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  • Author: Steven B. Kamin
  • Publication Date: 06-2010
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: This paper reviews the available evidence and previous research on potential effects of financial globalization, that is, the international integration of financial markets. In particular, we address the questions: Has financial globalization materially increased the influence of external developments on domestic monetary conditions? And, has it reduced the influence of central banks over financial and economic conditions in their own country? We find that central banks with floating currencies retain the ability to independently determine short-term interest rates and thus influence broader financial conditions and macroeconomic performance in their economies. However, domestic financial conditions appear to have become more vulnerable to a wide range of external shocks, complicating the task of making appropriate monetary policy decisions. Moreover, the financial crisis has highlighted the importance of cross-border channels for the transmission of liquidity and credit shocks. With financial transactions increasingly being undertaken in vehicle currencies such as dollars and euros, the liquidity provision and the lender-of-last resort functions of many central banks are being challenged. Accordingly, international arrangements for liquidity provision may become increasingly important in the future.
  • Topic: Economics, Globalization, International Cooperation, Monetary Policy, Interest Rates
  • Political Geography: Global Focus
  • Author: Jian Wang, Jason J. Wu
  • Publication Date: 01-2009
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: This paper attacks the Meese-Rogoff (exchange rate disconnect) puzzle from a different perspective: out-of-sample interval forecasting. Most studies in the literature focus on point forecasts. In this paper, we apply Robust Semi-parametric (RS) interval forecasting to a group of Taylor rule models. Forecast intervals for twelve OECD exchange rates are generated and modified tests of Giacomini and White (2006) are conducted to compare the performance of Taylor rule models and the random walk. Our contribution is twofold. First, we find that in general, Taylor rule models generate tighter forecast intervals than the random walk, given that their intervals cover out-of-sample exchange rate realizations equally well. This result is more pronounced at longer horizons. Our results suggest a connection between exchange rates and economic fundamentals: economic variables contain information useful in forecasting the distributions of exchange rates. The benchmark Taylor rule model is also found to perform better than the monetary and PPP models. Second, the inference framework proposed in this paper for forecast-interval evaluation can be applied in a broader context, such as inflation forecasting, not just to the models and interval forecasting methods used in this paper.
  • Topic: Economics, Exchange Rate Policy, Models
  • Political Geography: Global Focus
  • Author: Joseph Gagnon
  • Publication Date: 02-2009
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Sharp exchange rate depreciations, or currency crashes, are associated with poor economic outcomes in industrial countries only when they are caused by inflationary macroeconomic policies. Moreover, the poor outcomes are attributable to inflationary policies in general and not the currency crashes in particular. On the other hand, crashes caused by rising unemployment or external deficits have always had good economic consequences with stable or falling inflation rates.
  • Topic: Economics, Exchange Rate Policy, Inflation, Currency
  • Political Geography: Global Focus
  • Author: David Berger, Jon Faust, John H. Rogers, Kai Steverson
  • Publication Date: 04-2009
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: We analyze retail prices and at-the-dock (import) prices of speciÖc items in the Bureau of Labor Statisticsí(BLS) CPI and IPP databases, using both databases simultaneously to identify items that are identical in description at the dock and when sold at retail. This identiÖcation allows us to measure the distribution wedge associated with bringing traded goods from the point of entry into the United States to their retail outlet. We Önd that overall U.S. distribution wedges are 50-70%, around 10 to 20 percentage points higher than that reported in the literature. We discuss the implications of this for measuring the size of the "pure" tradeables sector, exchange rate pass-through, and real exchange rate determination. We Önd that distribution wedges are very stable over time but there is considerable variation across items. There is some variation across the country of origin for the imported item, for our major trading partners, but not as much as the cross-item variation. We also investigate the determinants of distribution wedges, Önding that wedges do not vary systematically with exchange rates, but are related to other features of the micro data.
  • Topic: Economics, Exchange Rate Policy
  • Political Geography: Global Focus
  • Author: Emine Boz, Ceyhun Bora Durdu, Nan Li
  • Publication Date: 12-2009
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: This paper shows that labor markets of emerging economies are characterized by large fluctuations in wages while employment fluctuations are subdued. We find that a real business cycle model of a small open economy that embeds a Mortensen-Pissarides type of search-matching frictions can account for these aforementioned regularities. Moreover, the joint interaction of countercyclical interest rates and search-matching frictions can go a long way in accounting for higher consumption variability relative to output and countercyclical current account observed in emerging markets. Extending this baseline model to incorporate procyclical variations in the technical efficiency at which matches are generated, the model can match the unemployment variability observed in the data.
  • Topic: Economics, Emerging Markets, Labor Issues
  • Political Geography: Global Focus
  • Author: Martin Bodenstein, Christopher J. Erceg, Luca Guerrieri
  • Publication Date: 08-2008
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: In a stylized DSGE model with an energy sector, the optimal policy response to an adverse energy supply shock implies a rise in core inflation, a larger rise in headline inflation, and a decline in wage inflation. The optimal policy is well-approximated by policies that stabilize the output gap, but also by a wide array of “dual mandate” policies that are not overly aggressive in stabilizing core inflation. Finally, policies that react to a forecast of headline inflation following a temporary energy shock imply markedly different effects than policies that react to a forecast of core, with the former inducing greater volatility in core inflation and the output gap.
  • Topic: Economics, Energy Policy, Inflation, Supply
  • Political Geography: Global Focus
  • Author: James M. Nason, John H. Rogers
  • Publication Date: 09-2008
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Exchange rates have raised the ire of economists for more than 20 years. The problem is that few, if any, exchange rate models are known to systematically beat a naive random walk in out of sample forecasts. Engel and West (2005) show that these failures can be explained by the standard-present value model (PVM) because it predicts random walk exchange rate dynamics if the discount factor approaches one and fundamentals have a unit root. This paper generalizes the Engel and West (EW) hypothesis to the larger class of open economy dynamic stochastic general equilibrium (DSGE) models. The EW hypothesis is shown to hold for a canonical open economy DSGE model. We show that all the predictions of the standard-PVM carry over to the DSGE-PVM. The DSGE-PVM also yields an unobserved components (UC) models that we estimate using Bayesian methods and a quarterly Canadian--U.S. sample. Bayesian model evaluation reveals that the data support a UC model that calibrates the discount factor to one implying the Canadian dollar--U.S. dollar exchange rate is a random walk dominated by permanent cross-country monetary and productivity shocks.
  • Topic: Economics, Finance, Exchange Rate Policy
  • Political Geography: Global Focus
  • Author: Charles Engel, John H. Rogers
  • Publication Date: 09-2008
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Survey data show that the expected growth rates of consumption across countries vary widely and are not highly correlated. This data contradicts the simplest of open-economy models in which there is a freely traded non- state-contingent bond and purchasing power parity holds. We explore two alternative explanations for the finding: that households in each country in effect face different ex ante real interest rates or that there are significant credit constraints, so that expected consumption growth rates are driven largely by expected income growth. The empirical evidence strongly supports the latter hypothesis. These findings challenge the modeling of consumption that is at the heart of many, if not most, macroeconomic models.
  • Topic: Economics, Finance, Interest Rates, Credit
  • Political Geography: Global Focus
  • Author: Elizabeth Demers, Clara Vega
  • Publication Date: 10-2008
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: This paper examines whether the “soft” information contained in the text of management’s quarterly earnings press releases is incrementally informative over the company’s reported “hard” earnings news. We use Diction, a textual-analysis program, to extract various dimensions of managerial net optimism from more than 20,000 corporate earnings announcements over the period 1998 to 2006 and document that unanticipated net optimism in managers’ language affects announcement period abnormal returns and predicts post- earnings announcement drift. We find that it takes longer for the market to understand the implications of soft information than those of hard information. We also find that the market response varies by firm size, turnover, media and analyst coverage, and the extent to which the standard accounting model captures the underlying economics of the firm. We also show that the second moment of soft information, the level of certainty in the text, is an important determinant of contemporaneous idiosyncratic volatility, and it predicts future idiosyncratic volatility.
  • Topic: Economics, Finance
  • Political Geography: Global Focus
  • Author: Meredith Beechey, Erik Hjalmarsson, Par Osterholm
  • Publication Date: 10-2008
  • Content Type: Working Paper
  • Institution: Board of Governors of the Federal Reserve System
  • Abstract: Nominal interest rates are unlikely to be generated by unit-root processes. Using data on short and long interest rates from eight developed and six emerging economies, we test the expectations hypothesis using cointegration methods under the assumption that interest rates are near integrated. If the null hypothesis of no cointegration is rejected, we then test whether the estimated cointegrating vector is consistent with that suggested by the expectations hypothesis. The results show support for cointegration in ten of the fourteen countries we consider, and the cointegrating vector is similar across countries. However, the parameters di§er from those suggested by theory. We relate our Öndings to existing literature on the failure of the expectations hypothesis and to the role of term premia.
  • Topic: Economics, Interest Rates
  • Political Geography: Global Focus