Dollarization Persistence and Individual Heterogeneity

The most salient feature of financial dollarization, and the one that causes more concern to policymakers, is its persistence: even after successful macroeconomic stabilizations, dollarization ratios often remain high. In this paper we claim that this persistence is connected to the fact that the participants in the dollar deposit market are fairly heterogenous, and so is the way they form their optimal currency portfolio. We develop a simple model when agents differ in their ability to process information, which turns out to be enough to generate persistence upon aggregation. We find empirical support for this claim with data from three Latin American countries and Poland.Dollarization, individual heterogeneity, persistence, aggregation

Monetary Policy in the presence of Informal Labour Markets

In this paper we analyse the effects of informal labour markets on the dynamics of inflation and on the transmission of aggregate demand and supply shocks. In doing so, we incorporate the informal sector in a modified New Keynesian model with labour market frictions as in the Diamond-Mortensen-Pissarides model. Our main results show that the informal economy generates a "buffer" effect that diminishes the pressure of demand shocks on aggregate wages and inflation. Finding that is consistent with the empirical literature on the e¤ects of informal labour markets in business cycle fluctuations. This result implies that in economies with large informal labour markets the interest rate channel of monetary policy is relatively weaker. Furthermore, the model produces cyclical flows from informal to formal employment consistent with the data.Monetary Policy, New Keynesian Model, Informal Economy, Labour Market Frictions.

Inflation Premium and Oil Price Volatility

In this paper we establish a link between the volatility of oil price shocks and a positive expected value of inflation in equilibrium (inflation premium). In doing so, we implement the perturbation method to solve up to second order a benchmark New Keynesian model with oil price shocks. In contrast with log linear approximations, the second order solution relaxes certainty equivalence providing a link between the volatility of shocks and inflation premium. First, we obtain analytical results for the determinants of the level of inflation premium. Thus, we find that the degree of convexity of both the marginal cost and the phillips curve is a key element in accounting for the existence of a positive inflation premium. We further show that the level of inflation premium might be potentially large even when a central bank implements an active monetary policy. Second, we evaluate numerically the second order solution of the model to explain the episode of high and persistent inflation observed in the US during the 70's. We find, in contrast with Clarida, Gali and Gertler (QJE, 2000), that even when there is no difference in the monetary policy rules between the pre-Volcker and post-Volcker periods, oil price shocks can generate high inflation levels during the 70's through a positive high level of inflation premium. As by product, our analysis shows that oil price shocks along with a distorted steady state can generate a time-varying endogenous trade-off between inflation and deviations of output from its efficient level. The previous trade-off, once uncertainty is taking into account, implies that a positive level of inflation premium is an optimal response to oil price shocksPhillips Curve, Second Order Solution, Oil Price Shocks, Endogenous Trade-off

Dollarization Persistence and Individual Heterogeneity

The most salient feature of financial dollarization, and the one that causes more concern to policy makers, is its persistence: even after successful macroeconomic stabilizations, dollarization ratios often remain high. In this paper we claim that this persistence is connected to the fact that the participants in the dollar deposit market are fairly heterogenous, and so is the way they form their optimal currency portfolio.We develop as simple model when agents differ in their ability to process information, which turns out to be enough to generate persistence up on aggregation. We find empirical support for this claim with data from three Latin American countries and Poland.Dollarization, individual heterogeneity, persistence, aggregation

Facing up a sudden stop of capital flows: Policy lessons from the 90's peruvian experience

This paper assesses the policies implemented in the Peruvian economy in response to the sudden stop of capital flows of the end of the nineties. The Peruvian experience during this episode is an interesting case-study because it offers an example of a highly dollarized economy where a sudden stop of capital flows neither had dramatic negative effects on the banking system nor generated an abrupt fall on output. We argue that the large pool of international reserves, the investments on the tradable sector before 1997 and the performance of the fiscal policy during and before the period of financial distress were fundamental to this outcome. We further extract policy lessons and discuss the strengths and the weakness of the Peruvian economy to this type of shocks nowadays.Sudden Stops, Peru, International Reserves, and Policy Responses

Monetary Policy, Regime Shifts, and Inflation Uncertainty in Peru (1949-2006)

This paper evaluates the link between inflation and inflation uncertainty in a context of monetary policy regime shifts for the Peruvian economy. We use a model of unobserved components subject to regime shifts to evaluate this link. We verify that periods of high(low) inflation me an were accompanied by periods of high(low) both short -and long- run uncertainty in inflation. Interestingly, unlike developed countries, short run uncertainty is important. These relationaships are consistent with the presence of three clearly differentiated regimes. First, a period of price stability, then a high -inflation high-volatility regime, and finally a hyperinflation period. We also verify that during a recent period of price stability, both permanent and transitory shocks to inflation have decreased in volatility. Finally, we find evidence that inflation and money growth rates share similar regime shifts.inflation dynamics, monetary policy, Markov-switching models, unobserved component models, sthocastic trends

Inflation Premium and Oil Price Volatility

In this paper we establish a link between the volatility of oil price shocks and a positive expected value of inflation in equilibrium (inflation premium). In doing so, we implement the perturbation method to solve up to second order a benchmark New Keynesian model with oil price shocks. In contrast with log linear approximations, the second order solution relaxes certainty equivalence providing a link between the volatility of shocks and inflation premium. First, we obtain analytical results for the determinants of the level of inflation premium. Thus, we find that the degree of convexity of both the marginal cost and the Phillips curve is a key element in accounting for the existence of a positive inflation premium. We further show that the level of inflation premium might be potentially large even when a central bank implements an active monetary policy. Second, we evaluate numerically the second order solution of the model to explain the episode of high and persistent inflation observed in the US during the 70’s. We find, in contrast with Clarida, Gali and Gertler (QJE, 2000), that even when there is no difference in the monetary policy rules between the pre-Volcker and post-Volcker periods, oil price shocks can generate high inflation levels during the 70’s through a positive high level of inflation premium. As by product, our analysis shows that oil price shocks along with a distorted steady state can generate a time-varying endogenous trade-off between inflation and deviations of output from its efficient level. The previous trade-off, once uncertainty is taking into account, implies that a positive level of inflation premium is an optimal response to oil price shocks.

Inflation Premium and Oil Price Volatility

This paper provides a fully micro-founded New Keynesian framework to study the interaction between oil price volatility, pricing behavior of firms and monetary policy. We show that when oil has low substitutability, firms find it optimal to charge higher relative prices as a premium in compensation for the risk that oil price volatility generates on their marginal costs. Overall, in general equilibrium, the interaction of the aforementioned mechanisms produces a positive relationship between oil price volatility and average inflation, which we denominate inflation premium. We characterize analytically this relationship by using the perturbation method to solve the rational expectations equilibrium of the model up to second order of accuracy. The solution implies that the inflation premium is higher when: a) oil has low substitutability, b) the Phillips Curve is convex, and c) the central bank puts higher weight on output fluctuations. We also provide some quantitative evidence showing that a calibrated model for the US with an estimated active Taylor rule produces a sizable inflation premium, similar to the levels observed in the US during the 70s.Second Order Solution, Oil Price Shocks, Endogenous Trade-off