Challenges for monetary policy in the European Monetary Union

This article was originally presented as the Homer Jones Memorial Lecture, organized by the Federal Reserve Bank of St. Louis, St. Louis, Missouri, April 13, 2011.Monetary policy - European Union countries ; Monetary unions - European Union countries

Sources of Purchasing Power Disparities Between the G3-Economies

Recent theoretical and empirical research in international macroeconomics has rediscovered the problem of purchasing power parity (PPP). Empirically, PPP is a bad approximation of both the short-term and medium-term properties of the data. Economists have had difficulties in explaining the persistent misalignments of real exchange rates, but new empirical research by Clarida and Galí (1995) suggests that much of these real exchange rate movements are due to relative demand shocks. The present paper challenges this view by using an extended version of their structural vector autoregressive (SVAR) model in order to identify a larger number of real shocks (labour supply, productivity and aggregate demand) and nominal shocks (money demand and money supply). It is found that whilst some of their results go through in our extended framework, there is serious doubt with respect to the appropriateness of labelling those shocks which drive real exchange rates as aggregate demand disturbances.purchasing power parity, real exchange rates, shocks, structural vector autoregression, impulse response functions, variance decompositions

Sources of Currency Crisis: An Empirical Analysis

Two types of currency crisis models coexist in the literature: first generation models view speculative attacks as being caused by economic fundamentals which are inconsistent with a given parity. Second generation models claim self-fulfilling speculation as the main source of a currency crisis. Recent empirical research in international macroeconomics has attempted to distinguish between the sources of currency crises. This paper adds to this literature by proposing a new empirical approach to identifying the speculative and fundamental components of currency crises in the context of a structural vector autoregression model. Our results suggest that only for the French franc can a substantial speculative component be identified as a potential source of the 1992-93 ERM crisis.exchange rates, speculation, fundamentals, currency crisis, purchasing, power parity, structural vector autoregression, impulse response

How wide are European borders? : On the integration effects of monetary unions

We use consumer price data for 81 European cities (in Germany, Austria, Finland, Italy, Spain, Portugal and Switzerland) to study the impact of the introduction of the euro on goods market integration. Employing both aggregated and disaggregated consumer price index (CPI) data we confirm previous results which showed that the distance between European cities explains a significant amount of the variation in the prices of similar goods in different locations. We also find that the variation of relative prices is much higher for two cities located in different countries than for two equidistant cities in the same country. Under the EMU, the elimination of nominal exchange rate volatility has largely reduced these border effects, but distance and border still matter for intra-European relative price volatility

Option Pricing of Twin Assets

How to price and hedge claims on nontraded assets are becoming increasingly important matters in option pricing theory today. The most common practice to deal with these issues is to use another similar or "closely related" asset or index which is traded, for hedging purposes. Implicitly, traders assume here that the higher the correlation between the traded and nontraded assets, the better the hedge is expected to perform. This raises the question as to how \textquoteleft{}closely related\textquoteright{} the assets really are. In this paper, the concept of twin assets is introduced, focusing the discussion precisely in what does it mean for two assets to be similar. Our findings point to the fact that, in order to have very similar assets, for example identical twins, high correlation measures are not enough. Specifically, two basic criteria of similarity are pointed out: i) the coefficient of variation of the assets and ii) the correlation between assets. From here, a method to measure the level of similarity between assets is proposed, and secondly, an option pricing model of twin assets is developed. The proposed model allows us to price an option of one nontraded asset using its twin asset, but this time knowing explicitly what levels of errors we are facing. Finally, some numerical illustrations show how twin assets behave depending upon their levels of similarities, and how their potential differences will traduce in MAPE (mean absolute percentage error) for the proposed option pricing model

How wide are European borders? New evidence on the integration effects of monetary unions

We use consumer price data for 81 European cities (in Germany, Austria, Switzerland, Italy, Spain and Portugal) to study deviations from the law-of-one-price before and during the European Economic and Monetary Union (EMU) by analysing both aggregate and disaggregate CPI data for 7 categories of goods we find that the distance between cities explains a significant amount of the variation in the prices of similar goods in different locations. We also find that the variation of the relative price is much higher for two cities located in different countries than for two equidistant cities in the same country. Under EMU, the elimination of nominal exchange rate volatility has largely reduced these border effects, but distance and border still matter for intra-European relative price volatility. JEL classification: F40, F4

Economic integration and the exchange rate regime: how damaging are currency crises? : [This Version: October 2003]

We use consumer price data for 205 cities/regions in 21 countries to study PPP deviations before, during and after the major currency crises of the 1990s. We combine data from industrialized nations in North America (Unites States, Canada and Mexico), Europe (Germany, Italy, Spain and Portugal), Asia (Japan and South Korea), and Oceania (Australia and New Zealand) with corresponding data from emerging market economies in South America (Argentina, Bolivia, Brazil, Columbia) and Asia (India, Indonesia, Malaysia, Philippines, Taiwan, Thailand). By doing so, we confirm previous results that both distance and border explain a significant amount of relative price variation across different locations. We also find that currency attacks had major disintegration effects by considerably increasing these border effects and by raising within-country relative price dispersion in emerging market economies. These effects are found to be quite persistent since relative price volatility across emerging markets today is still significantly larger than a decade ago

Economic integration and the exchange rate regime: how damaging are currency crises?

We use consumer price data for 205 cities/regions in 21 countries to study deviations from the law-of-one-price before, during and after the major currency crises of the 1990s. We combine data from industrialised nations in North America (Unites States, Canada, Mexico), Europe (Germany, Italy, Spain and Portugal) and Asia (Japan, Korea, New Zealand, Australia) with corresponding data from emerging market economies in the South America (Argentine, Bolivia, Brazil, Columbia) and Asia (India, Indonesia, Malaysia, Philippines, Taiwan, Thailand). We confirm previous results that both distance and border explain a significant amount of relative price variation across different locations. We also find that currency attacks had major disintegration effects by significantly increasing these border effects, and by raising within country relative price dispersion in emerging market economies. These effects are found to be quite persistent since relative price volatility across emerging markets today is still significantly larger than a decade ago. JEL classification: F40, F4