Wage Rigidity and Monetary Union

We compare monetary union to flexible exchange rates in an asymmetric, threecountry model with active monetary policy. Unlike the traditional OCA literature, we find that countries with a high degree of nominal wage rigidity benefit from monetary union, specially when they join other, similarly rigid countries. Countries with relatively more flexible wages tend to be worse off in unions with countries that have more rigid wages. We examine France, Germany and the UK and find that the welfare implications of alternative monetary arrangements depend more on the degree of wage asymmetry than on other types of asymmetries (in shocks, monetary policy etc.). And that, higher degree of wage flexibility in the UK relative to France and Germany would make its participation in EMU costly.Monetary union, wage rigidity, asymmetry, multi-country model

Wage Rigidity and Monetary Union

We compare monetary union to flexible exchange rates in an asymmetric, three- country model with active monetary policy. Unlike the traditional OCA literature, we find that countries with high nominal wage rigidities benefit from monetary union, specially when they join other, similarly rigid countries. Countries with relatively more flexible wages lose when they form a union with more rigid wage countries. We study the France, Germany and the UK and find that wage asymmetries across these three countries dominate other types of asymmetries (in shocks, monetary policy etc.) in welfare comparisons. And that, if the UK had a substantially higher degree of wage flexibility than France and Germany, then her participation in EMU would be costly.monetary union; wage rigidity; asymmetry; multi-country model

The New Keynesian Phillips Curve and Inflation Expectations: Re-Specification and Interpretation

A theoretical analysis of the new Keynesian Phillips curve (NKPC) is provided, formulating the conditions under which the NKPC coincides with a real-world relation that is not spurious or misspecified. A time-varying-coefficient (TVC) model, involving only observed variables, is shown to exactly represent the underlying “true” NKPC under certain conditions. In contrast, “hybrid” NKPC models, which add lagged-inflation and supply-shock variables, are shown to be spurious and misspecified. We also show how to empirically implement the NKPC under the assumption that expectations are formed rationally.Time-varying-coefficient model; Inflation-unemployment trade-off; “Objective” probability; Spurious correlation; Rational expectation; Coefficient driver

The Global Implications of Regional Exchange Rate Regines

We examine the implications of a regional, fixed exchange rate regime for global exchange rate volatility. The concept of the optimum currency area turns out to play an important role. The formation of a regional regime tends to decrease global volatility when countries are symmetric. The effects tend to be ambiguous in the case of asymmetries. The reduction in global volatility is larger when the rest of the world has more rigid labor markets than the peggers. When the exchange rate management is done mostly by countries with relatively more flexible labor markets. And in the presence of a negative correlation in productivity shocks across countries.Regional exchange rate systems, global exchange rate volatility, optimum currency area

The fatal flaw: the revived Bretton-woods system, liquidity creation, and commodity-price bubbles

Dooley, Folkerts-Landau and Garber (DFG) argue that the present constellation of global exchange-rate arrangements constitutes a revived Bretton-Woods system. DFG ALSO argue that the revived system will be sustainable, despite its large global imbalances. We argue that, to the extent that the present system constitutes a revived Bretton-Woods system, it is vulnerable to the same set of destabilizing forces - - including asset price bubbles and global financial crises - - that led to the breakdown of the earlier regime.Bretton-Woods system;international liquidity;price bubbles;Markov switching model

The Debate about the Revived Bretton-Woods Regime: A Survey and Extension of the Literature*

This paper surveys the literature dealing with the thesis put forward by Dooley, Folkerts-Landau and Garber (DFG) that the present constellation of global exchange-rate arrangements constitutes a revived Bretton-Woods regime. DFG also argue that the revived regime will be sustainable, despite its large global imbalances. While much of the literature generated by DFG’s thesis points to specific differences between the earlier regime and revived regime that render the latter unstable, we argue that an underlying similarity between the two regimes renders the revived regime unstable. Specifically, to the extent that the present system constitutes a revived Bretton-Woods system, it is vulnerable to the same set of destabilizing forces -- including asset price bubbles and global financial crises -- that marked the latter years of the earlier regime, leading to its breakdown. We extend the Markov switching model to examine the relation between global liquidity and commodity prices. We find evidence of commodity-price bubbles in both the latter stages of the earlier Bretton-Woods regime and the revived regime.Bretton-Woods regime, international liquidity, price bubbles, Markov switching model

The Classification and Perfomance of Alternative Exchange-Rate Systems

Owing to dissatisfaction with the IMF’s de jure classification of exchange-rate regimes, a substantial literature has emerged presenting de facto classifications of exchange-rate systems and using the latter classifications to compare performances of alternative regimes in terms of key macroeconomic variables. This paper critically reviews the literature on de facto regimes. In particular the paper (1) describes the main methodologies that have been used to construct de facto codings, (2) surveys the empirical literature generated by de facto regime codings, and (3) lays-out the problems inherent in constructing de facto classifications. The empirical literature is found to yield few robust findings. We argue that the as-yet unfulfilled objective of this literature, and the major research agenda for the future in this area, lies in the need of a more thorough investigation of the degree of monetary-policy independence without relying exclusively on movements in exchange rates, an agenda the attainment of which is made especially challenging because of the lack of comprehensive and reliable data on reserves and interest rates.Exchange-rate regimes; Economic growth; Inflation; Bipolar hypothesis

The New Keynesian Phillips Curve and Lagged Inflation: A Case of Spurious Correlation?

The New Keynesian Phillips Curve (NKPC) specifies a relationship between inflation and a forcing variable and the current period’s expectation of future inflation. Most empirical estimates of the NKPC, typically based on Generalized Method of Moments (GMM) estimation, have found a significant role for lagged inflation, producing a “hybrid” NKPC. Using U.S. quarterly data, this paper examines whether the role of lagged inflation in the NKPC might be due to the spurious outcome of specification biases. Like previous investigators, we employ GMM estimation and, like those investigators, we find a significant effect for lagged inflation. We also use time varying coefficient (TVC) estimation, a procedure that allows us to directly confront specification biases and spurious relationships. Using three separate measures of expected inflation, we find strong support for the view that, under TVC estimation, the coefficient on expected inflation is near unity and that the role of lagged inflation in the NKPC is spurious.New Keynesian Phillips curve; time-varying coefficients; spurious relationships.

The Nonexistence of Instrumental Variables

The method of instrumental variables (IV) and the generalized method of moments (GMM) and their applications to the estimation of errors-in-variables and simultaneous equations models in econometrics require data on a sufficient number of instrumental variables which are (insert space)both exogeneous and relevant. We argue that in general such instruments (weak or strong) cannot exist.

Bretton-Woods systems, old and new, and the rotation of exchange-rate regimes

A recent contribution to the literature argues that the present international monetary system in many ways operates like the Bretton-Woods system. Asia is the new periphery of the system and pursues an export-led development strategy based on undervalued exchange rates and accumulated foreign reserves. The United States remains the centre country, pursuing a monetary-policy strategy that overlooks the exchange rate. Under both regimes the United States does not take external factors into account in conducting monetary policy while the periphery does take external factors into account. We provide results of a test of this hypothesis. Then, we present a new method for decomposition of a seasonally adjusted series the business cycle and other components using a time-varying-coefficient technique that allows us to test the relationship between the cycle and macroeconomic policies under both regimes.Revived Bretton-Woods system, asymmetry hypothesis, time-series, decomposition, time-varying-coefficient estimation