Monetary Policy: A Theoretical and Econometric Approach

251 Pages·1990·5.355 MB·English

by  Ulrich Camen, Hans Genberg, Michael Salemi (auth.), P. Artus, Y. Barroux (eds.)

MONETARY POLICY
Advanced Studies in Theoretical and Applied Econometrics
Volume 19
Managing Editors:
J.P. Ancot, Netherlands Economic Institute, Rotterdam, The Netherlands
A.J. Hughes Hallet, University of Strathclyde, Glasgow, United Kingdom
Editorial Board:
F.G. Adams, University of Pennsylvania, Philadelphia, U.S.A.
P. Balestra, University of Geneva, Switzerland
M.G. Dagenais, University of Montreal, Canada
D. Kendrick, University of Texas, Austin, U.S.A.
J.H.P. Paelinck, Netherlands Economic Institute, Rotterdam, The Netherlands
R.S. Pindyck, Sloane School of Management, M.I. T., U.S.A.
H. Theil, University of Florida, Gainesville, U.S.A.
W. Welfe, University of Lodz, Poland
For a list of volumes in this series see final page.
Monetary Policy
A Theoretical and Econometric Approach
edited by
P. Artus and Y. Barroux
SPRINGER-SCIENCE+BUSINESS MEDIA, BV.
Library of Congress Cataloging in Publication Data
Monetary policy : a theoretical and econoMetric approach / edited by
P. Artus and Y. Barroux.
p. CN. -- (Advanced studies in theoretical and applied
econoNetrics ; v. 19)
Selected papers from a ~an. 1987 international conference
organised by the Applied Econometric Association.
ISBN 978-90-481-4062-6 ISBN 978-94-015-7852-3 (eBook)
DOI 10.1007/978-94-015-7852-3
1. Monetary policy. 2. Monetary policy--EconoMetric models.
1. Artus. Patrick. II. Barroux. Y. (Yves). 1945- III. Appl ied
EconoMetric Association. IV. Ser ies.
HG230.3.M836 1990
332.4·6--dc20 89-26856
ISBN 978-90-481-4062-6
Printed on acid-free paper
AII Rights Reserved
© 1990 by Springer Science+Business Media Dordrecht
Originally published by Kluwer Academic Publishers in 1990
Softcover reprint of the hardcover 1s t edition 1990
No part of the material protected by this copyright notice may be reproduced or
utilized in any form or by any means, electronic or mechanical,
including photocopying, recording or by any information storage and
retrieval system, without written permission from the copyright owner.
TABLE OF CONTENTS
Introduction vii
P. Artus and Y. Barroux
P ART I: OPTIMAL MONETARY POLICY AND REACTION FUNCTION
OF THE MONETARY AUTHORITIES
1. Optimal Monetary Policy and the Revealed Preference 3
Function of the Swiss National Bank
U. Camen, H. Genberg and M. Salemi
2. Optimal Monetary Policies in a Small Open Economy 15
T. Chauveau
PART II: CREDmILITY AND REPUTATION
3. Credibility, Reputation and the Indeterminacy of Macroeconomics 63
C. Carraro
4. Policy Credibility and the Lucas Critique - Some New Tests 79
with an Application to Denmark
M. Christensen
PART III: THE DEMAND FOR MONEY
5. Dynamics of the Demand for Money and Uncertainty: 99
The US Demand for Money Revisited
E. Koskela and M. Viren
6. Analysis of the Relationship between Money Stock and Monetary 117
Base: The French Experience during the Period of Quantitative
Controls on Credit (1973-1985)
y. Barroux and N. Dagognet
vi
PART IV: CAUSALITY ANALYSIS AND THE EFFECTS OF
MONETARY POLICY
7. Causal Relationships between Money and Income 133
in the Spanish Economy
A. Aznar and F.J. Trivez
8. Interest Rates and Inflation in Italy during the Seventies 163
E. D'Elia
9. A Short-Term Disequilibrium Model with Carry-Over, 179
for US Business Loans
M. G. Dagenais
PART V: ECONOMETRIC MODELS OF THE FINANCIAL MARKETS:
THEIR USE IN ASSESSING THE CROWDING-OUT EFFECTS
10. Real and Financial Linkages in the UK Economy 203
G. W. McKenzie and S.H. Thomas
11. Crowding-Out, Reagonomics and Monetary Policy 233
J. C. Siebrand and J. Swank
INTRODUCTION
Patrick Artus and Yves Barroux
The Applied Econometric Association organised an international conference on
"Monetary and Financial Models" in Geneva in January 1987. The purpose of
this book is to make available to the public a choice of the papers that were
presented at the conference. The selected papers all deal with the setting of
monetary targets and the effects of monetary policy on the economy as well as
with the analysis of the financial behaviours of economic agents. Other papers
presented at the same conference but dealing with the external aspects of
monetary policy (exchange rate policy, international coordination of economic
policies, international transmission of business cycles, ... ) are the matter of a
distinct publication.
The papers put together to make up this book either are theoretical research
contributions or consist of applied statistical or econometric work. It seemed to
be more logical to start with the more theoretical papers. The topics tackled in
the first two parts of the book have in common the fact that they appeared just
recently in the field of economic research and deal with the analysis of the
behaviour of Central Banks. They analyse this behaviour so as to be able to
exhibit its major determinants as well as revealed preferences of Central Banks:
this topic comes under the caption "optimal monetary policy and reaction
function of the monetary authorities". The second topic has a different purpose
and, in analysing the implementation of monetary policy and its consequences, is
mainly interested in the problems of time consistency that confront monetary
authorities: it is usually referred to as the problem of Central Bank credibility
and reputation.
The last three parts of the book give more room to empirical approaches.
Dealing with more traditional topics and often already widely explored fields of
economic research, the selected papers aim at giving sort of a comprehensive view
of the theoretical knowledge and econometric findings in any of the particular
fields. Sometimes, the purpose is to take into account the changes that have
materialised in the financial system, to suggest interpretation of recent breaks
vii
viii
and to try to guess their significance both in terms of the changing of the
behaviour of economic agents and in relationship with the efficiency of monetary
policy. Such topics are money demand and the analysis of the effects of monetary
policy appraised through the use of either a reduced form equation or a complete
model of the economy describing both the real and the financial sectors.
All these papers tend to bring out new ways of thinking that might be useful
to Central Banks in dealing with problems as important to them as the choice of
instruments of monetary policy, the setting of strategies able to enlarge the
credibility of the implemented monetary policy, the explanation for the recent
movements in the velocity of money, the estimation of the respective effects on
prices and output of changes in the money supply, the understanding of the
determination of interest rates and the evaluation of the size of crowding-out
effects.
PART I
OPTIMAL MONETARY POLICY AND REACTION FUNCTION OF THE
MONETARY AUTHORITIES
U. Camen, H. Genberg and M. Salemi seek to reveal the preferences of the Swiss
National Bank. To this end, they use a vector autoregression (VAR) model of the
Swiss economy, which includes an equation determining the monetary base. They
try to characterise the preference or loss function that would allow for the
correspondingly determined monetary base to be as close as possible to the
observed data. They conclude that reducing inflation appears to be the major
objective of the Swiss monetary authorities.
Th. Chauveau, using a traditional model with rational expectations, seeks to
specify optimal rules for either setting the money market rate or controlling the
monetary base. He assumes that the objective of the authorities might consist
either in lowering the variance of the foreign exchange reserves or in reducing the
fluctuations of output and inflation. Solving his model in the two cases of fixed
and flexible exchange rates leads him to the two conclusions that:
Whenever the money multiplier is instable, controlling the money market
rate appears to be preferable to controlling the monetary base;
whatever the exchange rates system might be, optimal monetary policies
exhibit very similar features and the exogenous variables entering the
reaction functions are the same as those showing in most of the empirical
studies (foreign interest rate, foreign exchange reserves, expected exchange
rate, ... ).
ix
PART II
CREDillILITY AND REPUTATION
C. Carraro is interested in the definition of an economic policy strategy that
would be optimal from the point of view of the policy maker. We know that pure
optimal economic policies are time inconsistent and time-consistent policies are
sub-optimal. Barro and Gordon have shown that, when the private sector
threatens the policy maker to adopt a non-cooperative behaviour if the latter
does not stick to its announced policy, a better outcome than the one achieved in
a non-cooperative environment can be obtained. Carraro underlined the fact that
there might be a large number of such outcomes and it looks very unlikely that
the private sector will threaten the policy maker in such a way that it would
allow the latter to implement the policy it precisely wants to. He then suggests
that the policy maker might be the leader of the game and, in a Stackelberg
trigger strategy, threatens the private sector. Under these assumptions, he shows
that the policy maker can achieve a multiplicity of outcomes, any of them being
better than the non-cooperative one, and, of course, the one it thinks is optimal;
the time consistency problem is thus solved.
M. Christensen analyses empirically the consequences of a change of policy
regime that took place in Denmark in 1982: in October, the monetary authorities
let it be known that the system of recurrent devaluations of the exchange rate
would not be pursued. He wonders if, in so doing, the authorities have acquired a
better reputation. In order to find out whether they actually did, an equation for
the long term interest rate is estimated, in which the exchange rate variability
comes in both directly and as a parameter influencing other explanatory
variables. Observing that the exchange rate variability has been reduced because
of the policy change, he concludes to its credibility and underlines that the use of
a varying parameter model allows for taking into account the Lucas critique,
stating that the decisions and actions of the private sector depends on
expectations on the policy to be implemented.
PART III
THE DEMAND FOR MONEY
E. Koskela and M. Viren estimate various money demand functions for the
United States using different specifications: the usual partial adjustment model,
the so-called threshold model (where the parameters take different values
x
depending on whether any particular driving variable is below or above the
"threshold"), error correction models. They finally turn to a specification which
looks closer to the theoretical model of portfolio choice, where variances and
covariances of interest rates and inflation rate intervene explicitly. This model
shows the most satisfactory results.
Y. Barroux and N. Dagognet analyse the evolution of the monetary base (B)
over the last fifteen years in France compared to the one of the money stock (M).
As a matter of fact, they analyse the changes in the ratio B/M and seek to
uncover major explanatory factors. The method used consists in pairing a
traditional money demand function with a divisor-type relation and in deriving
from these an equation for B /M whose specification is very close to the error
correction model. Estimating this model, they obtain rather satisfactory results
that yields long term elasticities relative to interest rates that are weak and
appear to be consistent with the so---<:alled credit divisor framework, which was
governing the working of the French monetary system for at least the last fifteen
years.
PART IV
CAUSALITY ANALYSIS AND THE EFFECTS OF MONETARY POLICY
A. Aznar and F.J. Trivez consider the causal relationship between the money
stock and the gross domestic product at constant prices in Spain. The statistical
method they use consist in stationarising the series, determining the optimal
auto---<:orrelation coefficient of the variables and measuring the degree of
predicting performance of each equation, which allows for performing a causality
test "a la Granger". Applying this procedure to the Spanish data leads to the
conclusion that the money stock and the real output are independent.
E. d' Elia analyses the causal relationship between nominal interest rates and
inflation. Economic theory shows that the direction of this relationship might be
different depending on the nature of the shocks affecting the economy. However,
similar movements in the rate of inflation and in nominal interest rates may be
caused simultaneously by other variables, for instance domestic demand, the rate
of exchange or the trade deficit. Causality tests realised using Granger's method
show that, in Italy, the rate of inflation and the nominal interest rates were
influenced simultaneously by the evolution of other variables without being
indexed on one another.
M. Dagenais estimates a disequilibrium model of the U.S. credit market. The