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A theory of managed floating
(2003)
After the experience with the currency crises of the 1990s, a broad consensus has emerged among economists that such shocks can only be avoided if countries that decided to maintain unrestricted capital mobility adopt either independently floating exchange rates or very hard pegs (currency boards, dollarisation). As a consequence of this view which has been enshrined in the so-called impossible trinity all intermediate currency regimes are regarded as inherently unstable. As far as the economic theory is concerned, this view has the attractive feature that it not only fits with the logic of traditional open economy macro models, but also that for both corner solutions (independently floating exchange rates with a domestically oriented interest rate policy; hard pegs with a completely exchange rate oriented monetary policy) solid theoretical frameworks have been developed. Above all the IMF statistics seem to confirm that intermediate regimes are indeed less and less fashionable by both industrial countries and emerging market economies. However, in the last few years an anomaly has been detected which seriously challenges this paradigm on exchange rate regimes. In their influential cross-country study, Calvo and Reinhart (2000) have shown that many of those countries which had declared themselves as ‘independent floaters’ in the IMF statistics were charaterised by a pronounced ‘fear of floating’ and were actually heavily reacting to exchange rate movements, either in the form of an interest rate response, or by intervening in foreign exchange markets. The present analysis can be understood as an approach to develop a theoretical framework for this managed floating behaviour that – even though it is widely used in practice – has not attracted very much attention in monetary economics. In particular we would like to fill the gap that has recently been criticised by one of the few ‘middle-ground’ economists, John Williamson, who argued that “managed floating is not a regime with well-defined rules” (Williamson, 2000, p. 47). Our approach is based on a standard open economy macro model typically employed for the analysis of monetary policy strategies. The consequences of independently floating and market determined exchange rates are evaluated in terms of a social welfare function, or, to be more precise, in terms of an intertemporal loss function containing a central bank’s final targets output and inflation. We explicitly model the source of the observable fear of floating by questioning the basic assumption underlying most open economy macro models that the foreign exchange market is an efficient asset market with rational agents. We will show that both policy reactions to the fear of floating (an interest rate response to exchange rate movements which we call indirect managed floating, and sterilised interventions in the foreign exchange markets which we call direct managed floating) can be rationalised if we allow for deviations from the assumption of perfectly functioning foreign exchange markets and if we assume a central bank that takes these deviations into account and behaves so as to reach its final targets. In such a scenario with a high degree of uncertainty about the true model determining the exchange rate, the rationale for indirect managed floating is the monetary policy maker’s quest for a robust interest rate policy rule that performs comparatively well across a range of alternative exchange rate models. We will show, however, that the strategy of indirect managed floating still bears the risk that the central bank’s final targets might be negatively affected by the unpredictability of the true exchange rate behaviour. This is where the second policy measure comes into play. The use of sterilised foreign exchange market interventions to counter movements of market determined exchange rates can be rationalised by a central bank’s effort to lower the risk of missing its final targets if it only has a single instrument at its disposal. We provide a theoretical model-based foundation of a strategy of direct managed floating in which the central bank targets, in addition to a short-term interest rate, the nominal exchange rate. In particular, we develop a rule for the instrument of intervening in the foreign exchange market that is based on the failure of foreign exchange market to guarantee a reliable relationship between the exchange rate and other fundamental variables.
This study investigates the credit channel in the transmission of monetary policy in Germany by means of a structural analysis of aggregate bank loan data. We base our analysis on a stylized model of the banking firm, which specifies the loan supply decisions of banks in the light of expectations about the future course of monetary policy. Using the model as a guide, we apply a vector error correction model (VECM), in which we identify long-run cointegration relationships that can be interpreted as loan supply and loan demand equations. In this way, the identification problem inherent in reduced form approaches based on aggregate data is explicitly addressed. The short-run dynamics is explored by means of innovation analysis, which displays the reaction of the variables in the system to a monetary policy shock. The main implication of our results is that the credit channel in Germany appears to be effective, as we find that loan supply effects in addition to loan demand effects contribute to the propagation of monetary policy measures.
The development of free floating exchange rates can hardly be explained by macroeconomic fundamentals as supposed by traditional economic theories. Therefore, prominent economists yet conclude that there exists an ‘exchange rate disconnect puzzle’ (see Obstfeld and Rogoff [2000]). The observable exchange rate trends are often attributed to an excessive speculative trading behavior of foreign exchange market participants. In this study we deal with psychological factors, which may be important for understanding the observable exchange rate movements. Thus, our study belongs to the new research field of behavioral economics, which considers the relevance of psychological factors in economic contexts. The main objective of behavioral economists is to develop a more realistic view of the actual human behavior in the context of economics. Therefore, behavioral economists often refer to the work of behavioral decision theorists, who introduced new concepts under the general heading of bounded rationality. Central to the concept of bounded rationality is the assumption that humans’ actual behavior deviates from the ideal of economic rationality due to at least two reasons: first, decisions are usually based on an incomplete information basis (limited information) and, second, the information processing of human beings is limited by their computational capacities (limited cognitive resources). Due to these limitations people are forced to apply simplification mechanisms in information processing. Important simplification mechanisms, which play a decisive role in the process judgment and decision making, are simple heuristics. Simple heuristics can principally be characterized as simple rules of thumb, which allow quick and efficient decisions even under a high degree of uncertainty. In this study, our aim is to analyze the relevance of simple heuristics in the context of foreign exchange markets. In our view, the decision situation in foreign exchange markets can serve as a prime example for decision situations in which simple heuristics are especially relevant as the complexity of the decision situation is very high. The study is organized as follows. In Chapter II, we deal with the exchange rate disconnect puzzle. In particular, we discuss and check the main implications of the traditional economic approach for explaining exchange rate movements. The asset market theory of exchange rate determination implies that exchange rates are mainly driven by the development of macroeconomic fundamentals. Furthermore the asset market theory assumes that foreign exchange market participants form rational expectations concerning future exchange rate developments and that exchange rates are determined in efficient markets. Overall the empirical evidence suggests that the traditional approach for explaining exchange rate changes is at odds with the data. Chapter III addresses the existence of long and persistent trends in exchange rate time series. Overall, our empirical analysis reveals that exchange rates show a clear tendency to move in long and persistent trends. Furthermore, we discuss the relevance of speculation in foreign exchange markets. With regard to the impact of speculation, economic theory states that speculation can have either a stabilizing effect or a destabilizing effect on exchange rates. At the end of Chapter III, we examine the Keynesian view on the functioning of asset markets. In Chapter IV we explore the main insights from the new research field of behavioral economics. A main building block of behavioral economics is the concept of bounded rationality first introduced by Herbert Simon [1955]. In the centre of the concept of bounded rationality is a psychological analysis of the actual human judgment and decision behavior. In Chapter IV, we discuss the concept of bounded rationality in detail and illustrate important insights of behavioral decision theories. In particular, we deal with the relevance of simple heuristics in the context of foreign exchange markets. Chapter V provides experimental and empirical evidence for the suggested relevance of simple heuristics in foreign exchange markets. In the first experiment, we deal with the human expectation formation. We compare point forecasts of the EUR/USD exchange rate surveyed from professional analysts and experimentally generated point forecasts of students for a simulated exchange rate time series. The results show that the forecasting performance of both groups differs substantially. Afterwards we analyze the nature of expectation formation of both groups in detail to reveal similarities and differences, which allow us to draw reasonable explanations for the differences in the forecasting performances. In the second experiment, we analyze the expectation formation in an experimental foreign exchange market. This approach allows us to consider the relevance of expectation feedback as individuals’ expectations directly influence the actual realization of the time series. Thus, Keynes’ predictions on the importance of conventions in asset markets can be analyzed. Overall, both experiments reveal that the human beings tend to apply simple trend heuristics, when forming their expectations about future exchange rates. In the empirical part of Chapter V we deal with the usefulness of such simple trend heuristics in real world. Only if simple trend heuristics lead to profits in the specific environment of foreign exchange markets, their application can be recommended. Thus, we analyze the profitability of simple technical analysis tools in foreign exchange markets. Finally, Chapter VI provides concluding remarks.
A comprehensive approach for currency crises theories stressing the role of the anchor country
(2008)
The approach is based on the finding that new generations of currency crises theories always had developed ex post after popular currency crises. Discussing the main theories of currency crises shows their disparity: The First Generation of currency crises models argues based on the assumption of a chronic budget deficit that is being monetized by the domestic central bank. The result is a trade-off between an expansionary monetary policy that is focused on the internal economic balance and a fixed exchange rate which is depending on the rules of interest parity and purchasing power parity. This imbalance inevitably results in a currency crisis. Altogether, this theory argues with a disrupted external balance on the foreign exchange market. Second Generation currency crises models on the other side focus on the internal macroeconomic balance. The stability of a fixed exchange rate is depending on the economic benefit of the exchange rate system in relation to the social costs of maintaining it. As soon as social costs are increasing and showing up in deteriorating fundamentals, this leads to a speculative attack on the fixed exchange rate system. The term Third Generation of currency crises finally summarizes a variety of currency crises theories. These are also arguing psychologically to explain phenomena as contagion and spill-over effects to rationalize crises detached from the fundamental situation. Apart from the apparent inconsistency of the main theories of currency crises, a further observation is that these explanations focus on the crisis country only while international monetary transmission effects are left out of consideration. These however are a central parameter for the stability of fixed exchange rate systems, in exchange rate theory as well as in empirical observations. Altogether, these findings provide the motivation for developing a theoretical approach which integrates the main elements of the different generations of currency crises theories and which integrates international monetary transmission. Therefore a macroeconomic approach is chosen applying the concept of the Monetary Conditions Index (MCI), a linear combination of the real interest rate and the real exchange rate. This index firstly is extended for international monetary influences and called MCIfix. MCIfix illustrates the monetary conditions required for the stability of a fixed exchange rate system. The central assumption of this concept is that the uncovered interest parity is maintained. The main conclusion is that the MCIfix only depends on exogenous parameters. In a second step, the analysis integrates the monetary policy requirements for achieving an internal macroeconomic stability. By minimizing a loss function of social welfare, a MCI is derived which pictures the economically optimal monetary policy MCIopt. Instability in a fixed exchange rate system occurs as soon as the monetary conditions for an internal and external balance are deviating. For discussing macroeconomic imbalances, the central parameters determining the MCIfix (and therefore the relation of MCIfix to MCIopt) are discussed: the real interest rate of the anchor country, the real effective exchange rate and a risk premium. Applying this theory framework, four constellations are discussed where MCIfix and MCIopt fall apart in order to show the central bank’s possibilities for reacting and the consequences of that behaviour. The discussion shows that the integrative approach manages to incorporate the central elements of traditional currency crises theories and that it includes international monetary transmission instead of reducing the discussion on an inconsistent domestic monetary policy. The theory framework for fixed exchange rates is finally applied in four case studies: the currency crises in Argentina, the crisis in the Czech Republic, the Asian currency crisis and the crisis of the European Monetary System. The case studies show that the developed monetary framework achieves integration of different generations of crises theories and that the monetary policy of the anchor country plays a decisive role in destabilising fixed exchange rate systems.
This thesis deals with the economics of innovation. In a general introduction we illustrate how several aspects of competition policy are linked to firms' innovation incentives. In three individual essays we analyze more specific issues. The first essay deals with interdependencies of mergers and innovation incentives. This is particularly relevant as both topics are central elements of a firm's competitive strategy. The essay focuses on the impact of mergers on innovative activity and competition in the product market. Possible inefficiencies due to organizational problems of mergers are accounted for. We show that optimal investment strategies depend on the resulting market structure and differ significantly from insider to outsider. In our linear model mergers turn out to increase social surplus. The second essay analyzes the different competitive advantages of large and small firms in innovation competition. While large firms typically have a better access to product markets, small firms often have a superior research efficiency. These distinct advantages immediately lead to the question of cooperations between firms. In our model we allow large firms to acquire small firms. In a pre-contest acquisition game large firms bid sequentially for small firms in order to combine respective advantages. Innovation competition is modeled as a patent contest. Sequential bidding allows the first large firms to bid strategically to induce a reaction of its competitor. For high efficiencies large firms prefer to acquire immediately, leading to a symmetric market structure. For low efficiencies strategic waiting of the first large firm leads to an asymmetric market structure even though the initial situation is symmetric. Furthermore, acquisitions increase the chances for successful innovation. The third essay deals with government subsidies to innovation. Government subsidies for research and development are intended to promote projects with high returns to society but too little private returns to be beneficial for private investors. Apart from the direct funding of these projects, government grants may serve as a signal of good investments for private investors. We use a simple signaling model to capture this phenomenon and allow for two types of risk classes. The agency has a preference for high risk projects as they promise high expected social returns, whereas banks prefer low risk projects with high private returns. In a setup where the subsidy can only be used to distinguish between high and low risk projects, government agency's signal is not very helpful for banks' investment decision. However, if the subsidy is accompanied by a quality signal, it may lead to increased or better selected private investments. The last chapter summarizes the main findings and presents some concluding remarks on the results of the essays.
Subject of the present study is the agent-based computer simulation of Agent Island. Agent Island is a macroeconomic model, which belongs to the field of monetary theory. Agent-based modeling is an innovative tool that made much progress in other scientific fields like medicine or logistics. In economics this tool is quite new, and in monetary theory to this date virtual no agent-based simulation model has been developed. It is therefore the topic of this study to close this gap to some extend. Hence, the model integrates in a straightforward way next to the common private sectors (i.e. households, consumer goods firms and capital goods firms) and as an innovation a banking system, a central bank and a monetary circuit. Thereby, the central bank controls the business cycle via an interest rate policy; the according mechanism builds on the seminal idea of Knut Wicksell (natural rate of interest vs. money rate of interest). In addition, the model contains also many Keynesian features and a flow-of-funds accounting system in the tradition of Wolfgang Stützel. Importantly, one objective of the study is the validation of Agent Island, which means that the individual agents (i.e. their rules, variables and parameters) are adjusted in such a way that on the aggregate level certain phenomena emerge. The crucial aspect of the modeling and the validation is therefore the relation between the micro and macro level: Every phenomenon on the aggregate level (e.g. some stylized facts of the business cycle, the monetary transmission mechanism, the Phillips curve relationship, the Keynesian paradox of thrift or the course of the business cycle) emerges out of individual actions and interactions of the many thousand agents on Agent Island. In contrast to models comprising a representative agent, we do not apply a modeling on the aggregate level; and in contrast to orthodox GE models, true interaction between heterogeneous agents takes place (e.g. by face-to-face-trading).
This thesis analyzes the relationship between market concentration and efficiency of the market outcome in a differentiated good context from different points of view. The first chapter introduces the objectives of competition policy and antitrust authorities and outlines the importance of market concentration. Chapter 2 analyzes the relationship between social surplus and market heterogeneity in a differentiated Cournot oligopoly. Market heterogeneity is due to differently efficient firms, each of them producing one variety of a differentiated good. All firms exhibit constant but different marginal costs without fixed costs. Consumers preferences are given by standard quadratic utility originated by Dixit (1979). Since preferences are quasi-linear social surplus is the measure for Pareto-optimality. The main finding is that consumer suprlus as well as producer surplus increase with the variance of marginal costs. The third chapter analyzes the relationship between the cost structure and market concentration measured by the Herfindahl-Hirschman Index. Market concentration increases with the variance of marginal costs as well as the mean of marginal costs. Chapter four analyzes welfare implications of present antitrust enforcement policy on basis of the same theoretical model. European as well as the US Merger Guidelines presume a negative impact of market concentration on the competitiveness of the market and, therefore, on the efficiency of the market outcome. The results of the previous chapters indicate that this assumption is false. The main finding is that post-merger joint profit of the insider increase with the size of the merger. Moreover, there is a negative relationship between the size of the merger and efficiency of the market outcome. Present antitrust enforcement policy increases the disparity of output levels and enforces the removal of the least efficient firm of the market. The welfare gains can be traced back on these two effects. Therefore, neither a minimum of market concentration nor a maximum of product diversity is necessarily welfare enhancing even in absence of fixed costs.
This thesis deals with three selected dimensions of strategic behavior, namely investment in R&D, mergers and acquisitions, and inventory decisions in dynamic oligopolies. The question the first essay addresses is how the market structure evolves due to innovative activities when firms' level of technological competence is valuable for more than one project. The focus of the work is the analysis of the effect of learning-by-doing and organizational forgetting in R&D on firms' incentives to innovate. A dynamic step-by-step innovation model with history dependency is developed. Firms can accumulate knowledge by investing in R&D. As a benchmark without knowledge accumulation it is shown that relaxing the usual assumption of imposed imitation yields additional strategic effects. Therefore, the leader's R&D effort increases with the gap as she is trying to avoid competition in the future. When firms gain experience by performing R&D, the resulting effect of knowledge induces technological leaders to rest on their laurels which allows followers to catch up. Contrary to the benchmark case the leader's innovation effort declines with the lead. This causes an equilibrium where the incentives to innovate are highest when competition is most intense. Using a model of oligopoly in general equilibrium the second essay analyzes the integration of economies that might be accompanied by cross-border merger waves. Studying economies which prior to trade were in stable equilibrium where mergers were not profitable, we show that globalization can trigger cross-border merger waves for a sufficiently large heterogeneity in marginal cost. In partial equilibrium, consumers benefit from integration even when a merger wave is triggered which considerably lowers intensity of competition. Welfare increases. In contrast, in general equilibrium where interactions between markets and therefore effects on factor prices are considered, gains from trade can only be realized by reallocation of resources. The higher the technological dissimilarity between countries the better can efficiency gains be realized in integrated general equilibrium. The overall welfare effect of integration is positive when all firms remain active but indeterminate when firms exit or are absorbed due to a merger wave. It is possible for decreasing competition to dominate the welfare gain from more efficient resource allocation across sectors. Allowing for firms' entry alters results as in an integrated world coexistence of firms of different countries is never possible. Comparative advantages with respect to entry and production are important for realizing efficiency gains from trade. The third essay analyzes the interaction between price and inventory decisions in an oligopoly industry and its implications for the dynamics of prices. The work extends existing literature and especially the work of Hall and Rust (2007) to endogenous prices and strategic oligopoly competition. We show that the optimal decision rule is an (S,s) order policy and prices and inventories are strategic substitutes. Fixed ordering costs generate infrequent orders. Additionally, with strategic competition in prices, (S,s) inventory behavior together with demand uncertainty generates cyclical pattern in prices The last chapter presents some concluding remarks on the results of the essays.
This thesis analyzes the 2001-2006 labor market reforms in Germany. The aim of this work is twofold. First, an overview of the most important reform measures and the intended effects is given. Second, two specific and very fundamental amendments, namely the merging of unemployment assistance and social benefits, as well as changes in the duration of unemployment insurance benefits, are analyzed in detail to evaluate their effects on individuals and the entire economy. Using a matching model with optimal search intensity and Semi-Markov methods, the effects of these two amendments on the duration of unemployment, optimal search intensity and unemployment are analyzed.