Downward wage rigidity and optimal steady-state inflation

This paper examines the impact of downward wage rigidity (nominal and real) on optimal steady-state inflation. For this purpose, we extend the workhorse model of Erceg, Henderson and Levin (2000) by introducing asymmetric menu costs for wage setting. We estimate the key parameters by simulated method of moments, matching key features of the cross-sectional distribution of individual wage changes observed in the data. We look at five countries (the US, Germany, Portugal, Belgium and Finland). The calibrated heterogeneous agent models are then solved for different steady state rates of inflation to derive welfare implications. We find that, across the European countries considered, the optimal steady-state rate of inflation varies between zero and 2%. For the US, the results depend on the dataset used, with estimates of optimal inflation varying between 2% and 5%. JEL Classification: E31, E52, J4downward wage rigidity, DSGE Models, optimal inflation

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

Macroeconomic Adjustment to Monetary Union

The move to monetary union in Europe led to convergence of interest rates among the participating countries. This was associated with notable cross-country differences in the behaviour of key macroeconomic aggregates. Compared to the low interest rate countries, former high interest rate countries experienced a boom in domestic demand, a deterioration of the current account and appreciation of the real exchange rate. This paper documents the key stylised facts of this experience and provides a compact two-country model, based on the Blanchard-Yaari setup, to analyze this phenomenon. This model, though simple, is able to broadly capture the main qualitative features of the adjustment. Using this model, we show that the creation of the monetary union leads to an increase in welfare for all generations in both country groups.euro area, interest rate convergence, overlapping generations model.

Macroeconomic adjustment to monetary union

The move to monetary union in Europe led to convergence of interest rates among the participating countries. This was associated with notable cross-country differences in the behaviour of key macroeconomic aggregates. Compared to the low interest rate countries, former high interest rate countries experienced a boom in domestic demand, a deterioration of the current account and appreciation of the real exchange rate. This paper documents the key stylised facts of this experience and provides a compact two-country model, based on the Blanchard-Yaari setup, to analyze this phenomenon. This model, though simple, is able to broadly capture the main qualitative features of the adjustment. Using this model, we show that the creation of the monetary union leads to an increase in welfare for all generations in both country groups. JEL Classification: F36, E21, F32euro area, interest rate convergence, overlapping generations model

Adjusting to the euro

In this paper we argue that, for a group of converging economies of the European Union, participation in the euro area has been associated with easier access to financing by domestic economic agents. Easier access to financing was a significant impulse leading to a sharp increase in households' expenditures and a corresponding fall in the savings ratio. Increased expenditure was associated with current account deficits, a sharp fall in the net foreign asset position and an increase in the households' indebtedness. At the same time there was a sizeable increase in the real exchange rate. In this paper, we show that it is possible to obtain all these qualitative features of adjustment using a simple analytical model of intertemporal equilibrium. Specifically, we consider a simple endowment economy with traded and non-traded goods populated by Blanchard-Yaari households. We also argue that the consideration of external habit formation improves the model's ability to mimic short to medium term adjustment dynamics while, at the same time, improving the plausibility of steady state effects. JEL Classification: F36, E21, F32euro area, interest rate convergence, overlapping generations model

Adjusting to the Euro

In this paper we argue that, for a group of converging economies of the European Union, participation in the euro area has been associated with easier access to financing by domestic economic agents. Easier access to financing was a significant impulse leading to a sharp increase in households' expenditures and a corresponding fall in the savings ratio. Increased expenditure was associated with current account deficits, a sharp fall in the net foreign asset position and an increase in the households' indebtedness. At the same time there was a sizeable increase in the real exchange rate. In this paper, we show that it is possible to obtain all these qualitative features of adjustment using a simple analytical model of intertemporal equilibrium. Specifically, we consider a simple endowment economy with traded and non-traded goods populated by Blanchard-Yaari households. We also argue that the consideration of external habit formation improves the model's ability to mimic short to medium term adjustment dynamics while, at the same time, improving the plausibility of steady state effects.

A money-based indicator for deflation risk

We employ a money-based early warning model in order to analyse the risk of a low inflation regime in the euro area, Japan and the US. The model specification allows for three different inflation regimes: Low, Medium and High inflation, while state transition probabilities vary over time as a function of monetary variables. Using Bayesian techniques, we estimate the model with data from the early 1970s up to the present. Our analysis suggests that the risks of a Low inflation regime in the euro area have been increasing in the course of the last six quarters of the sample; moreover, money growth appears to play a significant role in the assessment of such risks. Evidence for Japan and the US, on the other hand, shows that the inclusion of a monetary indicator variable does not substantially change the assessment of the risk of a Low inflation regime in either of the two countries

An area-wide model (AWM) for the euro area

This paper presents a quarterly estimated structural macroeconomic model for the euro area, denoted area-wide model (AWM). This model has been developed with four uses in mind: the assessment of economic conditions in the area, macroeconomic forecasting, policy analysis and deepening understanding of the functioning of euro area economy. Five key features of the model are highlighted. First, it treats the euro area as a single economy. Second, it is a medium sized model which, while detailed enough for most purposes, is nonetheless sufficiently small to be manageable in the context of forecasting and simulation exercises. Third, the model is designed to have a long run equilibrium consistent with classical economic theory, while its short run dynamics are demand driven. Fourth, the current version of the AWM is mostly backward-looking, i.e. expectations are reflected via the inclusion of lagged variables. Finally, the AWM uses quarterly data, allowing for a richer treatment of the dynamics, and is mostly estimated on the basis of historical data (rather than calibrated). The paper comprises the following elements. First, a general overview of the structure of the model and of its long-run and short-run properties is provided, with particular emphasis on how the model reaches its steady state. This is followed by a review of the key behavioural equations, showing e.g. the extent to which the standard behavioural equations are capable of fitting the historical euro area data which has been constructed. Finally results from two illustrative simulations are provided, i.e. a fiscal expenditure shock and a change in interest rates. Appended to the main text are the full list of econometric results, the detailed description of the database and the results of stochastic long run simulations. In addition, a companion file comprising all of the quarterly time series underlying the AWM is made availabl

A money-based indicator for deflation risk

We employ a money-based early warning model in order to analyse the risk of a low inflation regime in the Euro Area, Japan and the US. The model specification allows for three different inflation regimes: "Low", "Medium" and "High" inflation, while state transition probabilities vary over time as a function of monetary variables. Using Bayesian techniques, we estimate the model with data from the mid 1970s up to the present. Our analysis suggests that the risks of a "Low" inflation regime in the Euro Area have been increasing in the course of the last six quarters of the estimation sample; moreover, money growth plays a significant role in the assessment of such risks. Evidence for Japan and the US shows that for both countries the inclusion of an indicator variable does not substantially change the assessment of the risk of a "Low" inflation regime

Money Demand in EU Countries: A Survey

Money demand is probably one of the most extensively studied economic relationship in applied economics. While useful surveys of existing literature are available, much of the attention has focused on the US. However, a considerable number of papers have recently been produced dealing with the situation in the EU, both at a country and at an area- wide level, with much of this research being carried out at EU central banks. Therefore, it appears useful to also examine this recent work, both in order to assess the current situation, and to guide future research. The first part of the paper covers a range of general issues arising such as the theoretical models, the specifications, the variables employed, and estimation techniques that have been used. It is emphasised that the basis of all these papers appears to be a benchmark model, in which money is a function of a scale variable, of interest rates and, when necessary, of variables accounting for financial innovation. The second part of the paper focuses on the estimated equations for the individual countries, paying particular attention to the case of Germany. A reasonable summary of the results obtained in general is that money demand equations perform fairly well in EU countries. Estimated parameters have the signs, if not always the magnitudes, predicted by economic theory. In most cases, the evidence points to the existence of the long-run equilibrium relation between money and a few determinant variables (real income, prices and interest rates) although the size of the adjustment coefficients indicate that deviations from the steady state may be of long duration. The next section provides a review of empirical evidence of aggregate money demand in grouping of EU countries taken together, an area in which interest is increasing as EMU approaches. In this strand of the literature, there seems to be a consensus that EU-wide equations yield satisfactory results, with area-wide equations often performing better than comparable national equations. Some reasons underlying this result are also examined.Money demand, Cross-country comparisons, European union