The Maastricht Convergence Criteria and Optimal Monetary Policy for the EMU Accession Countries.

The EMU accession countries are obliged to fulfill the Maastricht convergence criteria prior to entering the EMU. This paper uses a DSGE model of a two-sector small open economy, to address the following question: How do the Maastricht convergence criteria modify optimal monetary policy in an economy facing domestic and external shocks? First, we derive the micro founded loss function that represents the objective function of the optimal monetary policy not constrained to satisfy the criteria. We find that the optimal monetary policy should not only target inflation rates in the domestic sectors and aggregate output fluctuations but also domestic and international terms of trade. Second, we show how the loss function changes when the monetary policy is constrained to satisfy the Maastricht criteria. The loss function of such a constrained policy is characterized by additional elements penalizing fluctuations of the CPI inflation rate, the nominal interest rate and the nominal exchange rate around the new targets which are potentially different from the steady state of the unconstrained optimal monetary policy. Under the chosen parameterization, the unconstrained optimal monetary policy violates two criteria: concerning the CPI inflation rate and the nominal interest rate. The constrained optimal policy results in targeting the CPI inflation rate and the nominal interest rate that are 0.7% lower (in annual terms) than the CPI inflation rate and the nominal interest rate in the countries taken as a reference. The welfare costs associated with these constraints need to be offset against credibility gains and other benefits related to the compliance with the Maastricht criteria that are not modelled. JEL Classification: F41, E52, E58, E61EMU accession countries, Maastricht convergence criteria, optimal monetary policy

Epstein-Zin preferences and their use in macro-finance models: implications for optimal monetary policy

Epstein-Zin preferences have attracted significant attention within the macro-finance literature based on DSGE models as they allow to substantially increase risk aversion, and consequently generate non-trivial risk premia, without compromising the ability of standard models to achieve satisfactory macroeconomic data coherence. Such appealing features certainly hold for structural modelling frameworks where monetary policy is set according to Taylor-type rules or seeks to minimize an ad hoc loss function under commitment. However, Epstein-Zin preferences may have significant quantitative implications for both asset pricing and macroeconomic allocation under a welfare-based monetary policy conduct. Against this background, the paper focuses on the impact of such preferences on the Ramsey approach to monetary policy within a medium-scale model based on Smets and Wouters (2007) including a wide range of nominal and real frictions that have proven to be relevant for quantitative business cycle analysis. After setting an empirical benchmark that generates a mean value of 100 bp for the ten-year term premium, we show that Epstein-Zin preferences significantly affect the macroeconomic outcome when optimal policy is considered. The level and the dynamic pattern of risk premia are also markedly altered. We show that the effect of Epstein-Zin preferences is extremely sensitive to the presence of real rigidities in the form of quasi-kinked demands. We also analyse how this effect can be linked to a combined e¤ect of capital accumulation and wage rigidities. JEL Classification: E44, E52, E61, G12macroeconometric equivalence, non time-separable preferences, optimal monetary policy, term premium

Sticky wages: evidence from quarterly microeconomic data

This paper documents nominal wage stickiness using an original quarterly firm-level dataset. We use the ACEMO survey, which reports the base wage for up to 12 employee categories in French firms over the period 1998 to 2005, and obtain the following main results. First, the quarterly frequency of wage change is around 35 percent. Second, there is some downward rigidity in the base wage. Third, wage changes are mainly synchronized within firms but to a large extent staggered across firms. Fourth, standard Calvo or Taylor schemes fail to match micro wage adjustment patterns, but fixed duration "Taylor-like" wage contracts are observed for a minority of firms. Based on a two-thresholds sample selection model, we perform an econometric analysis of wage changes. Our results suggest that the timing of wage adjustments is not state-dependent, and are consistent with existence of predetermined of wage changes. They also suggest that both backward- and forward-looking behavior is relevant in wage setting. JEL Classification: E24, J3wage predetermination, Wage stickiness

Fixed and variable-rate mortgages, business cycles and monetary policy

The aim of this paper is twofold. First, I study how the proportion of fixed and variable-rate mortgages in an economy can affect the way shocks are propagated. Second, I analyze optimal implementable simple monetary policy rules and the welfare implications of this proportion. I develop and solve a New Keynesian dynamic stochastic general equilibrium model that features a housing market and a group of constrained individuals who need housing collateral to obtain loans. A given proportion of constrained households borrows at a variable rate, while the rest borrows at a fixed rate. The model predicts that in an economy with mostly variable-rate mortgages, an exogenous interest rate shock has larger effects on borrowers than in a fixed-rate economy. Aggregate effects are also larger for the variable-rate economy. For plausible parametrizations, differences are muted by wealth effects on labor supply and by the presence of savers. More persistent shocks, such as inflation target and technology shocks, cause larger aggregate differences. From a normative perspective I find that, in the presence of collateral constraints, the optimal Taylor rule is less aggressive against inflation than in the standard sticky-price model. Furthermore, for given monetary policy, a high proportion of fixed-rate mortgages is welfare enhancin

What do asset prices have to say about risk appetite and uncertainty?

Implied volatility indices should have information about risk parameters, once they are cleansed of the influence of normal volatility dynamics and macro-economic uncertainty. Building on intuition from the dynamic asset pricing literature, we uncover unobserved risk aversion and fundamental uncertainty from the observed time series of the VIX and the credit spreads while controlling for realized volatility, expectations about the macroeconomic outlook, and interest rates. We apply this methodology to monthly data from both Germany and the US. We find that implied volatilities contain a substantial amount of information regarding risk aversion whereas credit spreads have a lot to say about both risk aversion and uncertainty. Moreover, there is a significant comovement in the German and US risk aversion. JEL Classification:Credit Spread, Economic uncertainty, risk aversion, Time variation in risk and return, Volatility dynamics

Assessing the benefits of international portfolio diversification in bonds and stocks.

This paper considers a stylized asset pricing model where the returns from exchange rates, stocks and bonds are linked by basic risk-arbitrage relationships. Employing GMM estimation and monthly data for 18 economies and the US (treated as the domestic country), we identify through a simple test the countries whose assets strongly comove with US assets and the countries whose assets might other larger diversification benefits. We also show that the strengthening of the comovement of returns across countries is neither a gradual process nor a global phenomenon, reinforcing the case for international diversification. However, our results suggest that fund managers are better other constructing portfolios selecting assets from a subset of countries than relying on either fully inter-nationally diversified or purely domestic portfolios. JEL Classification: F31, G10asset pricing, Exchange Rates, international parity conditions, market integration, stochastic discount factor

Sovereign debt markets in turbulent times : creditor discrimination and crowding-out effects

En 2007, los países de la periferia europea disfrutaban de un crecimiento estable, y défi cits fi scales y primas de riesgo reducidos. Sin embargo, la crisis fi nanciera global empujó a estas mismas economías a profundas recesiones, aumentando sus défi cits públicos y volúmenes de deuda pública de tal forma que en 2010 estas economías comenzaron a sufrir episodios de crisis de deuda soberana muy severos. Al tiempo que las primas de riesgo aumentaban, también lo hizo la proporción de la deuda pública en manos de inversores residentes. De esta forma, el crédito disponible fue reasignado del sector privado al sector público, lo que vino acompañado de una caída en la inversión privada y un agravamiento de la recesión económica. En este trabajo proponemos un modelo de riesgo soberano, en el que la deuda pública se negocia en mercados secundarios, y que es capaz de racionalizar todos estos hechos estilizados. El modelo tiene dos ingredientes principales: discriminación entre acreedores y «efecto expulsión» (crowding-out effect, en inglés)..In 2007, countries in the euro periphery were enjoying stable growth, low defi cits and low spreads. Then the fi nancial crisis erupted and pushed them into deep recession, raising their defi cits and debt levels. By 2010, they were facing severe debt problems. Spreads increased and, surprisingly, so did the share of the debt held by domestic creditors. Credit was reallocated from the private to the public sector, reducing investment and deepening the recession even further. To account for these facts, we propose a simple model of sovereign risk in which debt can be traded in secondary markets. The model has two key ingredients: creditor discrimination and crowding-out effects.

To surcharge or not to surcharge? A two-sided market perspective of the no-surchage rule

In Electronic Payment Networks (EPNs) the No-Surcharge Rule (NSR) requires that merchants charge the same final good price regardless of the means of payment chosen by the customer. In this paper, we analyze a three-party model (consumers, merchants, and proprietary EPNs) to assess the impact of a NSR on the electronic payments system, in particular, on competition among EPNs, network pricing to merchants and consumers, EPNs' profits, and social welfare. We show that imposing a NSR has a number of effects. First, it softens competition among EPNs and rebalances the fee structure in favor of cardholders and to the detriment of merchants. Second, we show that the NSR is a profitable strategy for EPNs if and only if the network e¤ect from merchants to cardholders is sufficiently weak. Third, the NSR is socially (un)desirable if the network externalities from merchants to cardholders are sufficiently weak (strong) and the merchants' market power in the goods market is sufficiently high (low). Our policy advice is that regulators should decide on whether the NSR is appropriate on a market-by-market basis instead of imposing a uniform regulation for all markets. JEL Classification: L13, L42, L80American Express, Discover, Electronic payment system, market power, MasterCard, network externalities, no-surcharge rule, regulation, two-sided markets, Visa

Money growth and inflation: a regime switching approach

We develop a time-varying transition probabilities Markov Switching model in which inflation is characterised by two regimes (high and low inflation). Using Bayesian techniques, we apply the model to the euro area, Germany, the US, the UK and Canada for data from the 1960s up to the present. Our estimates suggest that a smoothed measure of broad money growth, corrected for real-time estimates of trend velocity and potential output growth, has important leading indicator properties for switches between inflation regimes. Thus money growth provides an important early warning indicator for risks to price stability. JEL Classification: C11, C53, E31Bayesian inference, early warning, inflation regimes, Markov Switching model, money growth, time varying transition probabilities

Green shoots in the euro area : a real time measure

We show that an extension of the Markov-switching dynamic factor models that accounts for the speci cities of the day to day monitoring of economic developments such as ragged edges, mixed frequencies and data revisions is a good tool to forecast the Euro area recessions in real time. We provide examples that show the nonlinear nature of the relations between data revisions, point forecasts and forecast uncertainty. According to our empirical results, we think that the real time probabilities of recession are an appropriate statistic to capture what the press call green shoot