Peering Through Monetary Mist: Macroeconomic Effects of Monetary
Policy under Borderless World of Financial and Labor Market
Suchanan ChunanantathamJanuary 8, 2007
Presentation guide
Introduction: How did it all begin? What is it that I intend to study? How distinguish this thesis over the others in the same
area? Model summary
What is the building block behind the results? Results of the study
What is the answer to the questions at hand? Conclusion
What is the implication learned?
Introduction Objective 1
To study whether financial market integration strengthens or weakens the ability of policymakers to stabilize the economy using macroeconomic policy
Motivation A widespread acceleration in financial liberalization To the extent that such integration is a policy choice,
investigating its benefit and cost seem to be an obvious and promising direction for research
Among many aspects, the implication in term of macroeconomic policy is chosen.
Theoretical framework Classic workhorse model developed by Mundell(1962)
and Fleming (1963) Mixed results and drawbacks
Contribution New open economy macroeconomic model developed
by Ofstfeld and Rogoff (1995)
Introduction
Objective 2 To explore role played by labor market integration on the
effect of financial market integration on the adjustment of the economy to unanticipated changes in monetary policy
Motivation Most of works in international policy transmission assume
no migration of labor across countries. Through it alleviates the theoretical analysis, it is clearly at
variance with empirical evidences Contribution
Extending the model to include international labor flow would render the model to be more practical while allow for more detail study if financial market integration
Model
-Choose consumption, bond, and money holding to maximize utility subject to budget constraint
Producer- Price adjustment mechanism
Free entry and exit+ Inelastic labor supplyZero profit- Pricing rule
11
, , ,
1 1 1
1 1
Subject to (1 )
1 where
H H H H
s t
Hs t H H H Hs
s HC D M F s t s
H H H H H H H H H H Ht t t t
Ht
t t
H H H H H H H H H H H H Ht t t t t t t t
H Ht
MMax N C N N
P
N D i N D N M N M w N
P N C P N I P N N P N TZ
N Z
2
2
is given.H
H Ht
N
N I
( )( ) , here z=h,f
HH Htt tH
t
p zc z C w
P
H Hs sp w
11 111
0
( ) ( )n
H H H
n
P p h dh p f df
Government-Assume government spending is zero-Gov’t budget constraint
1( )t tt
t
M MT
P
-Each individual consumption of differentiated products need to be chosen so as to minimize the cost of attaining aggregate consumption
Consumer
Numerical results
In what follows, quantitative properties based on the previous chapter’s qualitative framework are explored.
Computational experiments No closed-form solution simulating a calibrated
version of the log-linear system numerically Method of undetermined coefficient
The results are interpreted by using impulse response analysis
Numerical results
Combination of experiments The plots, which represent the propagation of asymmetric
shock on various macroeconomic variables, are classified into four cases
Case 1: Prior to Labor Market Integration
1.1 Degree of Capital mobility: high
1.2 Degree of capital mobility: Low
Case 2: Subsequent to Labor Market Integration
2.1 Degree of Capital mobility: high
2.2 Degree of capital mobility: Low
Shock Follow Sutherland (1996), the shocks considered in this
thesis are permanent and asymmetric.
X
X
Case 1: Prior to international labor migration
First objective:
“how the degree of international financial market integration matters for the dynamics of the model in the aftermath of monetary shock with the labor market separated between nations.”
Numerical results
Numerical results
Nominal interest rate
Low barrier in making international flows of funds only one interest rate
An asymmetric shock
the interest rates are leaved unaffected by monetary shock from each country
-1 0 1 2 3 4 5 6 7 8-0.5
-0.4
-0.3
-0.2
-0.1
0
0.1
0.2
Years after shock
Per
cent
dev
iatio
n fr
om s
tead
y st
ate
-1 0 1 2 3 4 5 6 7 80
0.05
0.1
0.15
0.2
0.25
0.3
0.35
0.4
0.45
0.5
Years after shock
Per
cent
dev
iatio
n fr
om s
tead
y st
ate
Home Foreign
1.1 High degree of capital mobility with incomplete labor market integration: The benchmark case
General price index
Flexible-price model home price index increases by somewhat the same amount as a change in money supply.
-1 0 1 2 3 4 5 6 7 80
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1
Years after shock
Per
cent
dev
iatio
n fr
om s
tead
y st
ate
-1 0 1 2 3 4 5 6 7 8-1
-0.9
-0.8
-0.7
-0.6
-0.5
-0.4
-0.3
-0.2
-0.1
0
Years after shock
Per
cent
dev
iatio
n fr
om s
tead
y st
ate
Numerical results
Numerical results Wage (or price of individual differentiated products)
The symmetry of both countries individual prices of goods in each country (either own-produced or imported) behave like its general price index.
So, apparently individual prices in home, which is equal to wage in the model where flexible prices guarantee zero profit, rise by one percent as well.
-1 0 1 2 3 4 5 6 7 80
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1
Years after shock
Perc
ent
devia
tion f
rom
ste
ady s
tate
-1 0 1 2 3 4 5 6 7 8-1
-0.9
-0.8
-0.7
-0.6
-0.5
-0.4
-0.3
-0.2
-0.1
0
Years after shock
Perc
ent
devia
tion f
rom
ste
ady s
tate
ˆ ˆˆˆ 0H H F F
H H H Ft t t t
N C N Cp P C C
Q Q
Numerical results Implication:
Real wage remains unchanged at the level that generates steady state full employment,
i.e., we have zero deviation of outputs from steady state
Obviously, where full employment is assured by wage
and price flexibility, monetary policy has impact that would be predicted from the basic quantity theory of money.
That is, it is only price level in an economy, not real economic variables, such as output and employment, that is affected by quantity of money.
Contradict to Sutherland (1996) where there is price-rigidity, the general level of price will change in proportion to the change in money stock, leaving the real side of economy unchanged
ˆˆ 0or 0H Ht ty Y
Consumption index (and consumption of individual goods)
Once-and-for-all step change from its initial value to a new long-run steady state level.
-1 0 1 2 3 4 5 6 7 8-0.01
0
0.01
0.02
0.03
0.04
0.05
0.06
0.07
0.08
Years after shock
Per
cent
dev
iatio
n fr
om s
tead
y st
ate
-1 0 1 2 3 4 5 6 7 8-0.08
-0.07
-0.06
-0.05
-0.04
-0.03
-0.02
-0.01
0
0.01
Years after shock
Per
cent
dev
iatio
n fr
om s
tead
y st
ate
Numerical results
Numerical results The main reason for flat consumption:
Unchanged real interest no incentive to reallocate consumption overtime
In other words, a country will wish to smooth consumption in the situation where a subjective discount factor is equal to the market discount factor
Not surprisingly, in presence of an efficient ways of accumulating financial wealth, countries can gain more opportunity for consumption-smoothing, as confirmed in the above two graphs.
1 1ˆ ˆ ˆ ˆˆ1H H H H Ht t t t t tC C i E P P
1 (1 )H H Ht t tC C r
Exchange rate
Exchange rate dynamic
Indeed, home currency depreciates (foreign currency appreciates) to about 2 percent.
-1 0 1 2 3 4 5 6 7 80
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
1.8
2
Years after shock
Per
cent
dev
iatio
n fr
om s
tead
y st
ate
1 ˆ ˆˆ ˆ ˆ ˆ ˆH F H F H Ft t t t t t tE M M C C i i
no change in nominal interest rate
exchange rate must also jumps immediately to its long-run level.
The relative money supply andchange in relative consumption level
once-and-for-all step change
Numerical results
No-exchange-rate-overshooting property of the model Exchange rate dynamic is virtually identical to the central
equation of the flexible-price monetary model of exchange rates
According to above equation, once domestic currency is expected to depreciate over the coming period, the today demand for domestic currency will fall, causing an increase in exchange rate immediately.
Consequently, Dornbusch-type exchange rate overshooting does not essentially occur in this model.
s m m y y i i eti i s
ets m m y y s
Numerical results
Quantity of funds transferred
Domestic agents are accumulating foreign bonds (increase in net claim on the rest of the world) as the depreciation in domestic currency gives rise to national current account surplus
-1 0 1 2 3 4 5 6 7 8-0.02
0
0.02
0.04
0.06
0.08
0.1
Years after shock
Per
cent
dev
iatio
n fr
om s
tead
y st
ate
cons
umpt
ion
valu
e
-1 0 1 2 3 4 5 6 7 8-0.1
-0.08
-0.06
-0.04
-0.02
0
0.02
Years after shock
Per
cent
dev
iatio
n fr
om s
tead
y st
ate
cons
umpt
ion
leve
l
Numerical results
Numerical results
How does presence of imperfect financial market integration affect the dynamics of the model?
Equation (1) states that the yield differential between domestic and foreign bond( i.e., the nominal interest differential less the expected depreciation of the nominal exchange rate) is proportional to expected rate of change of the cross-border flow of funds.
1 1ˆ ˆ ˆ ˆˆ ˆ1 1H F H H H H
t t t t t t t ti i E E E N C E I I (1)
1.2 Low degree of capital mobility with incomplete labor market integration
Numerical results
Algebraically, with higher value of ,
A higher negative in international nominal interest rate differential
A bigger expected rate of change in value of home currency
the initial impact on exchange rate of monetary expansion when international financial market are segmented
would be smaller
A negative expected rate of change in cross-border flow of funds
-1 0 1 2 3 4 5 6 7 8-0.5
-0.4
-0.3
-0.2
-0.1
0
0.1
0.2
Years after shock
Per
cent
dev
iatio
n fr
om s
tead
y st
ate
-1 0 1 2 3 4 5 6 7 80
0.05
0.1
0.15
0.2
0.25
0.3
0.35
0.4
0.45
0.5
Years after shock
Per
cent
dev
iatio
n fr
om s
tead
y st
ate
-1 0 1 2 3 4 5 6 7 80
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
1.8
2
Years after shock
Per
cent
dev
iatio
n fr
om s
tead
y st
ate
1 1ˆ ˆ ˆ ˆˆ ˆ1 1H F H H H H
t t t t t t t ti i E E E N C E I I
Intuitively, the central implication of imperfect capital mobility is that domestic and foreign bonds become differentiated and can, therefore, pay different rate of return.
With low capital mobility,
relatively higher downward pressure on relative yield of domestic asset
The tendency for money supply to induce higher asset accumulation in domestic economy
First, nominal interest rate of each country becomes more diverge,i.e., nominal interest rate rises in home while falls in foreign.
Second, since one component of domestic yield is capital gain arisenfrom change in exchange rate, the higher domestic yield fall implies that
expected depreciation is relatively higher.
Numerical results
Price (individual prices of home product and wage)
In keeping parity of purchasing power among the countries,
the marginally increase in E home general price index rises by less
-1 0 1 2 3 4 5 6 7 80
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1
Years after shock
Per
cent
dev
iatio
n fr
om s
tead
y st
ate
-1 0 1 2 3 4 5 6 7 8-1
-0.9
-0.8
-0.7
-0.6
-0.5
-0.4
-0.3
-0.2
-0.1
0
Years after shockP
erce
nt d
evia
tion
from
ste
ady
stat
e
Numerical results
Numerical results Consumption (and consumption of individual goods)
Home consumption index rises sharply and then declines afterward.
Fall in real interest rate in home incentive for domestic consumers to bring consumption forward in time
When market interest rate differs from time-preference rate, the motivation to smooth consumption is modified by an incentive to tilt the consumption path.
Another reason: lower increase in price level
-1 0 1 2 3 4 5 6 7 8-0.01
0
0.01
0.02
0.03
0.04
0.05
0.06
0.07
0.08
Years after shock
Per
cent
dev
iatio
n fr
om s
tead
y st
ate
-1 0 1 2 3 4 5 6 7 8-0.08
-0.07
-0.06
-0.05
-0.04
-0.03
-0.02
-0.01
0
0.01
Years after shock
Per
cent
dev
iatio
n fr
om s
tead
y st
ate
First InvestigationMoney shock under different degrees of financial market
integration: Before international labors migration
Once-and-for-all in C
Once-and-for-all in E
Perfectly integrated
Price more
Output: unchange
Unchanged interest rate
Imperfectly integrated
sharply and afterward
E by less
Price less
Output: unchange
Interest rate-
+
+
--1 0 1 2 3 4 5 6 7 8
-0.5
-0.4
-0.3
-0.2
-0.1
0
0.1
0.2
Years after shock
Per
cent
dev
iatio
n fro
m s
tead
y st
ate
-1 0 1 2 3 4 5 6 7 8-0.01
0
0.01
0.02
0.03
0.04
0.05
0.06
0.07
0.08
Years after shock
Per
cent
dev
iatio
n fr
om s
tead
y st
ate
-1 0 1 2 3 4 5 6 7 80
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
1.8
2
Years after shock
Per
cent
dev
iatio
n fr
om s
tead
y st
ate
-1 0 1 2 3 4 5 6 7 80
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1
Years after shock
Per
cent
dev
iatio
n fr
om s
tead
y st
ate
Numerical results
ˆˆ 0or 0H Ht ty Y
Numerical results
In other words, at any degree of labor market integration, it would be sufficient to establish the financial market integration as the factor that reduces volatility of interest rates and increases in volatility of prices and exchange rate.
Hence, along the lines of Mundell-Fleming model and Sutherland (1996), the monetary policy effect toward exchange rate tends to be stronger, the higher is the degree of international capital mobility.
On the other hand, while it enhances the effect on exchange rate, its effect on output deteriorates as perfectly flexible prices and wages bring about the classic neutrality property of monetary policy.
Case 2: Subsequent to international labor migration
Second objective
“ Whether implications of international capital mobility for the macroeconomic effects of monetary policy are sensitive to the extent of integration in international labor market.”
Numerical results
Comparing between incomplete and complete labor market integration, it go without saying that
As before, the implications of lowering in trading friction in international financial transaction on monetary policy effects work through
the presence of international labors resettlement
the way any of macro variables response to shock from what is analyzed in the last section.
does not significantly alter
the interaction of relative asset return and exchange rate
Numerical results
Numerical results
After the lower impediments to cross-country capital flows are introduced, the fall in relative yield from holding assets in different countries is smaller.
This, simultaneously, means two things. The deviation of interest differential between domestic and foreign
bond becomes narrower
1 1ˆ ˆ1 ˆ ˆ ˆ1 ˆ H H H H
t t t ttH
t tF
t E E E N C E Ii i I
-1 0 1 2 3 4 5 6 7 8-1.2
-1
-0.8
-0.6
-0.4
-0.2
0
0.2
0.4
Years after shock
Pe
rcent devi
atio
n fro
m s
tea
dy
state
-1 0 1 2 3 4 5 6 7 8-0.1
-0.05
0
0.05
0.1
0.15
0.2
0.25
Years after shock
Pe
rce
nt
de
via
tion
fro
m s
tea
dy
sta
te
Home
Foreign
Because of the higher expected inflation in domestic economy as a result of greater monetary-induce exchange rate depreciation in the case where home agents can easily switch places to invest their assets the borrowers and lenders add inflation premium to interest rate. Ultimately, an expansion in money supply in home will raise interest rate when financial market integration is highly complete. “expected inflation effect”
Numerical results
The magnitude of an increase in depreciation expectation is getting smaller.
In contrast to the case where a nation’s capital market is less loosen up, lower expected depreciation generates dramatically higher monetary-induced increase in exchange rate, as confirmed by the following diagram.
-1 0 1 2 3 4 5 6 7 80
0.5
1
1.5
2
2.5
3
3.5
4
4.5
Years after shock
Per
cent
dev
iatio
n fr
om s
tead
y st
ate
1 1ˆ ˆˆ ˆˆ1 1 ˆH F H H H H
t t t tt tt tE Ei i N C I IE E
The nominal exchange rate increases by more from an symmetric shock in a relative money supply, as compared to the case previous to migration.
It appears from the equation that the relative difference between returns from holding assets of home and foreign country becomes smaller after labors relocate from home to foreign.
The smaller yield differential, then, implies that the expected domestic currency depreciation happens to be less significant in the world of high worldwide labor mobility.
So, with lower depreciation expected, it is necessary for the impact effect of monetary change on exchange rate to be larger
, i.e., higher depreciation (in either low or high degree of financial market integration) if labors are allowed to migrate.
1 1ˆ ˆ ˆ ˆˆ ˆ1 1H F H H
t t t t t ttH H
tN Ci i E E E E I I
Numerical results
How are things different in the presence of global linkages in labor market?
Armed with the dynamics of exchange rate, we can determine
If we compare to the world where difficulties in undertaking position in oversea financial market is more important, asymmetric shock in money supply causes home general price index and wage (or price of individual goods) to rise by more as it produces a bigger rate of home currency depreciation.
-1 0 1 2 3 4 5 6 7 80
0.5
1
1.5
2
2.5
3
3.5
Years after shock
Pe
rce
nt
de
via
tion
fro
m s
tea
dy
sta
te
-1 0 1 2 3 4 5 6 7 80
0.5
1
1.5
2
2.5
3
Years after shock
Pe
rce
nt
de
via
tion
fro
m s
tea
dy
sta
te
Price Wage
the effect of monetary policy change on other macro variables.
Numerical results
The direct effect of a change in the location of production on price index of that country:
After a given amount of home labors move to foreign country, steady state value of home total outputs, as well as the
number of varieties home produces, decline. This raises positive effect of expansionary monetary policy
on home price.
Accordingly, we can notice a larger rise in home price index, as compared to the circumstances before labor market integration.
Numerical results
“Price index effect”:Price index in a particular region would tend to be higher,the lower is the share of production sector in that region.
How are things different in the presence of global linkages in labor market?
Wage: Because a substantial depreciation in home currency creates
a higher demand for home products at the expense of foreign products,
moving of home labors to foreign country would appear to raise home wages up higher after the disturbance hits the economy.
Therefore, an asymmetric change in monetary policy would
cause a higher rise in home wage rate if labor is mobile across regions.
“Home market effect”With the vertical labor supply curve,
the producers in location with larger demand for its product would have to pay a higher nominal wage.
Numerical results
Dynamics of consumption and current account
In fact, home consumption climbs down by more, thus leading to greater current account surplus when the two financial markets are highly integrated.
• Of course, this is attributed to the higher increases in domestic price + smaller fall in domestic interest falls when countries become less isolated to the global financial market -1 0 1 2 3 4 5 6 7 8
-14
-12
-10
-8
-6
-4
-2
0
Years after shock
Per
cent
dev
iatio
n fro
m s
tead
y st
ate
Expansionary monetary policy in home gives rise toa fall in consumption, instead of raising it as it does in the caseahead of home emigration.
•This is so because it generates a much higher rise in price level,which implies a lower purchasing power and thus the incentive to spending.
•Plus, the fact the home interest rate fall by less as a result of money supply increase means that agents will wish to consume relatively more in the future, rather than now. Consequently, in the below panel, as the disturbance strikes,home consumption declines once labor is highly mobile across countries.
Numerical results
Second Investigation: Implications of international capital mobility for the effects of monetary policy: After
international labors migration
E more
Price more
Perfectly integrated
C more
Output: unchange
interest rate
Imperfectly integrated
E less
Price less
C less
Output: unchange
Interest rate
+
+
-+
Numerical results
ˆˆ 0or 0H Ht ty Y
-1 0 1 2 3 4 5 6 7 8-1.2
-1
-0.8
-0.6
-0.4
-0.2
0
0.2
0.4
Years after shock
Perc
ent devi
atio
n fro
m s
teady
state
-1 0 1 2 3 4 5 6 7 8-14
-12
-10
-8
-6
-4
-2
0
Years after shock
Per
cent
dev
iatio
n fro
m s
tead
y st
ate
-1 0 1 2 3 4 5 6 7 80
0.5
1
1.5
2
2.5
3
3.5
4
4.5
Years after shock
Per
cent
dev
iatio
n fr
om s
tead
y st
ate
-1 0 1 2 3 4 5 6 7 80
0.5
1
1.5
2
2.5
3
3.5
Years after shock
Per
cent
dev
iatio
n fr
om s
tead
y st
ate
Summary of simulation results
In the nutshell, the simulated results carried out at different degrees of financial and labor market integration ultimately indicate that
1) The way macroeconomic variables response after money shock hit economy obviously differs between economy with low and high capital mobility
Cases
Financial market integration
(i) Imperfect integrated labor market - - + + 0
(ii) Perfectly integrated labor market -* + + + 0
, ( )P p zE,i r , ( )C c z ( ),y z Y
Accordingly, although the approach taken here differs radically from that of traditional Mundell-Fleming model in that it allows policy issues to be analyzed by mean of full-fledged micro-founded dynamic model, the two approach share some implications as both models appear to predict that the nominal exchange rate effect of monetary policy tend to increase in the world where capital mobility is far above the ground.
At the same time, the flexile-price NOEM model developed in this paper and the quantity theorist also are not extremely far apart in terms of output implication of monetary policy.
Eventually, money is all that matters for change in nominal, not real, income, as reflected clearly in the basic quantity theory of money.
Summary of simulation results
Summary of simulation results2) Another interesting results concern the impact of having a
particular amount of labors migrates from home to foreign country.
As a consequence, regardless of the condition in terms of linkage in labor market of each nation, the international financial market integration does show a consistent and dependable effect toward the behavior of economy in the upshot of shock in money supply.
The simulation results suggest that quite the same pattern still applies even after the possibility of shift in labor location is incorporated.
Cases
Financial market integration
(i) Imperfect integrated labor market - - + + 0
(ii) Perfectly integrated labor market -* + + + 0
, ( )P p zE,i r , ( )C c z ( ),y z Y
The end
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