Felix Hüfner

Expected Budget Deficits and Interest Rate Swap Spreads - Evidence for France, Germany and Italy

This study analyses whether expected budget deficits have an impact on interest rate swap spreads in France, Germany and Italy. We use monthly deficit forecasts from financial market participants to take the forward-looking behaviour of financial markets into account. Results of a SUR estimation show no significant impact of expected deficits on swap spreads over the whole sample period (1994-2004). However, we find an increase in market discipline for Germany and France since the signing of the Stability and Growth Pact, and for Germany also since the start of European monetary union.

Exchange Rate Pass-through to Consumer Prices: A European Perspective

We study the pass-through of exchange rate changes to consumer prices for the euro area by estimating vector error correction models for Germany, France, Italy, the Netherlands and Spain. Using the weights of the Harmonized Index of Consumer Prices (HICP) we compute a weighted average of the country results for the euro area. We find that in response to a ten percent depreciation of the euro nominal effective exchange rate index, the HICP tends to increase by 0,4 percent after 12 months. The total effect amounts to 0,8 percent and the adjustment of consumer prices is completed after three years.

Forecasting Economic Activity in Germany - How Useful are Sentiment Indicators?

We analyze four economic sentiment indicators for the German economy regarding their ability to forecast economic activity. Using cross correlations and Granger causality tests we find that the ifo business expectations (ifo), the Purchasing Managers Index (PMI) and the ZEW Indicator of Economic Sentiment (ZEW) lead the yearon-year growth rate of German industrial production by five months. Taking into account the publication lag of industrial production this lead is even larger. On the contrary, the European Commission?s Economic Sentiment Indicator (ESIN) does not exhibit a lead but rather seems to coincide or even lag economic activity. Analyzing lead/lag structures among the indicators we find that the ZEW indicator leads the ifo business expectations significantly by one month and that the latter has a onemonth lead over the PMI. Out-of-sample forecast evaluations suggest that both ifo and ZEW provide the best forecasts for industrial production among the three indicators ifo, PMI and ZEW. It is found that the ZEW indicator performs better than the ifo and PMI over the whole sample (Jan. 1994 – Mar. 2002) and especially over horizons from six to twelve months. The ifo expectations predict better at shorter horizons (up to three months) and is superior to the ZEW and PMI indicator when a shorter sample (Jan. 1998 – Mar. 2002) is regarded.

Foreign Exchange Intervention as a Monetary Policy Instrument

1 Introduction.- 1.1 Background.- 1.2 Approach to the Problem and Research Strategy.- 1.3 Structure of the Analysis.- 2 The Conventional View on Inflation Targeting.- 2.1 Definition and Elements of Inflation Targeting.- 2.1.1 Lack of an Explicit Intermediate Target.- 2.1.2 Price Stability as the Final Target.- 2.1.3 Publication of a Numerical Target.- 2.1.4 Transparent Communication of Central Bank Decisions.- 2.1.5 Increased Accountability of the Central Bank.- 2.1.6 Summary and Assessment.- 2.2 Adoption of Inflation Targeting.- 2.2.1 Overview.- 2.2.2 Country Selection.- 2.3 A Basic Model for (Closed-Economy) Inflation Targeting.- 2.4 Open Economy Inflation Targeting.- 2.4.1 Exchange Rate Pass-Through and Monetary Policy.- 2.4.2 The Svensson Model.- 2.4.3 The Ball Model.- 2.4.4 Two Critical Assumptions.- 3 Uncovered Interest Parity in Practice.- 3.1 The Rationale of Interest Parity.- 3.1.1 Covered Interest Parity.- 3.1.2 Uncovered Interest Parity.- 3.2 An Empirical Test for Inflation Targeting Countries.- 3.3 Consequences of the Failure of UIP.- 4 Sterilised Interventions as an Additional Policy Instrument.- 4.1 Explaining and Interpreting Sterilised Interventions.- 4.1.1 Channels for Influencing Exchange Rates.- 4.1.2 Sterilised Interventions as a Monetary Policy Instrument.- 4.1.3 Sterilisation Evidence for Inflation Targeting Countries.- 4.1.4 Managed Floating in Theory.- 4.1.5 Limitations of Sterilised Interventions.- 4.2 The Effectiveness of Sterilised Interventions: A Review of the Literature.- 4.2.1 The Intervention Debate.- 4.2.2 The Inefficiency of Sterilised Interventions in Monetary Models.- 4.2.3 The Portfolio Balance Channel of Interventions.- 4.2.4 Interventions as a Signal of Future Monetary Policy.- 4.2.5 Noise-Traders and the Role of Sterilised Interventions.- 4.2.6 The Microstructure Approach and Sterilised Interventions.- 4.2.7 Assessment of Intervention Models.- 5 Sterilised Foreign Exchange Intervention in Practice.- 5.1 Foreign Exchange Reserves as an Intervention Proxy.- 5.1.1 Reasons for Holding Foreign Exchange Reserves.- 5.1.2 Mechanics of Foreign Exchange Intervention.- 5.1.3 External Influences on Foreign Exchange Reserves and Their Adjustment.- 5.1.3.1 Identification and Correction of Valuation Effects.- 5.1.3.2 Estimation of Interest Earnings.- 5.1.4 The Correlation between Official Interventions and Reserves.- 5.1.5 Active versus Passive Interventions.- 5.2 Intervention Activity in Inflation Targeting Countries.- 5.2.1 Comparison of Intervention Capacities.- 5.2.2 Comparison of Reserve Changes.- 5.2.2.1 Correction for Valuation Changes.- 5.2.2.2 Correction for Interest Earnings.- 5.2.3 Identification of Intervention Activity.- 5.2.3.1 Absolute Reserve Changes.- 5.2.3.2 Normalisation with the Degree of Openness.- 5.2.3.3 Normalisation with the Size of Foreign Exchange Markets.- 5.2.3.4 Response to Shocks.- 5.2.4 Ranking of Intervention Activity.- 5.3 The Use of Interventions as an Additional Policy Instrument.- 5.3.1 Interventions and the Variation of Interest Rates.- 5.3.1.1 Interest Rate Volatility Compared.- 5.3.1.2 Frequency of Policy Rate Changes Compared.- 5.3.1.3 Interpretation of the Findings.- 5.3.2 Policy Reaction Functions and Exchange Rates.- 5.3.2.1 Evolution of Taylor Rules.- 5.3.2.2 Description of Data and Methods.- 5.3.2.3 Stationarity Tests.- 5.3.2.4 Country-Specific Results and Interpretation.- 5.4 Short Case Studies of the Country Experiences.- 5.4.1 New Zealand.- 5.4.2 Canada.- 5.4.3 Australia.- 5.4.4 United Kingdom.- 5.4.5 Sweden.- 6 Performance of Inflation Targeting: An Evaluation.- 7 Conclusion and Outlook.- List of Figures.- List of Tables.

The Swedish Housing Market

While several sectors in the economy have been deregulated, the Swedish housing market remains distorted, hindering an optimal matching of supply and demand. In the rental market the rent setting framework with its focus on cost-based rents in the public sector prevents a price response, leading to long queues in some regions and vacancies in others. Many Swedes that would have preferred otherwise are driven into the owner-occupied segment, where prices are increasing strongly, and rising above an estimated fundamental value. The supply of new dwellings is made more difficult by an uncompetitive construction industry, coupled with cumbersome planning regulations and few incentives for municipalities to issue more land. On the fiscal side, real estate taxes are below neutral levels, implying an indirect subsidy to housing. This paper presents a review of the recent steps to abolish real estate taxes and also proposes comprehensive reform of regulations in the rental housing sector. This paper relates to the OECD Economic Survey of Sweden 2007 (www.oecd.org/eco/surveys/sweden). Le marche du logement suedois : Moins reglementer pour obtenir une meilleure allocation des ressources Alors que plusieurs secteurs de l’economie ont ete dereglementes, le marche suedois du logement reste soumis a de fortes distorsions qui entravent un rapprochement optimal de l’offre et de la demande. Sur le marche locatif, les loyers sont essentiellement fonction de ceux que pratique le secteur public dans l’optique des couts, ce qui empeche une reaction normale des prix et cree de longues files d’attente dans certaines regions, tandis que des logements restent vacants dans d’autres. Un grand nombre de Suedois sont contraints malgre eux d’acceder a la propriete, avec des prix en forte hausse, et augmentant au dessus d’une valeur fondamentale estimee. L’offre de logements neufs subit les effets negatifs d’un manque de concurrence dans le secteur de la construction, se doublant de tres strictes regles d’urbanisme et d’une faible incitation des communes a classer de nouveaux terrains en zone constructible. Sur le plan fiscal, l’impot foncier est deja inferieur au niveau de neutralite, ce qui veut dire que le logement est indirectement subventionne. Ce document passe en revue de maniere critique les recentes etapes pour supprimer les taxes foncieres et propose egalement une reforme comprehensive des reglementations du secteur locatif. Ce document de travail se rapporte a l’Etude economique de l’OCDE de la Suede 2007 (www.oecd.org/eco/etudes/suede).

The German Labor Market in the Great Recession: Lessons for Other Countries

The performance of the German labor market during the crisis that began in 2008 stands out among developed countries. During the crisis, employment was preserved to a much larger extent than in other countries, notably when compared with the scale of the downturn; this outcome is now frequently described as the “German miracle.” The increase in unemployment in the great recession—the global economic decline that started in 2008 and the effects of which continue—differed substantially among countries, with Germany occupying one end of the spectrum (almost no increase) and the US (and notably Spain) standing at the other end (with a larger increase than many observers had expected). Furthermore, while the German economy recovered forcefully from the recession, and unemployment has fallen below its estimated long-run structural rate (i.e., the unemployment rate that is unaffected by cyclical variations), the US labor market is plagued by an unusual stickiness of long-term unemployment. It is as if labor market flexibility, for example the relatively light employment protection legislation that eases hiring and firing, does not pay off in the US in terms of growth, while Germany is not punished for having frozen its employment structure by avoiding layoffs during the crisis. Explaining the driving factors behind these differences is essential not only for understanding the German labor market miracle but also for providing lessons for other countries.

The British Foreign Exchange Reserves Puzzle

The British foreign exchange reserves decreased by 40 percent during the period August 1996-December 1999 although the Pound Sterling is considered a floating exchange rate since it left the EMS in 1992. Since changes in the level of foreign exchange reserves are usually taken as indicators for foreign exchange interventions in the economic literature we investigate the case of the British reserves in detail. While the Pound Sterling has appreciated strongly against the Deutsch mark in this period its exchange rate versus the US dollar has remained comparatively stable. However, the Bank of England has denied any interventions in the foreign exchange markets. We find that transactions for the government, such as repayments of Treasury bonds, account for a large part of the decrease in reserves. Valuation changes due to exchange rate fluctuations can explain only a small fraction of the decrease. This result shows that variability in official reserves is not necessarily associated with foreign exchange intervention. However, even after estimating the effects of exchange rate fluctuations and interest earnings and correcting for government transactions we still find a considerable decrease in the UK reserves that is not explained by either the Bank of England or HM Treasury.