Browsing by Subject "C61"

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  • Chen, Yu-Fu; Funke, Michael; Glanemann, Nicole (2009)
    BOFIT Discussion Papers 21/2009
    Hong Kong's currency is pegged to the US dollar in a currency board arrangement. In autumn 2003, the Hong Kong dollar appreciated from close to 7.80 per US dollar to 7.70, as investors feared that the currency board would be abandoned. In the wake of this appreciation, the monetary authorities revamped the one-sided currency board mechanism into a symmetric two-sided system with a narrow exchange rate band. This paper reviews the characteristics of the new currency board arrangement and embeds a theoretical soft edge target zone model typifying many intermediate regimes, to explain the notable achievement of speculative peace and credibility since May 2005. JEL-Classification: C61, E42, F31, F32 Keywords: currency board arrangement, target zone model, credibility, Hong Kong
  • Huhtala, Heli (2008)
    Bank of Finland Research Discussion Papers 5/2008
    It is well known that under certain assumptions the strategy of an investor maximizing his expected utility coincides with the mean-variance optimal strategy. In this paper we show that the two strategies are not equal in general and find the connection between a utility maximizing and a mean-variance optimal strategy in a continuous semimartingale model. That is done by showing that the utility maximizing strategy of a CARA investor can be expressed in terms of expectation and the expected quadratic variation of the underlying price process. It coincides with the mean-variance optimal strategy if the underlying price process is a local martingale. Keywords: mean-variance portfolios, utility maximization, dynamic portfolio selection, quadratic variation JEL classification numbers: G11, C61
  • Crowley, Patrick M.; Hudgins, David (2016)
    Bank of Finland Research Discussion Papers 21/2016
    This paper uses wavelet-based optimal control to simulate fiscal and monetary strategies under different levels of policy restrictions. The model applies the Maximal Overlap Discrete Wavelet Transform (MODWT) to United States quarterly GDP data, and then uses the decomposed variables to build a large 80 dimensional state-space linear-quadratic tracking model. Using a political targeting design for the frequency range weights, we simulate jointly optimal fiscal and monetary policy where: (1) both fiscal and monetary policy are dually emphasized, (2) fiscal policy is unrestricted while monetary policy is restricted to achieving a steady increase in the market interest rate, and (3) only monetary policy is relatively active, while fiscal spending is restricted to achieving a target growth rate. The results show that fiscal policy must be more aggressive when the monetary authorities are not accommodating the fiscal expansion, and that the dual-emphasis policy leads a series of interest rate increases that are balanced between a steadily increasing target and a low, fixed rate. This research is the first to construct integrated fiscal and monetary policies in an applied wavelet-based optimal control setting using U.S. data.
  • Arango, Carlos; Bouhdaoui, Yassine; Bounie, David; Eschelbach, Martina; Hernandez, Lola (2015)
    Bank of Finland Research Discussion Papers 22/2015
    Despite various payment innovations, today, cash is still heavily used to pay for low-value purchases. This paper proposes a simulation model based on two optimal cash management and payment policies in the payments economics literature to explain cash usage. First, cash is preferred to other payment instruments whenever consumers have enough balances at hand. Second, it is optimal for consumers to hold a stock of cash for precautionary reasons. Exploiting survey payment diaries from Canada, France, Germany and the Netherlands, the results of the simulations show that both optimal policies are well suited to understand the high shares of low-value cash payments in Canada, France and Germany. Yet, they do not perform as well in the case of the Netherlands, overestimating the share of low-value cash payments. We discuss how the differences in payment markets across countries may explain the limitations of the two optimal policies.
  • Chen, Yu-Fu; Funke, Michael (2008)
    BOFIT Discussion Papers 29/2008
    Published in China Economic Review 20 (3), 2009, pp. 558-572
    In January 2008, China adopted a new labour contract law. This new law represents the most significant reform to the legislation on employment relations in mainland China in more than a decade. The paper provides a theoretical framework on the inter-linkages between labour market regulation, option value and the choice and timing of employment. All in all, the paper demonstrates that the Labour Contract Law in its own right will have only small impacts upon employment in the fast-growing Chinese economy. Rather, induced increasing unit labour costs represent the real issue and may reduce employment. JEL-Classification: C61, D81, D92, J23 Keywords: China, labour contract law, real options, employment
  • Crowley, Patrick M.; Hudgins, David (2015)
    Bank of Finland Research Discussion Papers 12/2015
    This paper first applies the MODWT (Maximal Overlap Discrete Wavelet Transform) to Euro Area quarterly GDP data from 1995 – 2014 to obtain the underlying cyclical structure of the GDP components. We then design optimal fiscal and monetary policy within a large state-space LQ-tracking wavelet decomposition model. Our study builds a MATLAB program that simulates optimal policy thrusts at each frequency range where: (1) both fiscal and monetary policy are emphasized, (2) only fiscal policy is relatively active, and (3) when only monetary policy is relatively active. The results show that the monetary authorities should utilize a strategy that influences the short-term market interest rate to undulate based on the cyclical wavelet decomposition in order to compute the optimal timing and levels for the aggregate interest rate adjustments. We also find that modest emphasis on active interest rate movements can alleviate much of the volatility in optimal government spending, while rendering similarly favorable levels of aggregate consumption and investment. This research is the first to construct joint fiscal and monetary policies in an applied optimal control model based on the short and long cyclical lag structures obtained from wavelet analysis.
  • Crowley, Patrick M.; Hudgins, David (2014)
    Bank of Finland Research Discussion Papers 32/2014
    Published in Economic Modelling. Volume 51, December 2015, Pages 502–514
    In this paper discrete wavelet filtering techniques are applied to decompose macroeconomic data so that they can be simultaneously analyzed in both the time and frequency domains. The MODWT (Maximal Overlap Discrete Wavelet Transform) is applied to U.S. quarterly GDP data from 1947–2012 to obtain the underlying cyclical structure of the GDP components. A MATLAB program is then used to design optimal fiscal policy within a LQ-tracking model with wavelet decomposition, and the results are compared with an aggregate model with no frequency decomposition. The results show that fiscal policy is more active under the wavelet-based model, and that the consumption and investment trajectories under the aggregate model are misaligned. We also simulate FHEC (Frequency Harmonizing Emphasis Control) strategies that allow policymakers to concentrate the policy thrust on tracking frequencies that are optimally aligned with policy goals under different targeting priorities. These strategies are only available by using time-frequency analysis. This research is the first to construct fiscal policy in an applied optimal control model on the short and cyclical lag structures obtained from wavelet analysis. Our wavelet-based optimal control procedure allows the policymaker to construct a pragmatic tracking policy, avoid suboptimal policies gleaned from an aggregate model, and reduce the potential for destabilization that might otherwise result due to improper thrust and timing. Keywords: LQ tracking, macroeconomics, optimal control, discrete wavelet analysis, fiscal policy
  • Crowley, Patrick M.; Hudgins, David (2020)
    BoF Economics Review 1/2020
    When the central bank sets monetary policy according to a conventional or modified Taylor rule (which is known as the Taylor Principle), does this deliver the best outcome for the macroeconomy as a whole? This question is addressed by extending the wavelet-based control (WBC) model of Crowley and Hudgins (2015) to evaluate macroeconomic performance when the central bank sets interest rates based on a conventional or modified Taylor rule (TR). We compare the simulated performance of jointly optimal fiscal and monetary policy under an unrestricted baseline model with performance under the TR. We simulate the model under relatively small and large weighting of the output gap in the TR specification, and for both low and high inflation environments. The results show that the macroeconomic outcome depends on whether the conventional or modified Taylor rule is used, and whether the central bank is operating in a low or high inflation environment.
  • Alvarez, Luis H. R.; Koskela, Erkki (2003)
    Suomen Pankin keskustelualoitteita 29/2003
    Published in Journal of Business, 79, 2, March 2006: 623-644
    The current literature on irreversible investment decisions usually makes the assumption of a constant interest rate.We study the impact of interest rate and revenue variability on the decision to carry out an irreversible investment project.Given the generality of the valuation problem considered, we first provide a thorough mathematical characterization of the two-dimensional optimal stopping problem and develop some new results.We establish that interest rate variability has a profound decelerating or accelerating impact on investment demand depending on whether the current interest rate is below or above the long run steady state interest rate, and that its quantitative size may be very large. Allowing for interest rate uncertainty is shown to decelerate rational investment demand by raising both the required exercise premium of the irreversible investment opportunity and the value of waiting.Finally, we demonstrate that increased revenue volatility strengthens the negative impact of interest rate uncertainty and vice versa. Key words: irreversible investment, variable interest rates, free boundary problems JEL classification numbers: Q23, G31, C61 AMS classification numbers: 91B76, 49K15, 49J15
  • Chadha, Jagjit S.; Newby, Elisa (2013)
    Bank of Finland Research Discussion Papers 20/2013
    This paper assesses Revolutionary and Napoleonic wartime economic policy. Suspension of gold convertibility in 1797 allowed the Bank of England to nurture British monetary orthodoxy. The Order of the Privy Council suspended gold payments on Bank of England notes and afforded simultaneous protection to the government and the Bank in pursuit of the conflicting goals of price stability and war finance. The government, the Bank of England and the commercial banks formed a loose alliance drawing on due political and legal processes and also paid close attention to public opinion. We suggest that the ongoing solvency of the Bank of England was facilitated by suspension and allowed the Bank to continue to make substantial profits throughout the Wars. It became acceptable for merchants to continue to trade with non-convertible Bank of England notes and for the government to finance the war effort, even with significant recourse to unfunded debt. These aspects combined to create a suspension of convertibility that did not undermine the currency. By contrast, the Assignats debacle had cost the French monetary system its reputation in the last decade of the 18th century and so Napoleonic finance had to evolve within a more rigid and limiting framework. JEL Classification: C61, E31, E4, E5, N13 Keywords: Monetary Orthodoxy, Suspension of Convertibility, War Finance
  • Hudgins, David; Crowley, Patrick M. (2017)
    Bank of Finland Research Discussion Papers 32/2017
    This paper develops a wavelet-based control system model that can be used to simulate fiscal and monetary strategies in an open economy context in the time-frequency domain. As the emphasis on real exchange rate stability is increased, the model simulates the effects on both the aggregate and decomposed trade balance under both constant and depreciating real exchange rate targets, and also the effects on the real GDP expenditure components. This paper adds to recent research in this area by incorporating an external sector via the use of a real effective exchange rate as a driver of output. The research is also the first to analyze exchange rate effects within a time-frequency model with integrated fiscal and monetary policies in an open-economy applied wavelet-based optimal control setting. To demonstrate the usefulness of this model, we use post-apartheid South African macro data under a political targeting design for the frequency range weights, where we simulate jointly optimal fiscal and monetary policy under varying preferences for real exchange rate stability.
  • Chen, Yu-Fu; Funke, Michael; Glanemann, Nicole (2010)
    BOFIT Discussion Papers 6/2010
    Published in Studies in Nonlinear Dynamics and Econometrics, 2013; 17(4): 373-393
    This paper provides a modelling framework for evaluating the exchange rate dynamics of a target zone regime with undisclosed bands. We generalize the literature to allow for asymmetric one-sided regimes. Market participants' beliefs concerning an undisclosed band change as they learn more about central bank intervention policy. We apply the model to Hong Kong's one-sided currency board mechanism. In autumn 2003, the Hong Kong dollar appreciated from close to 7.80 per US dollar to 7.70, as investors feared that the currency board would be abandoned. In the wake of this appreciation, the monetary authorities finally revamped the regime as a symmetric two-sided system with a narrow exchange rate band. Keywords: Currency Board Arrangement, Target Zone Model, Hong Kong JEL-Classification: C61, E42, F31, F32
  • Kilponen, Juha (2004)
    Suomen Pankin keskustelualoitteita 5/2004
    This paper extends Svensson and Woodford's (2003) partial information framework by allowing the private agents to achieve robustness against incomplete information about the structure of the economy by distorting their expectations in a particular direction.It shows how a linear rational expectations equilibrium under concern for robustness can be solved by exploiting the recursive structure of the problem and appropriately modifying the Bellman equations in their framework.The standard Kalman filter is then used for information updating under imperfect measurement of the state variables.The standard New Keynesian model is used for illustrating how concern for modelling errors interacts with imperfect information.Agents achieve robustness by simultaneously over-estimating the persistence of exogenous shocks, but under-estimating the policy response to the output gap.This under-estimation, combined with imperfect measurement, leads to larger and more persistent responses of private consumption to government expenditure shocks under robust expectations. Key words: expectations, robust control, model uncertainty, monetary policy, imperfect information JEL classification numbers: D81, C61, E52
  • Chen, Hongyi; Funke, Michael; Lozev, Ivan; Tsang, Andrew (2017)
    BOFIT Discussion Papers 3/2017
    Published in International Journal of Central Banking, IJCB, Vol. 16, No. 5, October 2020, pp. 49–94
    This paper discusses the macroeconomic effects of China’s informal banking regulatory tool “win-dow guidance,” introduced in 1998. Using an open-economy DSGE model that includes the com-mercial banking sector, we study the stabilizing effects of this non-standard quantitative monetary policy tool and the implications of quantity-based vs. price-based monetary policy instruments for welfare. The analyses are relevant to the current overhaul of Chinese monetary policy.
  • Crowley, Patrick M.; Hudgins, David (2019)
    Bank of Finland Research Discussion Papers 11/2019
    It is widely recognized that the policy objectives of fiscal and monetary policymakers usually have different time horizons, and this feature may not be captured by traditional econometric techniques. In this paper, we first decompose U.S macroeconomic data using a time-frequency domain technique, namely discrete wavelet analysis. We then model the behavior of the U.S. economy over each wavelet frequency range and use our estimated parameters to construct a tracking model. To illustrate the usefulness of this approach, we simulate jointly optimal fiscal and monetary policy with different short-term targets: an inflation target, a money growth target, an interest rate target, and a real exchange rate target. The results determine the reaction in fiscal and monetary policy that is required to achieve an inflation target in a low inflation environment, and when both fiscal and monetary policy are concerned with meeting certain economic growth objectives. The combination of wavelet decomposition in an optimal control framework can also provide a new approach to macroeconomic forecasting.