Peering Through Monetary Mist: Macroeconomic Effects of Monetary Policy under Borderless World of Financial and Labor Market

1
Peering Through Monetary Mist Macroeconomic
Effects of Monetary Policy under Borderless World
of Financial and Labor Market
Suchanan Chunanantatham January 8, 2007
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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?

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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)

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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

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Model

• Choose consumption, bond, and money holding to
  maximize utility subject to budget constraint

Consumer
-Each individual consumption of differentiated
products need to be chosen so as to minimize the
cost of attaining aggregate consumption
Producer - Price adjustment mechanism Free entry
and exit Inelastic labor supply ?Zero profit -
Pricing rule
Government -Assume government spending is
zero -Govt budget constraint
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Numerical results

• In what follows, quantitative properties based on
  the previous chapters 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

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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
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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.

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Numerical results
1.1 High degree of capital mobility with
incomplete labor market integration The
benchmark case

• 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

Home
Foreign
10
Numerical results

• General price index
• Flexible-price model ? home price index
  increases by somewhat the same amount as a change
  in money supply.

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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.

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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

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Numerical results

• 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.

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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-smoothin
  g, as confirmed in the above two graphs.

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Numerical results

• Exchange rate
• Exchange rate dynamic
• ?Indeed, home currency depreciates (foreign
  currency appreciates) to about 2 percent.

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.
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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.

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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

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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?
• 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)
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Numerical results

• Algebraically, with higher value of ?,

A negative expected rate of change in
cross-border flow of funds
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
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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.
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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

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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

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Numerical results
First Investigation Money shock under different
degrees of financial market integration Before
international labors migration
Perfectly integrated
Unchanged interest rate
-
Once-and-for-all in C
-
Once-and-for-all in E

Price more

Output unchange
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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.

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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.

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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
does not significantly alter
the way any of macro variables response to shock
from what is analyzed in the last section.
the interaction of relative asset return and
exchange rate
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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

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
Home
Foreign
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Numerical results

• The magnitude of an increase in depreciation
  expectation is getting smaller.
• ?In contrast to the case where a nations
  capital market is less loosen up, lower expected
  depreciation generates dramatically higher
  monetary-induced increase in exchange rate, as
  confirmed by the following diagram.

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Numerical results
How are things different in the presence of
global linkages in labor market?

• 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.

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Numerical results

• 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.

the effect of monetary policy change on other
macro variables.
Price Wage
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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.
• Accordingly, we can notice a larger rise in home
  price index, as compared to the circumstances
  before labor market integration.

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.
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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.
• 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.
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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

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Numerical results
Second Investigation Implications of
international capital mobility for the effects of
monetary policy After international labors
migration
Perfectly integrated
interest rate
-
E more

Price more

C more

Output unchange
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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 Financial market integration Financial market integration Financial market integration Financial market integration Financial market integration
(i) Imperfect integrated labor market - - 0
(ii) Perfectly integrated labor market - 0
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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.

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Summary of simulation results

• 2) 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 Financial market integration Financial market integration Financial market integration Financial market integration Financial market integration
(i) Imperfect integrated labor market - - 0
(ii) Perfectly integrated labor market - 0
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Summary of simulation results

• 3) In sensitivity, I also discuss how the scale
  of market integration affects the main results.
• After all, the sign of the volatility effects of
  financial market integration hardly change as the
  constraints in investing in international
  financial market or in migrate across border is
  less intense.
• Nonetheless, the extent of international market
  integration does consistently take a very vital
  part in determining how strong the effect of
  increasing degree of capital mobility on how each
  variable reacts to the monetary policy change in
  all variations.
• ? without changing in the direction, the higher
  is the volume of transaction cost reduction the
  greater is the change in adjustment of the
  economy in propagation of monetary shock.
• ? Similarly, as the amount of home labor
  departure is greater, the magnitude of the change
  in volatility as a result of financial market
  integration is bigger as well.

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Summary of simulation results

• Therefore, altogether our results exhibit that,
  although the perfect integrated financial market
  integration rests only in theory, the overtone of
  financial market integration, both for the
  economy prior and subsequent to labor market
  integration, is unambiguously robust with
  extended size of market integration positively
  means greater importance of integration of the
  worlds financial market.

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• The end
• Thank you