly, unaffected by the potential interactions of other economic variables such as expected real output. The negative relationship between inflation and stock returns widely reported in the literature may be spurious because they have not made such a distinction. By using forward exchange rate premium as a proxy for expected inflation, we find that stock returns, inflation, expected inflation, and unexpected inflation are cointegrated during the German hyperinflation period. The results also indicate that the fundamental relationship between stock returns and both realized and expected inflation is highly positive. JEL classification: E310; G120

Monetary Policy in the Open Economy Revisited: Price Setting and Exchange Rate Flexibility

This paper develops a welfare-based model of monetary policy in an open economy. We focus on the extent to which monetary policy should be employed in stabilising the exchange rate. The traditional approach maintains that exchange rate flexibility is desirable in the presence of real country-specific shocks that require adjustment in relative prices. However, in light of empirical evidence on nominal price response to exchange-rate changes - specifically, that there appears to be a large degree of local-currency pricing in industrialized countries — the expenditure-switching role played by nominal exchange rates may be exaggerated in the traditional literature. In the presence of local-currency pricing, we find that optimal monetary policy in response to real shocks is fully consistent with fixed exchange rates. On the other hand, when real country-specific shocks are not important, and when a country's monetary sector is stable, the case for freely floating rates is strengthened in the presence of local-currency pricing. We thank an anonymous referee for very helpful comments on an earlier draft. We have also benefited greatly from comments by a large number of our colleagues in the profession. Engel acknowledges assistance from a National Science Foundation grant to the National Bureau of Economic Research. Devereux thanks the Social Sciences and Humanities Research Council of Canada for financial assistance. This paper was completed when Devereux was visiting the HKIMR. He thanks the institute for its hospitality. The views presented in this paper are those of the authors and do not necessarily reflect those of the Hong Kong Institute for Monetary Research, its Council of Advisors or Board of Directors.

An empirical analysis of economic fluctuations in Japan: 1885–1940

This paper analyzes economic fluctuations in Japan’s economy before World War II using the vector error correction model. It is found that causality from the real sector to the monetary sector can be observed but not vice versa in those years of Japanese economy.

The Macroeconomics of the East Asian Crisis and the Implications of the Crisis for Macroeconomic Theory

In the first part of the paper I argue that the afflicted East Asian countries’ opening up to short‐term international capital flows resulted not only in financial vulnerabilities, which have been emphasized as the cause of the crisis, but also in macroeconomic weaknesses that contributed to the eruption of the crisis. These macroeconomic weaknesses are in the form of deteriorating foreign exchange earning capabilities, coupled with overvaluation of the currencies. The overvaluation led to distortion in relative prices that contributed to the speculative bubbles.In the second part of the paper I argue strongly that Keynes’s theories are very relevant to the present crisis. They include Keynes’s denial of the dichotomy between the real and monetary sectors, and the speculative demand for money and its role in the ‘liquidity’ and ‘investment’ traps. Most important is Keynes’s neglected psychological and ‘animal spirits’ factors, which were discussed in Chapter 12 of The General Theory. A rereading of this chapter shows that Keynes’s analysis is stronger and more perceptive than the ‘market failure’ analysis of Stiglitz, Rodrik and Krugman in arguing for strong financial regulation and supervision, as well as capital controls of short‐term international flows. The monetarist and rational expectations schools of thought are strongly criticized. These schools of thought paradoxically were the theoretical bases for the initial monetary and fiscal austerity measures imposed on the afflicted countries, which deepened and prolonged their crisis. Finally I also briefly discuss the implications of the crisis on the endogenous growth models and on the economics of institutions and governance.

AN ECONOMETRIC MODEL FOR INDIA WITH EMPHASIS ON THE MONETARY SECTOR

The Developing EconomiesVolume 37, Issue 3 p. 275-327 AN ECONOMETRIC MODEL FOR INDIA WITH EMPHASIS ON THE MONETARY SECTOR Thangavel PALANIVEL, Thangavel PALANIVELSearch for more papers by this authorLawrence R. KLEIN, Lawrence R. KLEINSearch for more papers by this author Thangavel PALANIVEL, Thangavel PALANIVELSearch for more papers by this authorLawrence R. KLEIN, Lawrence R. KLEINSearch for more papers by this author First published: 06 March 2007 https://doi.org/10.1111/j.1746-1049.1999.tb00235.xCitations: 7 Substantial part of this work was done at the Department of Economics, University of Pennsylvania, Philadelphia, while the first author was a visiting scholar under a National Science Foundation (the United States) grant in 1997. This is a part of wider ongoing work on macroeconometric modeling for India being carried out at the Delhi School of Economics and Institute of Economic Growth, Delhi. An earlier version of the paper was presented at a conference on Money and Finance in the Indian Economy, Indira Gandhi Institute of Development Research, Mumbai, December 2–4, 1998. We have received helpful comments from seminar participants and others, particularly from Professor K. Krishnamurty, Professor V. Pandit, Dr. R. Krishnan, and Dr. P. K. Pani. Devender Pratap, U. Sarangi, and Inder Kumar helped with collection and computerization of data. Beverly Meyers provided an excellent secretarial assistance. We are grateful to all of them. The usual disclaimers apply. Financial assistance from the National Science Foundation for this project is acknowledged. AboutPDF ToolsRequest permissionExport citationAdd to favoritesTrack citation ShareShare Give accessShare full text accessShare full-text accessPlease review our Terms and Conditions of Use and check box below to share full-text version of article.I have read and accept the Wiley Online Library Terms and Conditions of UseShareable LinkUse the link below to share a full-text version of this article with your friends and colleagues. Learn more.Copy URL Share a linkShare onFacebookTwitterLinked InRedditWechat Citing Literature Volume37, Issue3September 1999Pages 275-327 RelatedInformation

Predicting Stock and Bond Returns: the Impact of Global Variables

Prior research demonstrates that returns on US stocks and bonds over time can be predicted using models containing proxies for domestic business conditions and the stance of monetary policy. This paper has two objectives. First, it examines the benefits of adding international economic and monetary variables to US stock and bond prediction models. We specify a base model (employing US variables only), along with two alternative approaches that supplement or replace US measures with weighted average measures of corresponding variables based on the economic environment of the G‐7 countries. Monthly and quarterly holding period returns are examined over the time period August 1976 to December 1997. We conclude that, for some assets, using international information can improve forecasts of returns. The second objective of this paper is to re‐examine issues addressed in earlier studies using the international versions of our models. Our findings suggest that bond returns can be predicted with a common set of variables and that variables characterizing the monetary sector contain information about expected bond returns beyond that of business conditions proxies.