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  • Ripatti, Antti (1998)
    Bank of Finland studies. E 13
    In order to study the role of money in an inflation-targeting regime for monetary policy, we compare the interest rate and money as monetary policy instruments.The theoretical part of the study builds on a dynamic stochastic general equilibrium model that combines the money-in-the-utility-function approach with sticky prices.Preference and technology shocks are the driving forces of the economy.We show that conditioning the interest rate on the expected future cost change can be used to achieve constant inflation or constant inflation expectations.The assumed adjustment costs in 'money demand' lead to an equilibrium in which inflation can be controlled by money growth without having information on the current state of the economy.The tradeoff between money and the interest rate as a monetary policy instrument depends on the parameter stability of the technology change process relative to that of the 'money demand' function. We experiment with the parameter stability of the demand for money using Finnish monthly data for 1980 - 1995.The steadystate - utility function - parameters of the model of narrow money (M1), estimated with cointegration techniques, are stable; whereas in the model of harmonized M3 (M3H) the parameters are not stable.The theoretical model fits the M1 data.The adjustment cost parameters of the M1 model describing the dynamics of the demand for money could indicate the occurrence of technological improvements in banking and payments during the sample period.These results suggest that from the Finnish viewpoint M1 would be a more appropriate intermediate target for monetary policy than harmonized M3.Due to small sample problems, we compare parameters of the theoretical model estimated using the Generalized Method of Moments and Full Information Maximum Likelihood method.The process driving the forcing variables is approximated with vector autoregression. Both the GMM and FIML parameter estimates are reasonable and the differences are negligible.The cross-equation restrictions implied by the rational expectations hypothesis are clearly rejected. Keywords: demand for money, monetary transmission, money-in-the-utility-function, sticky prices, technology shock, GMM, FIML
  • Mehrotra, Aaron (Edita Prima, 2006)
    Bank of Finland studies. E 34
    This thesis consists of four essays in empirical macroeconomics. The first three essays examine the conduct of monetary policy during a disinflationary and deflationary era, with the policy interest rates close to or at the zero bound.The questions of interest include the potency of the interest rate channel, the stability of broad money demand, and the possibility to use the exchange rate channel in order to affect economic activity and the price level.We use time series econometrics techniques, mainly vector autoregressions, focusing on Japan.While we find that basic relationships between the variables appear unaltered by deflation, a further stimulative impact is difficult to implement once the zero bound is hit.This can be due to political reasons, as in the case of introducing a tax on currency in order to bring about negative interest rates, or because the needed stimulus is very big, as in the case of yen depreciation to increase the price level.The last essay focuses on the fiscal policy aspects of the European Union's most recent enlargement.We examine whether the fiscal austerity required by the Maastricht criteria and the Stability and Growth Pact would be harmful for the socio-economic development of the new Member States.Introducing an indicator for socio-economic development and utilizing instrumental variables regressions, we find that fiscal retrenchment, including a lower level of public debt, would be advantageous for development.A policy implication is to maintain the Stability and Growth Pact or an equivalent intergovernmental fiscal rule to curb public spending and debt. Keywords: deflation, disinflation, zero lower bound, broadly defined liquidity, socio-economic development, Stability and Growth Pact, EU enlargement
  • Komulainen, Tuomas (2004)
    Bank of Finland studies. E 29
    The financial crises in emerging markets in 1997-1999 were preceded by financial liberalisation, rapid surges in capital inflows, increased levels of indebtedness, and then sudden capital outflows. The study contains four essays that extend the different generations of crisis literature and analyse the role of capital movements and borrowing in the recent crises. Essay 1 extends the first generation models of currency crises.It analyses bond financing of fiscal deficits in domestic and foreign currency, and compares the timing and magnitude of attack with the basic case where deficits are monetised.The essay finds that bond financing may not delay the crisis.But if the country's indebtedness is low, the crisis is delayed by bond financing, especially if the borrowing is carried out with bonds denominated in foreign currency. Essay 2 extends the second generation model of currency crises by adding capital flows.If these depend negatively on crisis probability, there will be multiple equilibria.The range of country fundamentals for which self-fulfilling crises are possible is wider when capital flows are included, and thus more countries may end up in crisis.An application of the model shows that in 1996 in many emerging economies the fundamentals were inside the range of multiple equilibria and hence self-fulfilling crises were possible. Essay 3 studies financial contagion and develops a model of the international financial system.It uses a basic model of financial intermediation, but adds several local banks and an international bank.These banks are able to use outside borrowing, the amount of which is determined by the value of their collateral.The essay finds that the use of leverage by local and global banks and the fall in collateral prices comprise an important channel and reason for contagion. Essay 4 analyses the causes of financial crises in 31 emerging market countries in 1980.2001.A probit model is estimated using 23 macroeconomic and financial sector indicators.The essay finds that traditional variables (eg unemployment and inflation) and several indicators of indebtedness (eg private sector liabilities and banks. foreign liabilities) explain currency crises.When the sample was divided into pre- and post-liberalisation periods, the indicators of indebtedness became more important in predicting crisis in the post-liberalisation period. Key words: currency crises, banking crises, emerging markets, borrowing, collateral, contagion, liberalisation
  • Ranki, Sinimaaria (1998)
    Bank of Finland studies. E 9
    Abstract This study, "Exchange Rates in European Monetary Integration", is an empirical contribution to exchange rate theory and international monetary cooperation.The first essay, "Realignment expectations in the ERM: 1987-1992", studies the five-year period of convergence and stability in the European Monetary System (EMS).Existing literature on target zones is utilized to model and estimate devaluation expectations.The results suggest that the exchange rates gained credibility towards the end of this five-year period. German Monetary Unification (GMU) initially had positive spill-over effects on partner countries.Later these effects reversed and the system became increasingly burdened by the consequences of high German interest rates. The second essay, "Monetary policy in the ERM: Internal targets or external constraints?", focuses on the role of the membership in the Exchange Rate Mechanism (ERM) as a determinant of monetary policy.We derive a monetary policy rule that trades off costs of interest rate instability against benefits from successful demand management and stable exchange rate in the ERM.The model is then used to interpret the empirical evidence from a VAR estimated on data from the member countries.The three main observations emphasized are the relatively stable role of the domestic variables, the declining importance of the foreign variables and the growing importance of domestic interest rate history as a determinant of monetary policy decisions. The content of the third essay, "On monetary policy in a bipolar international monetary system", focuses on the possible difficulties in reconciling a domestic inflation target with exchange rate stabilization when the currency is an international key currency.We analyse the international transmission of shocks, and the role of the exchange rate therein, within the framework of a model of two large symmetric open economies.The model's implications are then discussed in the context of the empirical evidence from a VAR estimated on data from Germany and the US.From the model's perspective, the inflation rate seems to be driven by domestic supply shocks in both countries.If the initial source of the disturbance is a US supply shock, Europe can stabilize the exchange rate only at the cost of domestic price stability. Alternatively, Europe has to let the exchange vary to sustain domestic price stability. Keywords: ERM, exchange rates, devaluation expectations, reaction function, monetary policy, international spillovers
  • Brunila, Anne (1997)
    Bank of Finland studies. E 8
    This study considers the effects of fiscal policy on private consumption in a framework that encompasses both the conventional (Keynesian) view of fiscal policy and the Ricardian debt neutrality hypothesis.The model is built on Blanchard's stochastic model of intertemporal optimization with finitely lived consumers.As an extension to the basic framework, public consumption is explicitly incorporated in the model.The model also nests the excess sensitivity hypothesis enabling an investigation of the role of current income in consumption.The empirical analysis is based on annual data from ten EU countries covering the years 1961-1994 and uses the nonlinear instrumental variable GMM estimator both in countryspecific and panel estimations.The tests clearly reject Ricardian debt neutrality for the majority of countries in the sample.The deviations from Ricardian neutrality seem to arise from excess sensitivity of consumption to current income rather than from a finite planning horizon on the part of consumers.The results also suggest that in consumers' utility functions, government consumption and private consumption tend to be unrelated or complements rather than substitutes. Keywords: private consumption, private saving, current income, fiscal policy, planning horizon
  • Castrén, Olli (1998)
    Bank of Finland studies. E 12
    This study contains four essays in the areas of fiscal-monetary policy coordination, public finance and optimal monetary institutions. Essay 1 analyses inflation targeting in an economy with decentralised monetary and fiscal policies and centralised wage setting.Depending on the specification of the trade unions' utility functions, both fiscal and monetary policy can be subject to time-inconsistency problems.Inflation targeting can achieve society's optimal outcome in this model only when the trade unions do not have an employment target which is lower than full employment.The result is robust to uncertainty about the monetary authority's preferences. Essay 2 studies inflation targeting in the context of a monetary union.The setup resembles the Maastricht treaty where a politically representative council delegates monetary policy to an independent central bank.The optimal delegation decision is shown to include an inflation target and a central banker with conservative preferences.It is shown that fiscal discipline in the union increases under such optimal delegation.Moreover, if the voting rules for the delegating council are designed optimally, the council's incentives to renegotiate ex post the central bank's target can be eliminated. Essay 3 focuses on Central Bank (CB) institutions and fiscalmonetary policy coordination under debt stabilisation programmes.When the government and the CB cooperate, a less inflation-averse CB induces faster debt reduction.Under non-cooperative strategies, the opposite result holds.In the presence of political instability, the government shifts fiscal adjustment to the future.Additional adjustment time does not alleviate the situation, but electoral incentives can induce earlier adjustment. Essay 4 looks at optimal fiscal policy in the presence of foreseeable shocks.When the government cares about the future, the deficit is optimally set lower before the arrival of the shock and more adjustment effort is shifted from ex post to ex ante.In EMU, fiscal policy will be constrained by the Stability and Growth Pact, which penalises excessive deficits.Thus, in the presence of shocks, fiscal policy before the shock can become highly restrictive under the pact. Key words: fiscal-monetary policy coordination, optimal institutions, inflation targeting, dynamic budget constraint, debt stabilisation.
  • Leinonen, Harry (2005)
    Bank of Finland studies. E 31
    This publication consists of eleven separate studies on payment and settlement systems conducted using simulation techniques. Most have been carried out using the payment and settlement system simulators BoF-PSS1 or BoF-PSS2 provided by the Bank of Finland and presented at the simulator seminars arranged by the Bank. The main focus in the analyses is on liquidity requirements, settlement speed, gridlock situations, gridlock resolving methods, liquidity economising, systemic risk, and the impact of shocks on system performance. The studies look at systems in several countries and cover both RTGS and netting systems as well as securities settlement systems.
  • Ranki, Sinimaaria (1996)
    Bank of Finland studies. E 4
    The purpose of this study is to analyze realignment expectations in the exchange rate mechanism of the European Monetary System (EMS), in particular with reference to the five year period (1987-1992) during which no realignments were done.The period chosen for this study provides us an interesting sample in this respect, because, in mid-1990, the EMS faced a historical asymmetric shock of German Monetary Unification (GMU).Dramatic changes in the fundamentals of the anchor country of the system can help us to detect channels through which macroeconomic developments affect the pressure to realign and, therefore, expectations of such realignments. By using a model that breaks the interest rate differential in two components, the expected rate of depreciation within the allowed fluctuation band and the expected rate of depreciation of the central parity rate, we get a measure for the credibility of the exchange rate.We estimate the expected rate of depreciation of the exchange rate within the band, subtract the results from the interest rate differential and obtain values for the expected rate of devaluation.Finally, the estimated values for the expected rate of devaluation are regressed on selected macroeconomic variables in order to find out to which extent the expected rate of devaluation depends on economic fundamentals.The model was built by including the commonly most important factors for exchange rate determination. We observed increased exchange rate credibility in the form of decreasing devaluation expectations over the period 1987-1992.The explanation for this increase in the stability of the EMS is that German interest rates and inflation, were moving upwards and hence, approaching the corresponding variables of the other EMS countries. It was the convergence of these variables that eased the pressure on the nominal exchange rates.Therefore, signs of the 1992 crisis could not be seen in advance in expectations. Our results emphasize the role of the relative cyclical positions of the pegging countries vis-à-vis the anchor country of the system.Thus, expectations of possible realignments as a means of adjustment became actual first after it could be seen that there was a discrepancy between the cyclical needs of the economies in the other EMS countries and the high interest rates imposed on the ERM by Germany.These discrepancies became visible first in the traditional weak-currency countries that faced the most difficult domestic economic situation.This is mirrored by the fact that for these countries the government deficit, relative to Germany, clearly affected devaluation expectations.The divergence of the business cycles added to this effect.The level of foreign exchange reserves of the central bank was observed by the markets, which indicates the praneness of these currencies to get under a speculative attack.In the hard-currency countries, by contrast, devaluation expectations could not be seen even in the very eve of the crisis.For these countries, we obtained the inverse result that a growing government domestic deficit as compared to Germany tends to strengthen the currency of the home country.Markets also seem to observe the inflation rate differential.For the crisis, however, this factor could not play a crucial role because the inflation rates of the hard-currency countries were practically at the German inflation rate level.All in all, the results of this study suggest that the crisis was due to the reversal in the German business cycle in a situation where the anchor country conducted a strict monetary policy to fight domestic inflation pressures. Keywords: Exchange Rate Mechanism, target zone, devaluation expectations, exchange rates, German Monetary Unification