Activist Monetary Policy, Imperfect Capital Mobility, and the Overshooting Hypothesis

The hypothesis of exchange rate over shooting is investigated in the context of a model that incorporates activist monetary policy, variable output, imperfect capital mobility, and slow price adjustment. Monetary policy which accommodates prices and/or interest rates is shown to increase the likelihood of undershooting. Using constrained maximum likelihood methods,the model is estimated for Germany and Japan since the advent of generalized floating in 1973. Based on the estimated parameter values, the mark exhibits overshooting while the yen is characterized by undershooting. The constraints implied by the model cannot (by likelihood ratio tests) be rejected at standard significance levels for either country.

Exchange Rate and Current Account Dynamics Under Rational Expectations: An Econometric Analysis

An econometric portfolio balance model of an open economy, incorporating exchange rate, price, and current account dynamics, is derived and estimated.The usual stability conditions do not guarantee a unique rational expectations solution, and several proposals for resolving this situation are considered. Using constrained maximum likelihood methods, the model is estimated for Japan.The estimation results indicate that the model is quite successful in explaining the patterns found in the data. The model is estimated using several methods of resolving the question of non-uniqueness, and the results are compared.

Activist Monetary Policy and Exchange Rate Overshooting: The Deutsche Mark/Dollar Rate

After a decade of generalized floating, it is clear that bilateral exchange rates exhibit more variability than the economic aggregates; relative prices, incomes, and money supplies, that generally comprise the fundamentals of theories of exchange rate determination. Dornbush's over-shooting hypothesis is the best known explanation of this phenomenon. This paper shows that accommodative monetary policy (with respect to prices) has the potential to cause the economy to switch from exchange rate overshooting to undershooting. Using constrained maximum likelihood methods, the model is estimated for Germany and the United States. The results provide strong evidence in support of the overshooting hypothesis for the Deutsche Mark/Dollar exchange rate.

The Great Wars, The Great Crash, and the Unit Root Hypothesis: Some New Evidence About an Old Stylized Fact

For decades, the prevailing sentiment among economists was that growth rates remain constant over the long run. Kaldor considered this to be one of the six important 'stylized facts' that theory should address, and until the emergence of endogenous growth models, this was a fundamental feature of growth theory. This paper uses an endogenous trend break model to investigate the unit root hypothesis for 16 countries, using annual GDP data spanning up to 130 years. Rejection of the unit root, which is facilitated by the inclusion of a trend break, introduces the possibility of examining the long run behavior of growth rates. We find that most countries exhibited fairly steady growth for a period lasting several decades. The termination of this period was usually characterized by a significant, and sudden, drop in GDP levels. But rather than simply returning to their previous steady state path, as predicted by the standard neoclassical growth model, most countries continued to grow at roughly double their prebreak rates for many decades, even after their original growth path had been surpassed.

Are Real GDP Levels Trend, Difference, or Regime-Wise Trend Stationary? Evidence from Panel Data Tests Incorporating Structural Change

The unit root hypothesis for international real GDP and real GDP per capita has been the subject of extensive investigation. Using panel methods that incorporate structural change, we reject the unit root null in favor of the alternative of trend stationarity with one or two changes in the slope for two panels with postwar data and one or two changes in both the slope and the intercept for a panel with long-horizon data. We conclude that real GDP levels are better characterized as regime-wise trend stationary than as either trend stationary without structural change or difference stationary with unit roots.

Convergence to Purchasing Power Parity at the Commencement of the Euro

We investigate convergence towards Purchasing Power Parity (PPP) within the Euro Zone and between the Euro Zone and its main partners using panel data methods that incorporate serial and contemporaneous correlation. We find strong rejections of the unit root hypothesis, and therefore evidence of PPP, in the Euro Zone for different numeraire currencies, as well as in the Euro Zone plus the United States, with the US dollar as the numeraire currency, starting between 1996 and 1999. The process of convergence towards PPP, however, begins earlier, generally in 1992 or 1993 following the adoption of the Maastricht Treaty.PPP EURO PANEL UNIT ROOT

Convergence of Euro Area Inflation Rates

We study the behavior of inflation rates among the 12 initial Euro countries in order to test whether and when the group convergence initially dictated by the Maastricht treaty and now by the ECB, occurs. We also assess the impact of events such as the advent of the Euro and the 2008 financial crisis. Due to the small size of the estimation sample, we propose a new procedure that increases the power of panel unit root tests when used to study group-wise convergence. Applying this new procedure to Euro area inflation, we find strong and lasting evidence of convergence among the inflation rates soon after the implementation of the Maastricht treaty and a dramatic decrease in the persistence of the differential after the occurrence of the single currency. After the 2008 crisis, Euro area inflation rates follow the ECB’s price stability benchmark, although Greece reports relatively higher inflation.groupwise convergence, inflation, Euro area, 2008 crisis.

Inflation Persistence and the Taylor Principle

Although the persistence of inflation is a central concern of macroeconomics, there is no consensus regarding whether or not inflation is stationary or has a unit root. We show that, in the context of a “textbook” macroeconomic model, inflation is stationary if and only if the Taylor rule obeys the Taylor principle, so that the real interest rate is increased when inflation rises above the target inflation rate. We estimate Markov switching models for both inflation and real-time forward looking Taylor rules. Inflation appears to have a unit root for most of the 1967 – 1981 period, and is stationary before 1967 and after 1981. We find that the Fed’s response to inflation is also regime dependent, with both the pre and post-Volcker samples containing monetary regimes where the Fed both did and did not follow the Taylor principle. This contrasts to recent research that suggests the Fed’s response to inflation has been time invariant, and that changes in monetary policy only occurred with respect to the output gap.Taylor rule, real-time data, Great inflation, policy regimes, Markov switching

Median-Unbiased Estimation in DF-GLS Regressions and the PPP Puzzle

Using median-unbiased estimation, recent research has questioned the validity of Rogoff’s “remarkable consensus” of 3-5 year half-lives of deviations from PPP. These half-life estimates, however, are based on estimates from regressions where the resulting unit root test has low power. We extend median-unbiased estimation to the DF-GLS regression of Elliott, Rothenberg, and Stock (1996). We find that median-unbiased estimation based on this regression has the potential to tighten confidence intervals for half-lives. Using long horizon real exchange rate data, we find that the typical lower bound of the confidence intervals for median-unbiased half-lives is just under 3 years. Thus, while previous confidence intervals for half-lives are consistent with virtually anything, our tighter confidence intervals now rule out economic models with nominal rigidities as candidates for explaining the observed behavior of real exchange rates. Therefore, while we obtain more information using efficient unit root tests on longer term data, this information moves us away from solving the PPP puzzle.PPP, median unbiased, detrended half life

The Purchasing Power Parity Persistence Paradigm

No abstract.