Transcript Peering Through Monetary Mist: Macroeconomic Effects of

Peering Through Monetary Mist:
Macroeconomic Effects of Monetary
Policy under Borderless World of
Financial and Labor Market
Suchanan Chunanantatham
January 8, 2007
Presentation guide

Introduction:




Model summary


What is the building block behind the results?
Results of the study


How did it all begin?
What is it that I intend to study?
How distinguish this thesis over the others in the same
area?
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


Motivation



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
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
Consumer
-Choose consumption, bond, -Each individual consumption of
and money holding to maximizedifferentiated products need to be
chosen so as to minimize the cost
utility subject to budget
of attaining
aggregate consumption
constraint 


C
Max
H
H
H
,D ,M ,F

H 
s t

s t
1
s t
 1
H


H
H
H  Ms 


N  Cs  
N  H 
1 
  1
 Ps 


 H
N 



Subject to N H DtH  (1 itH1 ) N H DtH1  N H M tH1  N H M tH  wtH N H
 Pt H N H CtH  Pt H N H I tH  Pt H N H Z tH  N H  tH  Pt H N H Tt H
2
1
where N H Z tH    N H I tH 
2
N H is given.
Producer
- Price adjustment mechanism
Free entry and exit
+ Inelastic labor supply
Zero profit
- Pricing rule psH  wsH
H


p
H
t ( z)
ct ( z )   H  CtH , where z=h,f
 Pt 
1
1
 n H 1
1
1
H
P    p (h) dh    p ( f )  df 
n
0

H
Government
-Assume government
spending is zero
-Gov’t budget constraint
Tt 
( M t 1  M t )
Pt
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 X
Case 2: Subsequent to Labor Market Integration
2.1 Degree of Capital mobility: high
2.2 Degree of capital mobility: Low X


Shock

Follow Sutherland (1996), the shocks considered in this
thesis are permanent and asymmetric.
Numerical results
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
1.1 High degree of capital mobility with incomplete labor
market integration: The benchmark case
Nominal interest rate
0.2
0.5
0.45
Percent deviation from steady state
0.1
Percent deviation from steady state

0
-0.1
-0.2
Home
-0.3
0.4
0.35
0.3
0.25
0.2
Foreign
0.15
0.1
-0.4
0.05
-0.5
-1


0
1
2
3
4
Years after shock
5
6
7
8
0
-1
0
1
2
3
4
Years after shock
5
6
7
8
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
Numerical results
General price index
1
0
0.9
-0.1
0.8
-0.2
Percent deviation from steady state
Percent deviation from steady state

0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
-1
-0.3
-0.4
-0.5
-0.6
-0.7
-0.8
-0.9
0
1
2
3
4
Years after shock
5
6
7
8
-1
-1
0
1
2
3
4
Years after shock
5
6
7
8
Flexible-price model  home price index
increases by somewhat the same amount as a
change in money supply.
Numerical results
Wage (or price of individual differentiated products)
1
0
0.9
-0.1
0.8
-0.2
Percent deviation from steady state
Percent deviation from steady state

0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
-1

-0.3
-0.4
-0.5
-0.6
-0.7
-0.8
-0.9
0
1
2
3
4
Years after shock
5
6
7
8
-1
-1
1
2
3
4
Years after shock
5
6
7
8
The symmetry of both countries  individual prices of goods in
each country (either own-produced or imported) behave like its
general price index.
H H
F F
N
C
N
C ˆF
H
H
H
ˆ
ˆ
 pˆ t   Pt 
Ct 
Ct  0
Q
Q
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.
 

0
 
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
yˆtH  0or Yˆt H  0
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
Numerical results
0.08
0.01
0.07
0
Percent deviation from steady state
Percent deviation from steady state
Consumption index (and consumption of individual goods)
0.06
0.05
0.04
0.03
0.02
0.01
0
-0.01
-1

-0.01
-0.02
-0.03
-0.04
-0.05
-0.06
-0.07
0
1
2
3
4
Years after shock
5
6
7
8
-0.08
-1
0
1
2
3
4
Years after shock
5
6
7
8
Once-and-for-all step change from its initial value
to a new long-run steady state level.
Numerical results

The main reason for flat consumption:
 Unchanged real interest  no incentive to
reallocate consumption overtime


CˆtH1  CˆtH   1    iˆt H  Et Pˆt H1  Pˆt H 



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
H
t 1
C

 C   (1  rt ) 
H
t
H

Not surprisingly, in presence of an efficient ways
of accumulating financial wealth, countries can
gain more opportunity for consumptionsmoothing, as confirmed in the above two graphs.
Numerical results

2
Exchange rate
Percent deviation from steady state
1.8
1.6
1.4
Exchange rate dynamic
1 ˆ H ˆ F  ˆH ˆF
Eˆt  Mˆ tH  Mˆ tF 
Ct  Ct   it  it 


1.2

1
0.8
0.6



0.4
0.2
0
-1
0
1
2
3
4
Years after shock
5
6
7
8
The relative money supply and
change in relative consumption level
once-and-for-all step change
no change
in nominal interest rate
exchange rate must also jumps immediately to its long-run level.
Indeed, home currency depreciates (foreign currency
appreciates) to about 2 percent.
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
s   m  m    y  y      i  i  
s  m  m




e
i

i


s
  t
   y  y   s

e
t
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.
Numerical results
Quantity of funds transferred

0.02
Percent deviation from steady state consumption level
Percent deviation from steady state consumption value
0.1
0.08
0.06
0.04
0.02
0
-0.02
-1
0
1
2
3
4
Years after shock
5
6
7
8
0
-0.02
-0.04
-0.06
-0.08
-0.1
-1
0
1
2
3
4
Years after shock
5
6
7
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
8
Numerical results
1.2 Low degree of capital mobility with incomplete labor
market integration
 How does presence of imperfect financial
market integration affect the dynamics of the
model?



H
F
H H
H
H
ˆ
ˆ
ˆ
ˆ
ˆ
ˆ
1    it  1    it  Et Et 1  Et   N C Et It 1  It

(1)
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.
Numerical results
1    iˆt H  1    iˆt F  Et  Eˆt 1  Eˆt    N H C H Et  IˆtH1  IˆtH 

Algebraically, with higher value of ,
A negative expected rate of change in cross-border flow of funds
0.5
0.2
0.45
Percent deviation from steady state
Percent deviation from steady state
0.1
0
-0.1
A higher negative in international
nominal interest rate differential
-0.2
-0.3
0.4
0.35
0.3
0.25
0.2
0.15
0.1
-0.4
0.05
-0.5
-1
0
1
2
3
4
Years after shock
5
6
7
0
-1
8
0
1
2
2
3
4
Years after shock
5
6
7
8
A bigger expected rate of change
in value of home currency
Percent deviation from steady state
1.8
the initial impact on exchange rate of monetary expansion
when international financial market are segmented
would be smaller
1.6
1.4
1.2
1
0.8
0.6
0.4
0.2
0
-1
0
1
2
3
4
5
6
7
8
Numerical results


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,
The tendency for money supply to induce higher asset
accumulation in domestic economy
relatively higher downward pressure on
relative yield of domestic asset
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 arisen
from change in exchange rate, the higher domestic yield fall implies that
expected depreciation is relatively higher.
Numerical results
1
0
0.9
-0.1
0.8
-0.2
Percent deviation from steady state
Percent deviation from steady state
Price (individual prices of home product and wage)
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
-1


-0.3
-0.4
-0.5
-0.6
-0.7
-0.8
-0.9
0
1
2
4
3
Years after shock
5
6
7
8
-1
-1
0
1
2
3
4
Years after shock
5
6
In keeping parity of purchasing power among the
countries,
the marginally increase in E  home general price
index rises by less
7
8
Numerical results
Consumption (and consumption of individual goods)
0.08
0.01
0.07
0
Percent deviation from steady state
Percent deviation from steady state

0.06
0.05
0.04
0.03
0.02
0.01




-0.02
-0.03
-0.04
-0.05
-0.06
-0.07
0
-0.01
-1
-0.01
0
1
2
3
4
Years after shock
5
6
7
8
-0.08
-1
0
1
2
3
4
Years after shock
5
6
7
8
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
Numerical results
First Investigation
Money shock under different degrees of financial market
integration: Before international labors migration
Imperfectly integrated
Perfectly integrated
0.2
0.06
0.05
0.04
Once-and-for-all in C
0.03
0.02
0.01
0
-0.01
-1
0
1
2
3
4
Years after shock
5
6
7
Interest rate
0
-0.1
-0.2
-0.3
-0.4
-0.5
-1
0
1
2
3
4
Years after shock
5
6
sharply and afterward
8
2
Once-and-for-all in E +
1
E
by less
0.9
0.8
Percent deviation from steady state
1.8
Percent deviation from steady state
Percent deviation from steady state
0.07
-
Unchanged interest rate
0.08
Percent deviation from steady state
0.1
1.6
1.4
1.2
1
0.8
0.6
0.4
0.7
0.2
0.6
Price
0.5
0.4
0.3
0.2
+
more
Price
less
0
-1
0
1
2
3
4
Years after shock
0.1
0
-1
0
1
2
3
4
Years after shock
5
6
7
8
Output: unchange
Output: unchange
yˆtH  0or Yˆt H  0
5
6
7
8
7
8
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.
Numerical results
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
the presence of international labors resettlement
does not significantly alter
the way any of macro variables response to shock
from what is analyzed in the last section.

As before, the implications of lowering in trading
friction in international financial transaction on
monetary policy effects work through
the interaction of relative asset return and exchange rate
1    iˆt H  1    iˆt F  Et  Eˆt 1  Eˆt 


0.4
0.2
0
-0.2
-0.4
-0.6
0.25
-0.8
-1
-1.2
-1

  N H C H Et IˆtH1  IˆtH

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
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
Home
places to invest their assets
 the borrowers and lenders add inflation
premium to interest rate.
Foreign
Ultimately, an expansion in money supply
in home will raise interest rate when financial
market integration is highly complete.
“expected inflation effect”
0
Percent deviation from steady state
Percent deviation from steady state
Numerical results
0.2
0.15
1
0.1
0.05
0
-0.05
-0.1
2
3
4
5
Years after shock
6
7
8
Numerical results
1    iˆtH  1    iˆtF  Et  Eˆt 1  Eˆt 

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.
4.5
Percent deviation from steady state


  N H C H Et IˆtH1  IˆtH
4
3.5
3
2.5
2
1.5
1
0.5
0
-1
0
1
2
3
4
5
Years after shock
6
7
8
Numerical results
How are things different in the presence of global linkages in labor market?
1    iˆt H  1    iˆt F  Et  Eˆt 1  Eˆt 






  N H C H Et IˆtH1  IˆtH
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.

Numerical results

Armed with the dynamics of exchange rate, we can determine
the effect of monetary policy change on other macro variables.
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.
3
Percent deviation from steady state
3.5
Percent deviation from steady state

3
Price
2.5
2
1.5
1
0.5
0
-1
0
1
2
3
4
5
Years after shock
6
7
8
2.5
Wage
2
1.5
1
0.5
0
-1
0
1
2
3
4
5
Years after shock
6
7
8
Numerical results
How are things different in the presence of global linkages in labor market?
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.
“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.

Accordingly, we can notice a larger rise in home price index,
as compared to the circumstances before labor market
integration.
Numerical results

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.
“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.

Therefore, an asymmetric change in monetary policy would
cause a higher rise in home wage rate if labor is mobile
across regions.
Numerical results

Dynamics of consumption and current account
Expansionary monetary policy in home gives rise to
a fall in consumption, instead of raising it as it does in the case
ahead 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.
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
Percent deviation from steady state
0
-2
-4
-6
-8
-10
-12
-14
-1
0
1
2
3
4
5
6
7
8
Numerical results
Second Investigation: Implications of international capital
mobility for the effects of monetary policy: After
international labors migration
Perfectly integrated
Imperfectly integrated
0.2
0
-0.2
-
Percent deviation from steady state
0.4
interest rate
-0.4
-0.6
-0.8
Interest rate
-1
0
1
2
3
4
5
6
7
8
Years after shock
E
E
+
less
3
2.5
2
Price
1.5
1
more
Price
+
4
3.5
3
2.5
2
1.5
1
0.5
0
-1
less
0
1
2
3
4
5
6
7
8
6
7
8
Years after shock
0.5
0
-1
0
1
2
3
4
5
6
7
0
8
Years after shock
C
+
more
Output: unchange
C
less
Percent deviation from steady state
Percent deviation from steady state
3.5
more
Percent deviation from steady state
4.5
-1.2
-1
-2
-4
-6
-8
-10
-12
Output: unchange
yˆtH  0or Yˆt H  0
-14
-1
0
1
2
3
4
5
Years after shock
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
i, r
C , c( z ) E
P, p( z) y( z), Y
Financial market integration
(i) Imperfect integrated labor market
-
-
+
+
0
(ii) Perfectly integrated labor market
-*
+
+
+
0
Summary of simulation results



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
2) Another interesting results concern the impact of having a
particular amount of labors migrates from home to
foreign country.
The simulation results suggest that quite the same pattern
still applies even after the possibility of shift in labor location
is incorporated.
Cases
i, r
C , c( z ) E
P, p( z) y( z), Y
Financial market integration
(i) Imperfect integrated labor market
-
-
+
+
0
(ii) Perfectly integrated labor market
-*
+
+
+
0
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 end
Thank you