Monetary Policy and the Economy Q4/06

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• Monetary Policy and the Economy Q4/06 (PDF, 1.6 MB) December 2006.

Studies and Analyses

• Austria’s Economy Will Continue to Grow Dynamically in 2007 (PDF, 262 kB) Fenz, Schneider. Fenz, Schneider – Monetary Policy and the Economy Q4/06 According to the economic outlook of the Oesterreichische Nationalbank (OeNB), Austria’s real gross domestic product (GDP) is expected to grow by 3.3% in 2006 and by 2.8% and 2.4% in 2007 and 2008, respectively. The OeNB’s growth forecasts for 2006 and 2007 have been revised upward by 0.8 and 0.6 percentage point, respectively, since the June 2006 outlook. Inflation will drop to 1.7% in 2006 and will fall further to 1.4% in 2007. A slight increase to 1.6% is forecast for 2008. Employment will continue to increase substantially, significantly reducing the unemployment rate from 5.2% in 2005 to 4.7% in 2008. en Economic developments, Economic outlook, Austria C5, E17 Dec 31, 2006, 12:00:00 AM

• Limited Pass-Through from Policy to Retail Interest Rates: Empirical Evidence and Macroeconomic Implications (PDF, 245 kB) Kwapil, Scharler. Kwapil, Scharler – Monetary Policy and the Economy Q4/06 In this paper we survey empirical evidence on the limited pass-through from policy to retail interest rates and summarize some recent research on potential implications for monetary policy and macroeconomic fluctuations. Empirical evidence suggests that while the pass-through is incomplete in the euro area as well as in the U.S.A., it appears to be higher in the U.S.A. This is especially true for the long-run pass-through. Research in this field suggests that a limited pass-through alters the Taylor Principle. In the case of a perfect pass-through, the Taylor Principle requires that policy rates increase by more than one-to-one with an increase in (expected) inflation. If the pass-through is incomplete, policy rates have to respond by even more to compensate for the smoothing of retail rates. However, the monetary policies currently implemented in the euro area and the U.S.A. seem to satisfy the conditions for a unique and stable equilibrium and thus avoid sunspot shocks. Furthermore, findings in the literature also show that a limited passthrough has implications for the stabilizing role of monetary policy and therefore, fluctuations arising from fundamental shocks. en Interest rate pass-through, Financial systems, Stability E32, E44, E52 Dec 31, 2006, 12:00:00 AM

• Globalization, Inflation and Monetary Policy (PDF, 327 kB) Gnan, Valderrama. Gnan, Valderrama – Monetary Policy and the Economy Q4/06 Following up on Glatzer, Gnan and Valderrama (2006), we investigate two further channels through which globalization may have dampened inflation in the euro area: first, changed incentives for policymakers; second, global demand and supply conditions. Our empirical evidence shows that the domestic output gap seems to have lost its influence on inflation in the euro area; however, we cannot confirm that euro area inflation is instead significantly influenced by the global output gap. Therefore and because of daunting measurement problems, we caution against attaching undue weight to global output gap developments in central banks’ reaction functions. The flattening of the euro area Phillips curve – together with weakened monetary policy control over inflation due to increasing global long-term interest links and heightened uncertainty for policymakers due to globalization – calls for the stabilization of inflation expectations as a primary goal for monetary policy. Central banks should not rely on the inflation-dampening effects of globalization to last indefinitely: Supply bottlenecks in energy and raw materials, a shift in emerging economies’ savings-investment balance, as well as protectionist pressure may put an end to these effects. en Globalization, Inflation, Monetary policy E31, E50, F15 Dec 31, 2006, 12:00:00 AM

• The New Keynesian Phillips Curve for Austria – An Extension for the Open Economy (PDF, 324 kB) Rumler. Rumler – Monetary Policy and the Economy Q4/06 Following the empirical breakdown of the traditional Phillips curve relationship, the baseline New Keynesian Phillips Curve (NKPC) theory was formulated in the 1990s. Unlike the traditional Phillips curve, it derives from a theoretical model that is based on microeconomic principles. It expresses current inflation as a function of expected future inflation, past inflation and a measure of firms’ marginal cost. The NKPC serves to estimate the model’s structural parameters that capture price-setting behavior in an economy. This study estimates the NKPC using Austrian data. As Austria is a fairly open economy and the NKPC was initially formulated for a closed economy, the theoretical model is extended to include open-economy aspects and is then estimated in various specifications. The extended NKPC proves to explain inflation developments in Austria since 1980 quite accurately. The estimation of the structural parameters shows that around 30% of all Austrian firms change their prices every quarter, indicating that overall, prices are constant for an average of roughly ten months. Moreover, between 30% and 50% of all firms follow a backward-looking rule of thumb in setting their prices. Compared to the other euro area countries, this price duration represents an average, whereas the degree of backwardlooking behavior in price setting is above average. However, the NKPC is not found to be as suitable for forecasting purposes as time-series models, as none of the inflation forecasts based on the NKPC model was able to outperform a naive forecast (unchanged inflation rate over the forecast horizon). en New Keynesian Phillips Curve, Inflation dynamics, GMM, Inflation forecasting E31, C22, E12 Dec 31, 2006, 12:00:00 AM

• Revised and New Competitiveness Indicators for Austria Reflect Improvement Trend since EMU Accession (PDF, 574 kB) Köhler-Töglhofer, Magerl, Mooslechner. Köhler-Töglhofer, Magerl, Mooslechner – Monetary Policy and the Economy Q4/06 Maintaining and improving competitiveness is one key goal of economic policy. In the short run, it is primarily price and cost developments as well as exchange rate changes that have the biggest impact on the development of an economy’s competitiveness. The competitiveness of Austrian manufacturing exporters has continued to augment since the country’s entry into Economic and Monetary Union (EMU) – this has been confirmed by the 2006 revision of the price competitiveness indicator for Austria (deflated by the (Harmonised) Index of Consumer Prices – HICP/CPI) and even more so by the new cost competitiveness indicator (deflated by relative unit labor costs) launched in this context. The marked improvement of the cost competitiveness indicator in recent years reflects moderate wage policies coupled with comparatively solid productivity growth in the Austrian manufacturing sector. The lower gain measured by the price competitiveness indicator may be linked to the fact that the HICP/CPI was broadly driven by oil price developments in 2004 and 2005, which masked the favorable unit labor cost developments in the manufacturing industry. Contrary to the development in the manufacturing sector, the price competitiveness in Austria’s travel and tourism sector has deteriorated somewhat: Even though price developments in Austria were more favorable than in the competition markets, they did not wholly offset losses in competitiveness related to exchange rate developments. en Effective exchange rates, Price and cost competitiveness, Manufacturing and service sector F3, F4 Dec 31, 2006, 12:00:00 AM

• Reforming the International Monetary Fund – Some Reflections (PDF, 224 kB) Gratz, Grech. Gratz, Grech – Monetary Policy and the Economy Q4/06 This paper reviews the most recent issues in the ongoing debate on the reform of the International Monetary Fund (IMF). The Fund has recognized that IMF surveillance should put greater weight on analyzing and discussing global economic issues. By taking account of international spillovers, surveillance should in future be multilateral rather than purely country-specific. Exchange rates and policies should also be the focus of renewed interest. Moreover, there is no doubt that IMF quotas will have to be adjusted to take account of the changing economic weight of many IMF member countries in the world economy. Negotiations on a new quota formula started after the Annual Meeting in Singapore in September 2006. The influence of low income countries should be strengthened by increasing the number of basic votes in order to prevent the Fund from loosing legitimacy. However, with the IMF’s intention to put more weight on GDP in the new quota formula, the stage is set for complex, difficult and time-consuming negotiations. Finally, the IMF will need to reform its financing system and budgeting procedures to ensure that expenditures will be adequately curtailed to enable it to work efficiently despite income shortfalls, which might well be not transitory but of a permanent nature. en IMF, Representation, Constituencies, Governance, Surveillance F33, F42, F53 Dec 31, 2006, 12:00:00 AM