ECON-784 -- Seminar in International Money and Finance

Prof. Martha Starr

Department of Economics

American University

Fall 2007


Telephone:                                         (202) 885-3747

Office:                                    Roper Hall 201

Office hours:                       Tuesdays 3:00-6:00 pm, Fridays 11:15-2:15 pm


                                                  Please put “econ-784 seminar” in the subject line

Class website:                     AU blackboard


Course Description:


This is an advanced PhD seminar course, preparing students to write a dissertation in monetary economics or international money and finance. Essential to this process is leaving behind the role of passive “consumer” of economic knowledge -- and transitioning into the role of active and effective “producer” of it. This seminar aims to facilitate this process in three ways, corresponding to the three sections of the class.


First, we will delve into important theoretical and methodological developments that have been motivating much international monetary and financial research recently -- namely, New Open-Economy macroeconomic theory and dynamic stochastic general equilibrium (DSGE) models. Exploring this new literature should be beneficial for possibly identifying new avenues for approaching research questions. This section of the class will be primarily lecture-style.


Second, we will engage in active review and critique of current applied research on international monetary and financial topics. The research to be reviewed covers not necessarily top-tier journal articles -- but rather interesting or innovative efforts to bring economic modeling and/or econometric analysis to bear on contemporary research questions. In this section of the class, extending over 5-6 weeks, each student will read ~1 paper per week, chosen from a cluster of thematically interrelated papers; the student will concisely present that paper to the class, in each case identifying the paper’s key research question, methodology, contribution to the literature, strengths, and weaknesses. Because a good number of papers will be covered during this interval, students will acquire broad exposure to contemporary lines of research – as well as developing and refining their abilities to distinguish between more and less compelling ways of tackling research topics.


Third, students will develop their own research projects, revolving around: identifying a good research topic, motivating interest in it based on related research and policy debates, situating its original contribution relative to existing work in the area, defining a good methodology for tackling the issue (including data and/or econometric method), and taking some notable steps towards implementing the project. It is not necessary, by the end of the class, to have a completed, polished, fully-implemented research paper (although that would be great). Rather, the paper should show compelling, well-thought-through progress towards getting such a paper off the ground. Ideas for research projects and progress in implementing them will be discussed throughout the semester.



The following books are available at the AU bookstore and represent valuable resources for understanding New Open-Economy macro and contemporary macroeconometric methods respectively.

§         Fabio Canova, Methods for Applied Macroeconomic Research. Princeton University Press, 2007.

§         Nelson Mark, International macroeconomics & finance. Blackwell, 2001.

Other readings will be posted in Blackboard.




Grades will be assigned based on the required research paper, presentations of research papers in weeks 5-11 of the class, and general class participation. 






Aug. 28

General discussion of research interests


Sept. 4

Economic research in international money & finance: Resources and issues


Sept. 11

Theory: New open-economy macro


Sept. 18

Econometric methods, Part I: DSGE models


Sept. 25

Econometrics, methods Part II: SVARs and dynamic panel data models


Oct. 2

Paper cluster #1:  Examples of DSGE models


Oct. 9

Paper cluster #2:  Inflation targeting in emerging-market countries


Oct. 16

Paper cluster #3: Inflation targeting and financial stability


Oct. 23

Presentations and discussions of research ideas


Oct. 30

Paper cluster #4: Exchange rate issues


Nov. 6

Paper cluster #5: Commodity-price aspects of monetary and financial policies


Nov. 13

Paper cluster #6: Other issues


Nov. 20

No class (because Friday classes meet this day)


Nov. 27

Student presentations – first batch


Dec. 4

Student presentations – second batch




Note: Lest this list look inordinately long, remember that in Weeks 6-11, you have to read only the paper you will present.


WEEK 1: Economic research in international money & finance: Resources and issues

§         John Cochrane, “Writing tips for PhD students.”

§         Don Davis, “PhD research for thesis students: Where do I start?”

§         David Romer, “David Romer's Rules for Making It through Graduate School and Finishing Your Dissertation: ‘Out in Five’”


WEEK 2: Theory: New open-economy macro

§         Mark, Chapter 9

§         Lane, Philip (2001), “The new open economy macroeconomics: A survey,” Journal of International Economics 54 pp 235-266.

§         Maurice Obstfeld, “Keynote Speech: Exchange Rates and Adjustment: Perspectives from the New Open-Economy Macroeconomics,”

§         Lucio Sarno, “Toward a New Paradigm in Open Economy Modeling: Where Do We Stand?” Federal Reserve Bank of St. Louis Economic Review, May/June 2001.

§         David Bowman and Brian Doyle, “New Keynesian Open-Economy Models and Their Implications for Monetary Policy,” Federal Reserve Board, International Finance Discussion Paper (2003).

§         Bergin, Paul R. “How Well Can the New Open Economy Macroeconomics Explain the Exchange Rate and Current Account?” Journal of International Money and Finance, vol. 25, no. 5, August 2006, pp. 675-701.


WEEK 3: Empirical methodology, I: Dynamic stochastic general equilibrium models

§         Selections from Canova, pages TBA

§         Smets, Frank, and Raf Wouters. “An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area,” Journal of the European Economic Association, 2003.

§         Thomas A. Lubik and Frank Schorfheide. “Do central banks respond to exchange rate movements? A structural investigation,” Journal of Monetary Economics, Vol. 54, No. 4 (May), pp. 1069-1087.

We estimate a small-scale, structural general equilibrium model of a small open economy using Bayesian methods. Our main focus is the conduct of monetary policy in Australia, Canada, New Zealand and the UK. We consider generic Taylor-type rules, where the monetary authority reacts in response to output, inflation, and exchange-rate movements. We perform posterior odds tests to investigate the hypothesis whether central banks do target exchange rates. The main result of this paper is that the central banks of Australia and New Zealand do not, whereas the Bank of Canada and the Bank of England do include the nominal exchange rate in its policy rule. This result is robust for various specification of the policy rule. We also find that terms-of-trade movements do not contribute significantly to domestic business cycles.

A GAUSS program that implements the solution algorithm is available at

§         Dennis Botman, Philippe Karam, Douglas Laxton and David Rose. “DSGE Modeling at the Fund: Applications and Further Developments.” Aug. 2007.

Researchers in policymaking institutions have expended significant effort to develop a new generation of macro models with more rigorous micro-foundations. This paper provides a summary of the applications of two of these models. The Global Economy Model is a quarterly model that features a large assortment of nominal and real rigidities, which are necessary to create plausible short-run dynamics. However, because this model is based on a representative-agent paradigm, its Ricardian features make it unsuitable to study many fiscal policy issues. The Global Fiscal Model, which is an annual model that uses an overlapping generations structure, has been designed to analyze the longer-term consequences of alternative fiscal policies.


WEEK 4: Other macro/econometric methods: SVARS and dynamic panel-data models

§         Selections from Canova, pages TBA

§         Michael Hutchison and Ilan Noy.“Sudden stops and the Mexican wave: currency crises, capital flow reversals and output loss in emerging markets.” FEDERAL RESERVE BANK OF SAN FRANCISCO. Pacific Basin Working Paper Series. 02-03. Apr, 2002 --

Sudden Stops are the simultaneous occurrence of a currency/balance of payments crisis with a reversal in capital flows (Calvo, 1998). We investigate the output effects of financial crises in emerging markets, focusing on whether sudden-stop crises are a unique phenomenon and whether they entail an especially large and abrupt pattern of output collapse (a “Mexican wave”). Using a panel data set over the 1975-97 period and covering 24 emerging-market economies, we distinguish between the output effects of currency crises, capital inflow reversals, and sudden-stop crises. We find that sudden-stop crises have a large negative, but short-lived, impact on output growth over and above that found with currency crises. The empirical results are robust to alternative model specifications, lag structures and using estimation procedures (IV and GMM) that correct for bias associated with simultaneity and estimation of dynamic panel models with country-specific effects.

§         Tor Jacobson, Per Jansson, Anders Vredin, Anders Warne. “Monetary policy analysis and inflation targeting in a small open economy: A VAR approach,” Journal of Applied Econometrics. Jul/Aug 2001. Vol. 16, Iss. 4; p. 487

Empirical monetary policy research has increased in the last decade, possibly because deregulation and explicit monetary targets have made monetary policy issues more interesting. In particular, within the inflation targeting framework it has been argued that inflation forecasts can be used as optimal intermediate targets for monetary policy, and the development of empirical models that have good forecasting properties is therefore important. It is shown that a VAR model with long-run restrictions, justified by economic theory, is useful for both forecasting inflation and for analyzing other issues that are central to the conduct of monetary policy.

§         Leon Berkelmans, “Credit and Monetary Policy: An Australian SVAR.” (2005)

Credit is an important macroeconomic variable that helps to drive economic activity and is also dependent on economic activity. This paper estimates a small structural vector auto-regression (SVAR) model for Australia to examine the intertwined relationships of credit with other key macroeconomic variables. At short horizons, shocks to the interest rate, the exchange rate, and past shocks to credit are found to be important for credit growth. Over longer horizons, shocks to output, inflation and commodity prices play a greater role.


Week 5, Paper cluster 1: EXAMPLES OF DSGE MODELS

1.1               Vasco Cúrdia and Daria Finocchiaro, “Monetary Regime Change and Business Cycles,” Federal

Reserve Bank of New York Staff Reports, no. 294 (July 2007)

This paper analyzes how changes in monetary policy regimes influence the business cycle in a small open economy. We estimate a dynamic stochastic general equilibrium (DSGE) model on Swedish data, explicitly taking into account the 1993 monetary regime change, from exchange rate targeting to inflation targeting. The results confirm that monetary policy reacted primarily to exchange rate movements in the target zone and to inflation in the inflation-targeting regime. Devaluation expectations were the principal source of volatility in the target zone period. In the inflation-targeting period, labor supply and preference shocks have become relatively more important.

1.2               Malin Adolfson, Stefan Laséen, Jesper Lindé. “Evaluating an Estimated New Keynesian Small

Open Economy Model.” (2007).

This paper estimates and tests a new Keynesian small open economy model in the tradition of Christiano, Eichenbaum, and Evans (2005) and Smets and Wouters (2003) using Bayesian estimation techniques on Swedish data from 1980-2004. To account for the switch to an inflation targeting regime in 1993 we allow for a discrete break in the central bank’s instrument rule. The empirical results indicate that allowing for such a regime shift is indeed supported by the data. As one of the key-equations in the model is the uncovered interest rate parity (UIP) condition, which is well known to be rejected empirically, we explore the consequences of modifying the UIP condition to allow for a negative correlation between the risk premium and the expected change in the nominal exchange rate. The results show that the modification increases the persistence in the real exchange rate and that this model has an empirical advantage compared with the standard UIP specification.

1.3               Corsetti, Giancarlo, Luca Dedola, and Sylvain Leduc, “DSGE models of high exchange-rate

volatility and low pass-through,” Federal Reserve Board, International Finance Discussion Paper

No. 845 (Nov. 2005).

This paper develops a quantitative, dynamic, open-economy model which endogenously generates high exchange rate volatility, whereas a low degree of pass-through stems from both nominal rigidities (in the form of local currency pricing) and price discrimination. We model real exchange rate volatility in response to real shocks by reconsidering and extending two approaches suggested by the quantitative literature (one by Backus Kehoe and Kydland [1995], the other by Chari, Kehoe and McGrattan [2003]), within a common framework with incomplete markets and segmented domestic economies. Our model accounts for a variable degree of ERPT over different horizons. In the short run, we find that a very small amount of nominal rigidities--consistent with the evidence in Bils and Klenow [2004--lowers the elasticity of import prices at border and consumer level to 27% and 13%, respectively. Still, exchange rate depreciation worsens the terms of trade -- in accord with the evidence stressed by Obstfeld and Rogoff [2000]. In the long run, exchange-rate pass-through coefficients are also below one, as a result of price discrimination. The latter is an implication of distribution s

1.4               Pablo A. Acosta, Emmanuel K.K. Lartey, and Federico S. Mandelman, “Remittances and the

Dutch Disease”, Atlanta Fed Working Paper 2007-8, April 2007

Using data for El Salvador and Bayesian techniques, we develop and estimate a two-sector dynamic stochastic general equilibrium model to analyze the effects of remittances in emerging market economies. We focus our study on whether rising levels of remittances result in the Dutch disease phenomenon in recipient economies. We find that, whether altruistically motivated or otherwise, an increase in remittances flows leads to a decline in labor supply and an increase in consumption demand that is biased toward non-tradables. The increase in demand for non-tradables, coupled with higher production costs, results in an increase in the relative price of non-tradables, which further causes the real exchange rate to appreciate. The higher non-tradable prices serve as an incentive for an expansion of that sector, culminating in reallocation of labor away from the tradable sector. This resource reallocation effect eventually causes a contraction of the tradable sector. A vector auto-regression analysis provides results that are consistent with the dynamics of the model.

1.5               Ivan Tchakarov & Selim Elekdag & Alejandro Justiniano. “An Estimated Small Open Economy Model of the Financial Accelerator.” (2005).

This paper develops a small open economy model where entrepreneurs partially finance investment using foreign currency denominated debt subject to a risk premium above and beyond international interest rates. We use Bayesian estimation techniques to evaluate the importance of balance sheet vulnerabilities combined with the presence of the financial accelerator for emerging market countries. Using Korean data, we obtain an estimate for the external risk premium, indicating the importance of the financial accelerator and potential balance sheet vulnerabilities for macroeconomic fluctuations. Furthermore, our estimates of the Taylor rule imply a strong preference to smooth both exchange rate and interest rate fluctuations.

1.6               Elif? IO aspect of new open-economy macro: Pinelopi K. Goldberg, Rebecca Hellerstein,

Framework for Identifying the Sources of Local-Currency Price Stability with an Empirical

Application.” NBER Working Paper No. 13183 (June 2007). {access through ALADIN}

The inertia of the local-currency prices of traded goods in the face of exchange-rate changes is a well-documented phenomenon in International Economics. This paper develops a framework for identifying the sources of local-currency price stability. The empirical approach exploits manufacturers' and retailers' first-order conditions in conjunction with detailed information on the frequency of price adjustments in response to exchange-rate changes, in order to quantify the relative importance of fixed costs of repricing, local-cost non-traded components, and markup adjustment by manufacturers and retailers in the incomplete transmission of exchange-rate changes to prices. The approach is applied to micro data from the beer market. We find that: (a) wholesale prices appear more rigid than retail prices; (b) price adjustment costs account on average for up to 0.5% of revenue at the wholesale level, but only 0.1% of revenue at the retail level; (c) overall, 54.1% of the incomplete exchange rate pass-through is due to local non-traded costs; 33.7% to markup adjustment; and 12.2% to the existence of price adjustment costs.

Week 6, PAPER CLUSTER 2: Inflation targeting in emerging-market countries

2.1               Nicoletta Batini and Douglas Laxton, “Under what conditions can inflation targeting be adopted?

The experience of emerging markets”

While there have been numerous studies of inflation targeting in industrial countries, there has been much less analysis of the effects of inflation targeting in emerging market countries. Based on a new and detailed survey of 31 central banks, this paper shows that inflation targeting in emerging-market countries brings significant benefits to the countries that adopt it relative to other strategies, such as money or exchange rate targeting. Indeed, by comparing the performance of the inflation-targeting countries with a sample of countries that pursue other regimes we show that there are significant improvements in anchoring both inflation and inflation expectations with no adverse effects on output. In addition, under inflation targeting interest rates, exchange rates, and international reserves are less volatile, and the risk of currency crises relative to money or exchange rate targets is smaller. Interestingly, IT seems to outperform exchange rate pegs—even when only successful pegs are chosen in comparison. The survey evidence indicates that it is unnecessary for countries to meet a stringent set of institutional, technical, and economic “preconditions” for the successful adoption of inflation targeting.

2.2               Michael Hanson and Kwanghee Nam, “Inflation Targeting in an Emerging Market: the Case of


To evaluate the effectiveness of targeting monetary policy strategies in a small open economy, we develop a dynamic optimizing model calibrated to recent Korean data. We then explore the consequences of alternative specifications of the loss function for society and the central bank, with particular focus on exchange rate volatility. Policy simulations include variations on inflation targeting, nominal income growth targeting and exchange rate targeting. Our results indicate that inflation targeting remains the most preferred policy regime, even when an explicit motive for exchange rate smoothing is introduced. In this case, the optimal inflation targeting and nominal income growth targeting policies are characterized by a “conservative” central bank that places greater weight on both the primary target variable and on the exchange rate than in society’s objective function. However, the optimal policy reacts to changes in degree of exchange rate pass-though in a non-linear fashion, complicating the robustness of inflation targeting recommendations for emerging markets.

2.3               Gilberto A. Libanio, “’Good governance’ in monetary policy and the negative real effects of

inflation targeting in developing economies” (Dec. 2005)

This paper analyzes the growth effects of inflation targeting regimes in emerging market economies. In particular, it focuses on the case of three Latin American economies where the inflation targeting framework has been implemented, namely Brazil, Chile and Mexico. It is argued that not only monetary policy is procyclical under inflation targeting, but also that it is likely to react in an asymmetric way to fluctuations in economic activity and exchange rates (too ‘tight’ during recessions, not so ‘loose’ during expansions). Such pattern may generate a downward bias in aggregate demand, with negative long-run real effects on output growth and employment. Our results suggest that monetary policy is procyclical in Brazil and Chile, and countercyclical in Mexico. Also, they suggest that monetary policy has reacted asymmetrically to economic activity in the three countries. The main economic policy implication of this study is that central banks should consider more seriously the effects of monetary policy on output and employment.

2.4               Saade Chami, Selim Elekdag, Todd Schneider, and Nabil Ben Ltaifa. “Can a Rule-Based Monetary

Policy Framework Work in a Developing Country? The Case of Yemen”

Monetary policy in Yemen is largely rudimentary and ad hoc in nature. The Central Bank of Yemen’s (CBY) approach has been based on discretionary targeting of broad money without any clear target to anchor inflation expectations. This paper argues in favor of a new formal monetary policy framework for Yemen emphasizing a proactive and rule-based approach with a greater direct focus on price stability in the context of a flexible management of the exchange rate. Although, as in many developing countries, institutional capacity is a concern, adopting a more formal framework could impel the kind of changes that are required to strengthen the ability of the CBY in achieving low and stable rates of inflation over the medium term.

2.5               Mendoza, Alfonso, “Is there room for foreign exchange interventions under an inflation

targeting framework? Evidence from Mexico and Turkey”

The salient characteristics of emerging market economies coupled with the increasing adoption of inflation targeting in these countries has stimulated much debate about the role of the exchange rate in inflation targeting regimes. The authors aim at shedding more light on this issue by investigating whether central bank foreign exchange interventions have had any impact on the volatility of the exchange rate in Mexico and Turkey since the adoption of the floating regime. To this end, their study, using daily data on foreign exchange intervention, employs an Exponential GARCH framework. Empirical results suggest that both the amount and frequency of foreign exchange interventions have decreased the volatility of the exchange rates in these countries. The author’s findings corroborate the notion that if foreign exchange interventions are carried out with finesse and sensibly -- that is, not to defend a particular exchange rate -- they could play a useful role in containing the adverse effects of temporary exchange rate shocks on inflation and financial stability.

2.6               Valpy Fitzgerald, Monetary Models and Inflation Targeting in Emerging Market Economies”

This paper extends and modifies the Keynesian critique of inflation targeting with reference to stabilisation policy in emerging market economies. The IMF `basic monetary programming framework` for developing countries uses government borrowing and the exchange rate as policy instruments in order to achieve specific inflation and balance of payments targets. This paper first adapts this standard model in order to include short-term capital flows and the floating exchange rate arising from financial liberalisation. In this way, the macroeconomic consequences of the current Fund focus on inflation targeting and the use of a single monetary policy instrument (the interest rate, combined with rigid fiscal and reserve `rules`) in emerging market economies can be demonstrated. Second, the paper encompasses the structuralist critique of the negative effect of inflation targeting on capacity utilisation and trade competitiveness, leading to an argument for counter-cyclical monetary policy in response to external shocks. An alternative model is constructed within a comparable macroeconomic framework to that of the IMF in order to permit the shortcomings of inflation targeting to be rigorously demonstrated. A macroeconomic stabilisation policy based on real exchange rate targeting, bank credit regulation and an active fiscal stance is shown to be more effective in supporting growth and investment.

2.7               Ruy Lama Juan Pablo Medina. “Simple Monetary Policy Rules for Developing Countries.” (2004).

This paper evaluates the performance of simple monetary policy rules in a calibrated model for the Chilean economy. The monetary regimes considered are: exchange rate peg, money peg, inflation targeting, non-tradable inflation targeting, and a Taylor rule. We develop a small open economy model with tradable and non-tradable goods, monopolistic competition and staggered prices a la Calvo. Business cycles fluctuations in the economy are driven by three types of shocks: foreign interest rate, productivity, and government expenditure. In this environment, the role of monetary policy is to offset as much as possible the distortions in the economy, namely staggered prices and monopolistic competition. We ranked the rules according to their ablity to smooth consumption and leisure of the representative household. The welfare analysis suggests that, depending on the source of the shock, it is optimal to stabilize either the price of the tradable goods or the non-tradable goods. Rules with these targets are welfare superior to other monetary regimes, such as CPI inflation targeting or money peg. Our analysis tends to support some exchange rate intervention in order to achieve an efficient allocation of resources.


2.8          Mackowiak, Bartosz. How Much of the Macroeconomic Variation in Eastern Europe Is

                Attributable to External Shocks? Comparative Economic Studies, September 2006, 48(3), pp.


                Also available more readily as:


We decompose by origin the sources of the variation in real aggregate output and aggregate price level in the Czech Republic, Hungary and Poland. We find that a sizable fraction of the variation is attributable to external shocks, especially so for aggregate price level. We show that euroarea interest rate shocks can account for a significant fraction of the external spillover effects. We conclude that theoretical models of advanced transition economies and policy rules for these economies should feature a prominent role for external shocks.


Week 7, PAPER CLUSTER #3: Monetary policy and financial stability: Causes and effects


3.1          Álvaro Almeida, “40 Years of Monetary Targets and Financial Crises in 20 OECD Countries”

This paper examines differences in the stability of the foreign exchange, money, and stock markets, associated with the use of alternative monetary policy targets, based on data from a panel of 20 OECD countries, for the period 1961-2000. The main conclusion of the paper is that the choice of monetary policy target will significantly affect stability in financial markets. The use of inflation targets reduces the likelihood of crises in the foreign exchange and money markets (relative to any other monetary policy framework), suggesting that a central bank concerned with financial stability should adopt this framework. Results also suggest that exchange rate targeting frameworks tend to have higher likelihood of foreign exchange and money market crises, but multilateral exchange rate arrangements have lower likelihood of crises than unilateral pegs. The paper also includes a complete description of the monetary policy targets used in the countries analysed.

3.2          Q. Farooq Akram and Øyvind Eitrheim, “Flexible inflation targeting and financial stability: Is it

enough to stabilise inflation and output?”

We investigate empirically whether a central bank can promote financial stability by stabilising inflation and output, and whether additional stabilisation of asset prices and credit growth would enhance financial stability, in particular. We employ an econometric model of the Norwegian economy to investigate the performance of simple interest rate rules that allow a response to asset prices and credit growth, in addition to inflation and output. We find that output stability also promotes financial stability, while inflation stability is achieved at the expense of both output and financial stability. A stabilisation of house prices, equity prices and/or credit growth enhances stability in both inflation and output, but not financial stability. By contrast, stabilisation of the nominal exchange rate induces excess volatility in general.

3.3          Vasco Curdia, 2007. "Monetary policy under sudden stops," Staff Reports 278, Federal Reserve

                Bank of New York.

This paper proposes a model to investigate the effects of monetary policy in an emerging market economy that experiences a sudden stop of capital inflows. The model features credit frictions, debt denominated in foreign currency, imported inputs, and households that have access to the international capital market only indirectly, through their ownership of leveraged firms. The sudden stop is modeled as a change in the perceptions of foreign lenders that brings about an increase in the cost of borrowing. I show that the higher the elasticity of foreign demand, the lower the contraction in output - leading, at the extreme, to the possibility of an expansion, depending on policy. A second result is that the recession is most severe in a fixed exchange rate regime. Taylor rules that react to inflation and output are more stabilizing. A comparison of alternative rules shows that low commitment to inflation stabilization allows for less contraction in output and even expansion but at the cost of much stronger contraction in capital inflows and higher interest rates. Credibility is also shown to have an important role, with low credibility and the risk of loose policy implying increased trade-offs, stronger contraction of the economy, and higher interest rates.

3.4          Martın Uribe and Vivian Z. Yue, “Country Spreads and Emerging Countries: Who Drives Whom?”

(Oct. 2003).

A number of studies have stressed the role of movements in US interest rates and country spreads in driving business cycles in emerging market economies. At the same time, country spreads have been found to respond to changes in both the US interest rate and domestic conditions in emerging markets. These intricate interrelationships leave open a number of fundamental questions: Do country spreads drive business cycles in emerging countries or vice versa, or both? Do US interest rates affect emerging countries directly or primarily through their effect on country spreads? This paper addresses these and other related questions using a methodology that combines empirical and theoretical elements. The main findings are: (1) US interest rate shocks explain about 20 percent of movements in aggregate activity in emerging market economies at business-cycle frequency. (2) Country spread shocks explain about 12 percent of business-cycle movements in emerging economies. (3) About 60 percent of movements in country spreads are explained by country-spread shocks. (4) In response to an increase in US interest rates, country spreads first fall and then display a large, delayed overshooting; (5) US-interest-rate shocks affect domestic variables mostly through their effects on country spreads. (6) The fact that country spreads respond to business conditions in emerging economies significantly exacerbates aggregate volatility in these countries. (7) The US-interest-rate shocks and country-spread shocks identified in this paper are plausible in the sense that they imply similar business cycles in the context of an empirical VAR model as they do in the context of a theoretical dynamic general equilibrium model of an emerging market economy.

3.5          Marco Arena, Carmen Reinhart, Francisco Vázquez, “The Lending Channel in Emerging

                Economics: Are Foreign Banks Different?” NBER Working Paper No. 12340 (June 2006). {access

                through Aladin}

This paper assembles a dataset comprising 1,565 banks in 20 Asian and Latin American countries during 1989-2001 and compares the response of the volume of loans, deposits, and bank-specific interest rates on loans and deposits, to various measures of monetary conditions, across domestic and foreign banks. It also looks for systematic differences in the behavior of domestic and foreign banks during periods of financial distress and tranquil times. Using differences in bank ownership as a proxy for financial constraints on banks, the paper finds weak evidence that foreign banks have a lower sensitivity of credit to monetary conditions relative to their domestic competitors, with the differences driven by banks with lower asset liquidity and/or capitalization. At the same time, the lending and deposit rates of foreign banks tend to be smoother during periods of financial distress, albeit the differences with domestic banks do not appear to be strong. These results provide weak support to the existence of supply-side effects in credit markets and suggest that foreign bank entry in emerging economies may have contributed somewhat to stability in credit markets.

3.6          Elif? (has a micro/IO dimension) Simon Gilchrist and Jae Sim. “Investment during the Korean

Financial Crisis: A Structural Econometric Analysis.” NBER Working Paper No. 13315 (Aug. 2007). {access through Aladin}

This paper uses firm-level panel data to analyze the role of financial factors in determining investment outcomes during the Korean financial crisis. Our identification strategy exploits the presence of foreign-denominated debt to measure shocks to the financial position of firms following the devaluation that occurred during the crisis period. Structural parameter estimates imply that financial factors may account for 50% to 80% of the overall drop in investment observed during this episode. Our estimates also imply that foreign-denominated debt had relatively little effect on aggregate investment spending. Counterfactual experiments suggest sizeable contractions in investment through this mechanism for economies that are more heavily dependent on foreign-denominated debt however.


WEEK 9, PAPER CLUSTER 4: Exchange-rate issues

4.1               Égert, Balázs Halpern, László. “Equilibrium exchange rates in Central and Eastern Europe: A

                meta-regression analysis.”

This paper analyses the ever-growing literature on equilibrium exchange rates in the new EU member states of Central and Eastern Europe in a quantitative manner using meta-regression analysis. The results indicate that the real misalignments reported in the literature are systematically influenced, inter alia, by the underlying theoretical concepts (Balassa-Samuelson effect, Behavioural Equilibrium Exchange Rate, Fundamental Equilibrium Exchange Rate) and by the econometric estimation methods. The important implication of these findings is that a systematic analysis is needed in terms of both alternative economic and econometric specifications to assess equilibrium exchange rates.

4.2               Meissner, C.M. and N. Oomes. “Why Do Countries Peg the Way They Peg? The Determinants of

Anchor Currency Choice”

Conditional on choosing a pegged exchange rate regime, what determines the currency to which countries peg or “anchor” their exchange rate? This paper aims to answer this question using a panel multinomial logit framework, covering more than 100 countries for the period 1980-1998. We find that trade network externalities are a key determinant of anchor currency choice, implying that there are multiple steady states for the distribution of anchor currencies in the international monetary system. Other factors found to be related to anchor currency choice include the symmetry of output co-movement, the currency denomination of debt, and legal or colonial origins.

4.3          Etienne B. Yehoue. “On the Pattern of Currency Blocs in Africa.” 2005

This paper seeks to elucidate the debate over currency union in Africa. The paper examines whether empirical investigation points to the gradual emergence of currency blocs. Based on the historical data on inflation, trade, and the co-movements of prices and outputs, I argue that the emergence of large-scale currency blocs in Africa will follow a gradual path and that this dynamic does not lead to the emergence of a single continental currency at this time. Rather, the pattern which emerges seems to suggest three blocs: one in West Africa, a second around South Africa, and a third in Central Africa. Although little evidence is found supporting the emergence of a single African currency at this time, the emergence of an African currency union is not necessarily precluded, since the ultimate decision to surrender a nation's monetary policy to a supranational institution is not made based solely on economic considerations. I then address the issue of a possible anchor for the union, were it to emerge and opt for an anchorage. I find -- based on the trade criterion -- that the euro seems to be a good choice.

4.4           David Fielding & Kalvinder Shields. “Economic Integration in West Africa: Does the CFA Make a

Difference?” (2003).

 In this paper we use data from 17 African nations in order to investigate the hypothesis that monetary union – represented in this case by the CFA Franc Zone – augments the extent of macroeconomic integration in developing countries. The paper covers a number of dimensions of integration including the volume of bilateral trade, real exchange rate volatility and the magnitude of cross-country business cycle correlation.

4.5          Chudik, Alexander, and Mongardini, Johannes (2007). “In Search of Equilibrium: Estimating

       Equilibrium Real Exchange Rates in Sub-Saharan African Countries.” IMF Working Paper


This paper presents a methodology to estimate equilibrium real exchange rates (ERER) for Sub-Saharan African (SSA) countries using both single-country and panel estimation techniques. The limited data set hinders single-country estimation for most countries in the sample, but panel estimates are statistically and economically significant, and generally robust to different estimation techniques. The results replicate well the historical experience for a number of countries in the sample. Panel techniques can also be used to derive out of sample estimates for countries with a more limited data set.

WEEK 10, PAPER CLUSTER 5: Commodity prices and monetary/IF policies

5.1               Clinton, Kevin. “Commodity-Sensitive Currencies and Inflation Targeting.” 2001

Two aspects of the recent monetary history of Canada, Australia, and New Zealand stand out: the sensitivity of their dollars to prices of resource-based commodities, and inflation targeting. This paper explores various aspects of these phenomena. It uses standard empirical models, and an investigation of the different approaches to inflation targeting in the three countries—including a case study of the 1998 international financial crisis—to assess how well a floating currency serves a resource-rich economy, and how monetary policy ought to be conducted during periods of turbulence in commodity and currency markets. The broad swings and cycles in the Canadian, Australian, and New Zealand dollars are found to have been helpful to macroeconomic stability. It appears that the most effective monetary policy approach focuses on domestic inflation control over the medium term. In a crisis of confidence in the financial markets, of the kind that sporadically affected the Canadian dollar in the first half of the 1990s, a case can be made for short-term monetary actions to stabilize expectations. Apart from crisis situations, as long as a credible low-inflation policy is followed, monetary policy does not have to be concerned with the exchange rate per se.

5.2               Fiorella de Fiore & Giovanni Lombardo & Viktors Stebunovs. “Oil Price Shocks, Monetary Policy

Rules and Welfare.” 2006

Sudden and protracted oil-price increases are generally accompanied by economic contractions and high inflation. How should monetary policy react to oil-price shocks in order to minimize such adverse macroeconomic effects? We build a DSGE model characterized by two oil-importing countries and one oil-exporting country. Oil-importing countries use oil for consumption and as input in production. The oil-exporting country consumes imported goods and produces oil. We calibrate the model and evaluate the performance of simple Taylor-type interest rate rules, on the basis of a micro-founded welfare metric. We search for rules that i) maximize welfare to a second order of approximation, ii) satisfy the zero-lower-bound for the nominal interest rate and iii) produce either a Nash or a cooperative equilibrium. We show that the optimal reaction of monetary policy is strongly influenced by the presence of energy taxes. For calibrated values of energy taxes, we find that monetary policy should partially accommodate oil-price increases. The optimal interest rate rule is inertial, it reacts strongly and positively to inflation and output deviations from the steady state, while it reacts negatively to deviations of the real price of oil from its steady-state value

5.3               Juan Pablo Medina and Claudio Soto. “Oil Shocks and Monetary Policy in an Estimated DSGE

                Model for a Small Open Economy"

This paper analyzes the effects of oil-price shocks from a general equilibrium standpoint. We develop a dynamic stochastic general equilibrium (DSGE) model, estimated by Bayesian methods for the Chilean economy. The model explicitly includes oil in the consumption basket and also in the technology used by domestic firms. With the estimated model we simulate how monetary policy and other variables would respond to an oil-price shock under the policy rule that best describes the behavior of the Central Bank of Chile (CBC). We also simulate the counterfactual responses in a flexible prices and wages equilibrium, and under alternative monetary frameworks. We show that a 13% increase in the real price of oil leads to a fall in output of about 0.5% and an increase in inflation of about 0.4%. The contractionary effect of the oil shock is mainly due to the endogenous tightening of the monetary policy.

5.4               Uwe Böwer & André Geis & Adalbert Winkler. 2007. “Commodity price fluctuations and their

impact on monetary and fiscal policies in Western and Central Africa.”

Commodity prices play an important role in economic developments in most of the 24 Western and Central African (WCA) countries covered in this paper. It is confirmed that in the light of rising commodity prices between 1999 and 2005, net oil exporters recorded strong growth rates while net oil-importing countries – albeit benefiting from increases in their major non-oil commodity export prices – displayed somewhat lower growth. For most WCA economies, inflation rates appear less affected by commodity price changes and more determined by exchange rate regimes as well as monetary and fiscal policies. While pass-through effects from international to domestic energy prices were significant, notably in oil-importing countries, second-round effects on overall prices seem limited. Governments of oil-rich countries reacted prudently to windfall revenues, partly running sizable fiscal surpluses. A favourable supply response to rising spending as well as sterilisation efforts and increasing money demand also helped to dampen inflationary pressures. However, substantial excess reserves of commercial banks reflect challenges in financial sector developments and the effectiveness of monetary policy in many WCA countries. Given currently widely used fixed exchange rate regimes, fiscal policy will continue to carry the main burden of macroeconomic adjustment and of sustaining non-inflationary growth, which remains the key policy challenge facing WCA authorities.

5.5               Varangis, Panos, Elton Thigpen, and Sudhakar Satyanarayan, “The use of New York cotton

futures contracts to hedge cotton price risk in developing countries”

Cotton exports account for a significant share of commodity exports for some developing countries, especially in West Africa and Central Asia. In these countries, dependency on cotton for export revenues has increased in the past 20 years. These countries therefore have a high exposure to cotton price volatility. Cotton-producing developing countries and economies in transition make little use of hedging mechanisms to reduce risk from the volatility of cotton export revenues. Countries in Francophone West Africa use forward sales to hedge but only for a small share of the crop. These countries could use cotton futures and options contracts to hedge against short- to medium-term price volatility, making cotton export revenues more predictable. Cotton futures and options contracts could also make cotton-related commercial transactions more flexible. (Futures could be sold when there are no buyers in the physical market, for example.) In West Africa, futures and options could complement the existing system of forward sales. The authors examine the feasibility of using New York cotton futures and options contracts as hedging instruments. They base their analysis on a portfolio selection problem in which the hedger selects the optimal proportions of unhedged and hedged output to minimize risk. The results suggest that despite the existence of relatively high basis risk (that is, a relatively low correlation between spot and future prices), hedging reduces cotton price volatility by 30 to 70 percent. Moreover, for all varieties of cotton examined, the hedge ratio (the percentage of exports hedged) was below one. Using a hedge ratio of one (naive hedge), at times, increases rather than decreases risk. The results also show that hedging, while reducing risk, also reduces expected returns. Attitudes toward risk that is, the degree of risk aversion - determine how much of this risk-return tradeoff is acceptable. For a risk-averse agent, the main benefit of hedging lies in risk reduction rather than in the potential for increased returns.


WEEK 11, PAPER CLUSTER 6:  Miscellaneous interesting issues {OR select a paper of your choice}


6.1               David Fielding,How Does Monetary Policy Affect the Poor? Evidence from the West African

Economic and Monetary Union”

The West African Economic and Monetary Union (UEMOA) has a history of monetary stability and low inflation. Nevertheless, there is substantial variation in relative prices within some UEMOA countries, in particular in the price of food relative to other elements of the retail price index (IHPC). Using monthly time-series data for cities within the region, we analyze the impact of changes in monetary policy instruments on the relative prices of components of the IHPC. We are then able to explore how the burden of monetary policy innovations is likely to be shared between the rich and poor.

6.2               Jian Yang, Cheng Hsiao, Qi Li, Zijun Wang. “The emerging market crisis and stock market

linkages: further evidence,” Journal of Applied Econometrics, Sep/Oct 2006. Vol. 21, Iss. 6; p. 727


This study examines the long-run price relationship and the dynamic price transmission among the USA, Germany, and four major Eastern European emerging stock markets, with particular attention to the impact of the 1998 Russian financial crisis. The results show that both the long-run price relationship and the dynamic price transmission were strengthened among these markets after the crisis. The influence of Germany became noticeable on all the Eastern European markets only after the crisis but not before the crisis. We also conduct a rolling generalized VAR analysis to confirm the robustness of the main findings. [PUB

6.3          Fabio Canova. “The transmission of US shocks to Latin America,” Journal of Applied

                Econometrics. 2005. Vol. 20, Iss. 2; p. 229 (23 pages)

I study whether and how US shocks are transmitted to eight Latin American countries. US shocks are identified using sign restrictions and treated as exogenous with respect to Latin American economies. Posterior estimates for individual and average effects are constructed. US monetary shocks produce significant fluctuations in Latin America, but real demand and supply shocks do not. Floaters and currency boarders display similar output but different inflation and interest rate responses. The financial channel plays a crucial role in the transmission. US disturbances explain important portions of the variability of Latin American macro-variables, producing continental cyclical fluctuations and, in two episodes, destabilizing nominal exchange rate effects. Policy implications are discussed.

6.3               Tor Jacobson, Per Jansson, Anders Vredin, Anders Warne. “Monetary policy analysis and

inflation targeting in a small open economy: A VAR approach,” Journal of Applied Econometrics.

Jul/Aug 2001. Vol. 16, Iss. 4; p. 487

Empirical monetary policy research has increased in the last decade, possibly because deregulation and explicit monetary targets have made monetary policy issues more interesting. In particular, within the inflation targeting framework it has been argued that inflation forecasts can be used as optimal intermediate targets for monetary policy, and the development of empirical models that have good forecasting properties is therefore important. It is shown that a VAR model with long-run restrictions, justified by economic theory, is useful for both forecasting inflation and for analyzing other issues that are central to the conduct of monetary policy.

6.4               Dedola, Luca; Lippi, Francesco. “The Monetary Transmission Mechanism: Evidence from the

Industries of Five OECD Countries,” European Economic Review, vol. 49, no. 6, August 2005, pp.


This paper studies the monetary transmission mechanism using disaggregated industry data from five industrialized countries. Our goal is to document the cross-industry heterogeneity of monetary policy effects and relate it to industry characteristics suggested by monetary transmission theories. Sizable and significant cross-industry differences in the effects of monetary policy are found. Such differences swamp the hardly detectable cross-country variability. Sectoral output responses to monetary policy shocks are systematically related to the industry output durability, financing requirements, borrowing capacity and firm size. These findings are consistent with a quantitatively non-negligible role of financial frictions in the monetary transmission.

6.5               Francis Nathan Okurut. “Access to credit by the poor in South Africa: Evidence from Household

Survey Data 1995 and 2000” (2006).


This study specifically investigated the factors that influenced access by the poor and Blacks to credit in the segmented financial sector in South Africa, using income and expenditure survey data from 1995 and 2000. The study sheds light on the extent of financial sector deepening through household participation especially among the poor and Blacks, in the context of the fight against poverty. In this study, three types of credit were identified. Formal credit was defined to include debts from commercial banks (including mortgage finance and car loans), semi-formal credit included consumption credit (for household assets such as furniture and open accounts in retail stores), and informal credit specifically referred to debts from relatives and friends. Multinomial logit models and Heckman probit models with sample selection were used for analytical work. The results suggest that the poor and Blacks have limited access to the formal and semi-formal financial sectors. At the national level, access to bank credit is positively and significantly influenced by age, being male, household size, education level, household per capita expenditure and race (being Coloured, Indian or White). Being poor has a negative and significant effect on formal credit access.

6.6               Burnside, Craig; Fanizza, Domenico. “Hiccups for HIPCs? Implications of Debt Relief for Fiscal

Sustainability and Monetary Policy,” B.E. Journals in Macroeconomics: Contributions to

Macroeconomics, vol. 5, no. 1, 2005, pp. 1-37.

In this paper we discuss fiscal and monetary policy issues facing heavily-indebted poor countries (HIPCs) who receive debt reduction via the enhanced HIPC initiative. This debt relief program is distinguished from previous ones by its conditionality: freed resources must be used for poverty reduction. We argue that (i) this conditionality severely limits the extent to which the initiative provides significant debt relief; (ii) depending on the response of monetary policy to an increase in social spending there could be a short-run increase in inflation in HIPC countries and (iii) the keys to long-run fiscal sustainability in the HIPCs are significant fiscal reforms by their governments, and the effectiveness of their poverty reduction programs in raising growth.