Reexamination of the Purchasing Power Parity (PPP) under Cournot Competition

This paper reexamines the Purchasing Power Parity (PPP) in an open economy macroeconomic model with Cournot competition in the international trade of a unique good. Foreign and domestic firms have a Cournot perception of foreign and domestic markets and make separate quantity decisions for each market taking the quantity decisions of the other firm as given. In introducing the money, the balance of payments relation and the nominal exchange rate, the PPP implied by the law of one price can be reexamined. We show that the imperfect competition and symetric trade barriers are not enough to break the absolute and relative PPP. But under symmetric trade barriers, asymmetric policy and macroeconomic conditions are sufficient for the absolute PPP not to hold, while asymmetric trade barriers are enough to break it. These results are developed without calling on the role of non-tradable goods, shifts in the consumers’ tastes or technological changes, which are commonly considered as the principal factors to break the absolute and relative PPP. Conditions under which the relative PPP is not verified are discussed.Purchasing Power Parity (PPP), Cournot perception firms

External constraint and financial crises with balance sheet effects

This paper investigates the dynamic implications of Krugman’s (1999) model of financial crises with balance-sheet effects, which has a considerable impact on the literature as well as the teaching of international financial crisis. By explicitly taking account of wealth accumulation and external equilibrium condition, it is shown that a financial crisis in emerging market economies, instead of being interpreted as a jump from a good to a bad equilibrium with zero investment and zero foreign debt, could be explained as a jump from an unstable dynamic trajectory to a stable one. The dynamic framework illustrates well the analysis of different factors at the origin of financial vulnerability and crisis. By discriminating the financial crises according to the severity of their negative impacts on the domestic economy, the present study also adds some insights in the analysis of policy implications.Financial crisis, currency crisis, balance sheet effect, external solvency constraint.

The design of a ‘two-pillar’ monetary policy strategy

In this paper, it is argued that money supply in a narrow sense and repo interest rate are two independent monetary policy instruments when the effect of interest rate policy cannot be efficiently transmitted to the economy through the monetary and financial markets. In this case, the control of money supply is necessary to reduce the discrepancy between the repo interest rate and the interest rates at which private agents lend and borrow. Using a simple macro-economic model, this study shows how a two-pillar monetary policy strategy as practiced by the European central bank (ECB) can be conceived to guarantee macroeconomic stability and the credibility of monetary policy. This strategy can be interpreted as a combination of inflation targeting and monetary targeting. Well conceived monetary targeting with a commitment to a long-run money growth rate corresponding to inflation target could reinforce the credibility of central bank announcements and the role of inflation target as strong and credible nominal anchor for private inflation expectations. However, an inflation-targeting regime associated with Friedman’s money supply rule can generate dynamic instability in output, inflation and money demand. Three feedback monetary targeting rules, of which the design depends on economic structure and central bank preferences, are discussed relative to their capability of warranting macroeconomic stability. (This is a significantly revised version of the paper previously published under the title "A two-pillar strategy to keep inflation expectations at bay: A basic theoretical framework", Working paper of Beta n°2007-20.)Two-pillar monetary policy strategy, inflation targeting, monetary targeting, macroeconomic stability, Friedman’s k-percent rule, feedback money growth rules

External constraint and financial crises with balance sheet effects.

This paper examines a model of financial and exchange crises with balance-sheet effects by explicitly taking account of wealth accumulation and external equilibrium condition. We have found that, in a general equilibrium analysis, there are two stationary equilibria. Since foreign debt is always zero at these equilibria, financial crises in emerging market economies cannot be interpreted as jumps between equilibria but between trajectories leading to one equilibrium or another one. The mechanisms of financial crises due to monsoon or spill-over effects are also analysed in this framework.Financial crisis, exchange crisis, balance sheet effect, external solvency constraint.

Financial volatility and optimal instrument choice: A revisit to Poole's analysis

In this paper, using an IS-LM model with reserve market, we examine weather the operating procedure actually adopted by many central banks in the world, i.e. targeting directly short run interest rates and hence indirectly market interest rates, is more efficient in stabilizing output than a monetary base operating procedure if shocks affecting the interest rate policy are taken into account. Our results suggest that for an interest rate policy to be more efficient than a monetary aggregate oriented policy, central banks should directly target market interest rates which are narrowly linked to the aggregate spending.Poole's analysis, optimal instrument choice, financial volatility, monetary policy operating procedures.

Motivations and strategies for a real revaluation of the Yuan

Most Western economists and policy makers agree that the Yuan is significantly undervalued and push the Chinese government for a large nominal revaluation of the Yuan. This paper, while surveying recent research on Chinese exchange rate policy, gives some new insights into this issue. Notably, this paper defends that China is not solely responsible for the Yuan’s undervaluation, the Chinese central bank cannot optimally invest an increasing amount of foreign currency reserves, and the Yuan’s nominal revaluation is not the only way to resolve the problem. After having analyzed the advantages and disadvantages of a nominal versus a real revaluation of the Yuan for the Chinese economy, I advocate and analyze, besides a modest nominal revaluation, a multitude of alternative policies to achieve a complete revaluation of the Yuan in real terms, which allows absorbing external disequilibrium while laying down the foundation for the long-term growth of the Chinese economy.Renminbi (RMB), revaluation of the Yuan, foreign exchange reserves, external disequilibrium, measures of macroeconomic adjustment.

Financial volatility and optimal instrument choice: A revisit to Poole’s analysis

In this paper, using an IS-LM model with reserve market, we examine weather the operating procedure actually adopted by many central banks in the world, i.e. targeting directly short run interest rates and hence indirectly market interest rates, is more efficient in stabilizing output than a monetary base operating procedure if shocks affecting the interest rate policy are taken into account. Our results suggest that for an interest rate policy to be more efficient than a monetary aggregate oriented policy, central banks should directly target market interest rates which are narrowly linked to the aggregate spending.Poole’s analysis, optimal instrument choice, financial volatility, monetary policy operating procedures.

Quantitative and credit easing policies at the zero lower bound on the nominal interest rate

Using a New-Keynesian model extended to include credit, money and reserve markets, we examine the dynamics of inflation and output gap under some monetary policy options adopted when the economy is hit by large negative real, financial and monetary shocks. Relaxing the assumption that market interest rates are perfectly controlled by the central bank using the funds rate operating procedure, we have shown that the equilibrium at the zero lower bound on the nominal discount rate is stable (or cyclically stable, depending on monetary and financial parameters) and constitutes a liquidity trap, making the central bank’s communication skills useless in the crisis management. While the quantitative easing policy allows attenuating the effects of crisis, it is not always sufficient to restore the normal equilibrium. Nevertheless, quantitative and credit easing policies coupled with the zero discount rate policy could stabilize the economy and make central bank’s communication potentially credible during the crisis.Zero lower bound (ZLB) on the nominal interest rate, zero interest rate policy, liquidity trap, quantitative easing policy, credit easing policy, dynamic stability.

Multiplicative uncertainty, central bank transparency and optimal degree of conservativeness

This paper extends the results of Kobayashi (2003) and Ciccarone and Marchetti (2009) by considering the optimal choice of central bank conservativeness. It is shown that the government can choose a sufficiently populist but opaque central banker so that higher multiplicative uncertainty improves the social welfare only when the society is very conservative.Multiplicative uncertainty; optimal degree of conservativeness; Brainard conservatism; central bank transparency.

Public debt and currency crisis: how central bank opacity can make things bad?

This paper examines how the transparency in monetary policy decision can impact the likelihood of currency crisis in a simple open economy model with public debt. In the presence of opacity, it is found that if the debt is high, the government will devaluate and vice versa, and the self-fulfilling multiple equilibria solution disappears. Furthermore, the opacity reduces the threshold of public debt above which the government is considered as totally lacking the credibility in its pre-commitment to maintain fixed the exchange rate.