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on Central Banking |
| By: | Stuart J. Fowler |
| Abstract: | The effects of changes in monetary policy are studied in a general equilibrium model where money facilitates transactions. Because there are two types of agents, workers and capitalists, different elasticities of money demand exist, implying that monetary policy influences the distribution of income. Only when earnings inequality is incorporated into monetary policy rule is the model able to replicate cyclical fluctuations of both real and nominal aggregates as well as the inequality measure. Additionally, monetary policy becomes more countercyclical when the fraction of transfers received by the workers increases. These results can support a theory that the distribution of seigniorage revenues between the workers and capitalists changed in 1979 |
| Keywords: | Inflation, Income Distribution, Heterogenous Agents, Perturbation |
| JEL: | E32 E42 E50 |
| Date: | 2005–11–11 |
| URL: | http://d.repec.org/n?u=RePEc:sce:scecf5:184&r=cba |
| By: | Giancarlo Marini (University of Rome II - Faculty of Economics); Alessandro Piergallini (University of Rome II; University of Bristol - Department of Economics) |
| Abstract: | This paper studies the performance of monetary policy under alternative fiscal regimes in a dynamic New Keynesian optimizing general equilibrium model with wealth effects. The interactions between fiscal policy and interest rate rules are shown to have relevant implications for the existence of a unique rational expectations equilibrium. When calibrated to Euro Area quarterly data, the model simulation results show that the preferred monetary-fiscal regime for inflation stabilization consists of a generalized Taylor rule with a low degree of inertia coupled with a public debt-GDP ratio targeting rule. |
| Keywords: | Fiscal Policy Rules, Monetary Policy, Wealth Effects |
| JEL: | E52 E58 E63 |
| URL: | http://d.repec.org/n?u=RePEc:rtv:ceisrp:50&r=cba |
| By: | Gonzalez F.; Rodriguez A. (Economic Studies Division Bank of Mexico); Gonzalez-Garcia J.R. |
| Abstract: | Uncertainty about the persistence of periods characterized by large price shocks is an important aspect of monetary policy. This type of uncertainty posed some difficulties for central banks in 2004. This paper formalizes the treatment of this type of uncertainty by solving an optimal control problem in which the economy randomly alternates between two regimes characterized by different magnitudes of price shocks. By using an open economy model, we find that the optimal policy rule is both regime-contingent and robust. In particular, we find that: a) the optimal reaction of the interest rate is dependent on both the current regime and on the difference in the magnitude of the shocks between regimes; b) the alternation between regimes leads to more aggressive policy reactions with respect to inflation and the second lag of the real exchange rate; and c) after a robust selection of transition probabilities, the min-max probability of switching to the regime with large price shocks increases when such regime is more harmful. In general, cautious behavior renders smaller losses than recklessness for the central bank. This result argues in favor of caution over recklessness in the formulation of monetary policy when there is uncertainty about the persistence of periods with large price shocks |
| Keywords: | monetary policy, Markov regime-switching, optimal control, robustness, model uncertainty, inflation targeting |
| JEL: | C6 E5 |
| Date: | 2005–11–11 |
| URL: | http://d.repec.org/n?u=RePEc:sce:scecf5:402&r=cba |
| By: | Jukka Railavo (Monetary Policy and Research Department Bank of Finland) |
| Abstract: | In this paper we analyse the monetary impact of alternative fiscal policy rules using the debt and deficit, both mentioned as measures of fiscal policy performance in the Stability and Growth Pact (SGP). We use a New Keynesian model, with distortionary taxation and an appropriately defined output gap. The economy is hit by two fundamental shocks: demand and supply shocks, which are orthogonal to each other. Monetary policy is conducted by an independent central bank that will optimise. Under discretionary monetary policy the size of the inflation bias depends on the fiscal policy regime. Using the timeless perspective approach to precommitment, output persistence increases compared to the discretionary case. The result holds with the alternative fiscal policy rules, and inflation and output persistence reflects the economic data. With the deficit rules, the autocorrelation of the tax rate is near unity irrespective of the monetary policy regime, and irrespective of the fiscal policy parameters and targets. Thus we revive Barro's (1979) random walk result with the deficit rules |
| Keywords: | Inflation, monetary policy, fiscal policy, policy coordination |
| JEL: | E52 E31 E61 E62 |
| Date: | 2005–11–11 |
| URL: | http://d.repec.org/n?u=RePEc:sce:scecf5:145&r=cba |
| By: | Kirdan Lees (Economics Reserve Bank of New Zealand) |
| Abstract: | For policymakers, thinking about best practice monetary policy means thinking about uncertainty. Open economy monetary policymakers face an additional source of uncertainty – exchange rate dynamics. This paper identifies policy rules robust to the open economy inflation targeters face in practice. For Knight (1921), uncertainty differs from risk because the policymaker does not know the nature of the uncertainty and is unable to form a probability distribution or risk statement, over different possible models. Hansen and Sargent (2004) apply Knight’s (1921) philosophy to the linear-quadratic control framework, recognizing that policy-makers work with models which are approximations to some true, unknown model and seek a rule that is robust to models close to the policymaker’s best approximation. While there exist some open economy robust control policy experiments (Leitemo and Söderström (2004) obtain analytical robust control solutions for a purely forward-looking new Keynesian model) the majority of the literature focuses on the closed economy. This paper calibrates a single open economy model to capture the key open economy dynamics for Australia, Canada and New Zealand, three of the earliest inflation targeters that form a useful dataset for identifying robust monetary policy rules in practice. Robust policies are found to respond more aggressively to not only inflation and the output gap, but also the exchange rate and its associated shock. This result generalizes to the context of a flexible inflation targeting central bank that cares about the volatility of the real exchange rate. However, when the central bank places only a small weight on interest rate smoothing and fears misspecification in only exchange rate determination, a more aggressive response to the lag of the exchange rate is not warranted. It is shown that the benefits of an exchange rate channel far outweigh the concomitant costs of uncertain exchange rate determination. |
| Keywords: | uncertainty; open economy; robust control |
| JEL: | E52 E58 F41 |
| Date: | 2005–11–11 |
| URL: | http://d.repec.org/n?u=RePEc:sce:scecf5:246&r=cba |
| By: | Tommaso Monacelli; Ester Faia |
| Abstract: | We study optimal monetary policy in two prototype economies with sticky prices and credit market frictions. In the first economy, credit frictions apply to the financing of the capital stock, generate acceleration in response to shocks and the "financial markup" (i.e., the premium on external funds) is countercyclical and negatively correlated with the asset price. In the second economy, credit frictions apply to the flow of investment, generate persistence, and the financial markup is procyclical and positively correlated with the asset price. We model monetary policy in terms of welfare-maximizing interest rate rules. The main finding of our analysis is that strict inflation stabilization is a robust optimal monetary policy prescription. The intuition is that, in both models, credit frictions work in the direction of dampening the cyclical behavior of inflation relative to its credit-frictionless level. Thus neither economy, despite yielding different inflation and investment dynamics, generates a trade-off between price and financial markup stabilization. A corollary of this result is that reacting to asset prices does not bear any independent welfare role in the conduct of monetary policy |
| JEL: | E52 F41 |
| Date: | 2005–11–11 |
| URL: | http://d.repec.org/n?u=RePEc:sce:scecf5:452&r=cba |
| By: | Korkut Erturk |
| Keywords: | speculation, liquidity, monetary circulation |
| Date: | 2005–12 |
| URL: | http://d.repec.org/n?u=RePEc:uta:papers:2005_12&r=cba |
| By: | Paolo Surico (Monetary Assessment & Strategy Division Bank of England) |
| Abstract: | The New-Keynesian Phillips curve plays a central role in modern macroeconomic theory. A vast empirical literature has estimated this structural relationship over various postwar full-samples. While it is well know that in a New-Keynesian model a `weak' central bank response to inflation generates sunspot fluctuations, the consequences of pooling observations from different monetary policy regimes for the estimates of the structural Phillips curve had not been investigated. Using Montecarlo simulations from a purely forward-looking model, this paper shows that indeterminacy can introduce a sizable persistence in the estimated process of inflation. This persistence however is not an intrinsic feature of the economy; rather it is endogenous to the policy regime and results from the self full-filling nature of inflation expectations. By neglecting indeterminacy the estimates of the forward-looking term of the structural Phillips curve are shown to be biased downward. The implications are in line with the empirical evidence for the U.K and U.S |
| Keywords: | indeterminacy, New-Keynesian Phillips curve, Montecarlo, bias, persistence |
| JEL: | E58 E31 E32 |
| Date: | 2005–11–11 |
| URL: | http://d.repec.org/n?u=RePEc:sce:scecf5:313&r=cba |
| By: | Evi Pappa; Zheng Liu |
| Abstract: | This paper presents a new argument for international monetary policy coordination based on considerations of structural asymmetries across countries. In a two-country world with a traded and a non-traded sector in each country, optimal independent monetary policy cannot replicate the natural-rate allocations. There are potential welfare gains from coordination since the planner under a cooperating regime internalizes a terms-of-trade externality that independent central banks tend to overlook. Yet, with symmetric structures across countries, the gains are quantitatively small. If the size of the traded sector differs across countries, the gains can be sizable and increase with the degree of asymmetry. The planner's optimal policy not only internalizes the terms-of-trade externality, it also creates a terms-of-trade bias in favor the country with a larger traded sector. Further, the planner tries to balance the terms-of-trade bias against the need to stabilize fluctuations in the terms-of-trade gap. |
| Keywords: | International Policy Coordination; Optimal Monetary Policy; Asymmetric Structures; Terms-of-Trade Bias |
| JEL: | E52 F41 F42 |
| Date: | 2005–11–11 |
| URL: | http://d.repec.org/n?u=RePEc:sce:scecf5:457&r=cba |
| By: | Michael Kumhof (Modeling Division, Research Department International Monetary Fund); Douglas Laxton |
| Abstract: | This paper presents a monetary model with nominal rigidities and maximizing, rational, forward-looking households, intermediaries and firms. It differs from conventional models in this class in two key respects. First, price (and wage) setters set pricing policies, including an updating rate for future prices, instead of price levels. Second, output fluctuations during the period of a pricing policy are costly to firms. The paper is motivated by some important shortcomings of conventional models, namely their inability to generate inflation inertia, inflation persistence and recessionary disinflations without introducing either an ad-hoc updating rule or learning. While learning is clearly important, we are interested in the contribution that structural rigidities can make in a forward-looking and optimizing model. The model does generate all of the above effects in response to monetary policy shocks. The channel for these effects in the model is the long-run or inflation updating component of firms' pricing policies. This is distinct from another frequently stressed reason for inflation inertia and persistence, a slow response of marginal cost to shocks, which is also present in our model because all components of marginal cost, not just wages, are sticky. In work in progress, we are estimating the model using Bayesian techniques. |
| Keywords: | Inflation inertia, price setting behavior, output volatility |
| JEL: | E31 E32 |
| Date: | 2005–11–11 |
| URL: | http://d.repec.org/n?u=RePEc:sce:scecf5:429&r=cba |
| By: | Maarten Dossche (Research National Bank Belgium - Ghent University); Gerdie Everaert |
| Abstract: | Time series estimates of inflation persistence incur an upward bias if shifts in the inflation target of the central bank remain unaccounted for. Using a structural time series approach we measure different sorts of inflation persistence allowing for an unobserved time-varying inflation target. Unobserved components are identified using Kalman filtering and smoothing techniques. Posterior densities of the model parameters and the unobserved components are obtained in a Bayesian framework based on importance sampling. We find that inflation persistence, expressed by the half-life of a shock, can range from 1 quarter in case of a cost-push shock to several years for a shock to long-run inflation expectations or the output gap |
| Keywords: | Inflation persistence, Inflation target, Kalman filter |
| JEL: | C11 C13 C22 |
| Date: | 2005–11–11 |
| URL: | http://d.repec.org/n?u=RePEc:sce:scecf5:459&r=cba |
| By: | Sanjay K. Chugh |
| Abstract: | Ramsey models of fiscal and monetary policy with perfectly-competitive product markets and a fixed supply of capital predict highly volatile inflation with no serial correlation. In this paper, we show that an otherwise-standard Ramsey model that incorporates capital accumulation and habit persistence predicts highly persistent inflation. The result depends on increases in either the ability to smooth consumption or the preference for doing so. The effect operates through the Fisher relationship: a smoother profile of consumption implies a more persistent real interest rate, which in turn implies persistent optimal inflation. Our work complements a recent strand of the Ramsey literature based on models with nominal rigidities. In these models, inflation volatility is lower but continues to exhibit very little persistence. We quantify the effects of habit and capital on inflation persistence and also relate our findings to recent work on optimal fiscal policy with incomplete markets |
| Keywords: | Optimal fiscal and monetary policy, inflation persistence, Ramsey model, habit formation |
| JEL: | E50 E61 E63 |
| Date: | 2005–11–11 |
| URL: | http://d.repec.org/n?u=RePEc:sce:scecf5:369&r=cba |
| By: | Luis-Felipe Zanna; Marco Airaudo (International Finance Federal Reserve Board) |
| Abstract: | Using a closed economy model with a flexible-price good and a sticky-price good we study the conditions under which interest rate rules induce real determinacy and, more importantly, the MSV solution is learnable in the E-stability sense proposed by Evans and Honkapohja (2001). We show that these conditions depend not only on how aggressively the rule responds to inflation but also on the measure of inflation included in the rule and on whether the flexible-price good and the sticky-price good are Edgeworth complements, substitutes or utility separable. We consider three possible measures of inflation: the flexible-price inflation, the sticky price inflation and the core inflation; and we analyze three different types of rules: a forward-looking rule, a contemporaneous rule and a backward-looking rule. Our results suggest that in order to guarantee a unique equilibrium whose MSV representation is learnable, the government should implement a backward looking rule that responds exclusively to the sticky-price inflation. Forward-looking and contemporaneous rules that respond to either the flexible-price inflation or the core-inflation are more prone to induce multiple equilibria and E-instability of the MSV solution. More importantly backward-looking rules that react to either the flexible-price inflation or the core inflation may guarantee a unique equilibrium but in these cases the fundamental solution (MSV representation) is not learnable in the E-stability sense |
| Keywords: | Interest rate rules, Learning, E-stability, multiple equilibria, inflation |
| JEL: | E31 E52 |
| Date: | 2005–11–11 |
| URL: | http://d.repec.org/n?u=RePEc:sce:scecf5:176&r=cba |
| By: | Michael P. Dooley; David Folkerts-Landau; Peter M. Garber |
| Abstract: | In this paper we examine the behavior of interest rates and exchange rates following a variety of shocks to the international monetary system. Our analysis suggests that real interest rates in the US and Europe will remain low relative to historical experience for an extended period but converge slowly toward normal levels. During this adjustment interval, the US absorbs a disproportionate share of world savings. After a substantial initial appreciation of floating currencies relative to the dollar, the dollar and other floating currencies remain constant relative to each other. An improvement in the investment climate in Europe during the adjustment period would generate an immediate depreciation of the euro relative to the dollar. In real terms, the dollar and the floating currencies will eventually have to depreciate relative to the managed currencies. But most of the adjustment in the US trade account will come as US absorption responds to increases in real interest rates. |
| JEL: | F02 F32 F33 |
| Date: | 2005–11 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:11771&r=cba |
| By: | Christian Melzer; Thorsten Neumann |
| Abstract: | We estimate a time-varying coefficient VAR model for the U.S. economy to analyse (i) if the effect of monetary policy on output has been changing systematically over time, and (ii) if monetary policy has asymmetric effects over the business cycle. We find that the impact of monetary policy shocks has been gradually declining over the sample period (1962-2002), as some theories of the monetary transmission mechanism imply. In addition, our results indicate that the effects of monetary policy are greater in a recession than in a boom. |
| JEL: | E52 E32 C52 |
| Date: | 2005–11–11 |
| URL: | http://d.repec.org/n?u=RePEc:sce:scecf5:144&r=cba |
| By: | Christopher Ragan |
| Abstract: | The author provides a non-technical explanation of the role played by the exchange rate in Canada's inflation-targeting monetary policy. He reviews the motivation for inflation targeting and describes the monetary transmission mechanism. Though the exchange rate is an integral component of the transmission mechanism, the author explains why it is not a target for monetary policy. He provides a simple taxonomy for exchange rate movements, distinguishing between movements associated with direct shocks to aggregate demand and those unrelated to such direct shocks. He explains the importance to monetary policy of determining the cause of any given movement in the exchange rate, and of determining the net effect on aggregate demand. The author also describes Canadian monetary policy during the 200304 period, a time when the Canadian dollar appreciated sharply against the U.S. dollar. |
| Keywords: | Exchange rates; Inflation targets; Monetary policy implementation |
| JEL: | E50 E52 F41 |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:05-34&r=cba |
| By: | Vitor Gaspar; Frank Smets |
| Abstract: | The paper studies the conduct of monetary policy, in a simple new Keynesian model, with adaptive learning on the part of the private sector. A key feature is that even though we start out with a linear “structural†model, the system and hence policy responses inherit the non-linear feature of the updating equations for the estimated parameters. In the paper, we contrast two different monetary policy regimes. In the first the central bank follows a simple rule, which comes from the first order conditions, for optimal policy under discretion in the case of rational expectations. In the second, the central bank has full information about the structure of the economy, including the adaptive learning mechanism. It takes the expectations formation mechanism explicitly into account when deriving optimal policy. This framework allows an explicit discussion of the importance of keeping inflation expectations under control. We illustrate with an application to a regime change, where we assume that the incumbent policymaker did not take the learning into account and allowed the expectation formation process to become unhinged. However, before inflation expectations (and actual inflation) spirals out of control, we assume that a sophisticated central banker, who does take the effect of learning into account, takes charge and study how the economy adjusts after the regime change. Under our assumptions the transition is slow. We claim that some features of the transition match important stylised facts associated with the Volcker disinflation in the US. In the end the fully optimal policy delivers less inflation and output gap volatility. It does so by anchoring inflation expectations thereby contributing to the overall stability of the economy. To achieve this result optimal policy is conditional on the degree of perceived persistence. As perceived persistence increases so does inertia in the policy response in the face of inflation shocks. We compare the contrast between the two policy regimes in the paper with the difference between the rational expectations under discretion and commitment. |
| Keywords: | monetary policy, adaptive learning, regime change |
| JEL: | E5 E52 E65 |
| Date: | 2005–11–11 |
| URL: | http://d.repec.org/n?u=RePEc:sce:scecf5:80&r=cba |
| By: | Roberto Billi; Klaus Adam (Research Department CEPR and European Central Bank) |
| Abstract: | We study monetary and fiscal policy games in a dynamic sticky priceeconomy where monetary policy sets nominal interest rates and fiscal policy provides public goods financed with distortionary labor taxes. We compare the Ramsey outcome to non-cooperative policy regimes where one or both policymakers lack commitment power. Absence of fiscal commitment gives rise to a public spending bias, while lack of monetary commitment generates the well-known inflation bias. An appropriately conservative monetary authority can eliminate the steady state distortions generated by lack of monetary commitment and may even eliminate the distortions generated by lack of fiscal commitment. The costs associated with the central bank being overly conservative seem small, but insufficient conservatism may result in sizable welfare losses |
| Keywords: | optimal monetary and fiscal policy, lack of commitment, sequential policy, discretionary policy |
| JEL: | E52 E62 E63 |
| Date: | 2005–11–11 |
| URL: | http://d.repec.org/n?u=RePEc:sce:scecf5:62&r=cba |
| By: | Volker Wieland; Keith Kuester |
| Abstract: | In this paper, we examine the cost of insurance against model uncertainty for the Euro area considering four alternative reference models, all of which are used for policy-analysis at the ECB. We find that maximal insurance across this model range in terms of a Minimax policy comes at moderate costs in terms of lower expected performance. We extract priors that would rationalize the Minimax policy from a Bayesian perspective. These priors indicate that full insurance is strongly oriented towards the model with highest baseline losses. Furthermore, this policy is not as tolerant towards small perturbations of policy parameters as the Bayesian policy rule. We propose to strike a compromise and use preferences for policy design that allow for intermediate degrees of ambiguity-aversion. These preferences allow the specification of priors but also give extra weight to the worst uncertain outcomes in a given context |
| Keywords: | model uncertainty, robustness, monetary policy rules, minimax, euro area |
| JEL: | E52 E58 E61 |
| Date: | 2005–11–11 |
| URL: | http://d.repec.org/n?u=RePEc:sce:scecf5:100&r=cba |
| By: | B Bhaskara Rao (University of the South Pacific); Rup Singh (University of the South Pacific) |
| Abstract: | Demand for money is an important macroeconomic relationship. Its stability has implications for the choice of monetary policy targets. This paper estimates demand for narrow money in Fiji and evaluates its robustness and stability. It is found that there is a well determined stable demand for money in Fiji, for three decades, from 1971 to 2002 and its dynamics are adequately captured by the cointegration and error- correction models. Income and interest rate elasticities are found to be significant. |
| Keywords: | Demand for money, Monetary policy, Income and interest rate elasticities, Cointegration, Error correction, Unit roots, Stability. |
| JEL: | C1 C5 |
| Date: | 2005–11–11 |
| URL: | http://d.repec.org/n?u=RePEc:wpa:wuwpma:0511012&r=cba |
| By: | Julien Garnier (European University Institute and University of Parix X-Nanterre); Bjørn-Roger Wilhelmsen (Central Bank of Norway, Economics Department, Oslo, Norway) |
| Abstract: | The notion of a natural real rate of interest, due to Wicksell (1936), is widely used in current central bank research. The idea is that there exists a level at which the real interest rate would be compatible with output being at its potential and stationary inflation. This paper applies the method recently suggested by Laubach and Williams to jointly estimate the natural real interest rate and the output gap in the euro area over the past 40 years. Our results suggest that the natural rate of interest has declined gradually over the past 40 years. They also indicate that monetary policy in the euro area was on average stimulative during the 1960s and the 1970s, while it contributed to dampen the output gap and inflation in the 1980s and the 1990s. |
| Keywords: | Real interest rate gap; output gap; Kalman filter; euro area. |
| JEL: | C32 E43 E52 O40 |
| Date: | 2005–11 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20050546&r=cba |
| By: | Gustavo Piga (University of Rome II) |
| Abstract: | Why do dynamic inconsistencies in monetary policy exist? In this paper a traditional model without put inefficiencies is introduced, but monetary policy is allowed to be influenced by the various constituencies in the economy, that pressure Congress in turn to pressure the central bank to adopt a particular policy stance. The paper shows that in this economy an inflation bias arises due to the lobbying pressures of outsiders. Furthermore, it shows that if lobbying pressures are high enough, an inflation bias cannot be avoided for any finite level of central bank independence. It also shows that introducing the realistic feature of lobbying pressures has an impact on the stabilization properties of monetary policy. When a supply shock occurs, the shock is totally absorbed by a non myopic trade union which has no lobbying costs. This is independent of any finite degree of conservativeness of the central banker, who has to accept an extreme increase in price instability. It is shown that monetary policy delegation is therefore sub-optimal in achieving price-stability compared to labor-market reforms meant to remove monopsonistic elements. However, the same structural policies will induce greater output instability by strengthening the power of conservative central bankers |
| JEL: | E52 E58 E31 |
| Date: | 2005–02–04 |
| URL: | http://d.repec.org/n?u=RePEc:rtv:ceisrp:66&r=cba |
| By: | Roberto M. Billi (- Center for Financial Studies) |
| Abstract: | This paper characterizes the optimal inflation buffer consistent with a zero lower bound on nominal interest rates in a New Keynesian sticky-price model. It is shown that a purely forward-looking version of the model that abstracts from inflation inertia would significantly underestimate the inflation buffer. If the central bank follows the prescriptions of a welfare-theoretic objective, a larger buffer appears optimal than would be the case employing a traditional loss function. Taking also into account potential downward nominal rigidities in the price-setting behavior of firms appears not to impose significant further distortions on the economy |
| Keywords: | inflation inertia, downward nominal rigidity, nonlinear policy, liquidity trap |
| JEL: | C63 E31 E52 |
| Date: | 2005–11–11 |
| URL: | http://d.repec.org/n?u=RePEc:sce:scecf5:25&r=cba |
| By: | George Monokroussos (Economics UCSD) |
| Abstract: | I estimate, using real-time data, a forward-looking monetary policy reaction function that is dynamic and that also accounts for the fact that there are substantial restrictions in the period-to-period changes of the Fed's policy instrument. I find a substantial contrast between the periods before and after Paul Volcker's appointment as Fed Chairman in 1979, both in terms of the Fed's response to expected inflation and in terms of its response to the (perceived) output gap: In the pre-Volcker era the Fed's response to inflation was substantially weaker than in the Volcker-Greenspan era; conversely, the Fed seems to have been more responsive to real activity in the pre-Volcker era than later |
| JEL: | C25 E52 E58 |
| Date: | 2005–11–11 |
| URL: | http://d.repec.org/n?u=RePEc:sce:scecf5:460&r=cba |
| By: | Carlos Capistrán-Carmona |
| Abstract: | This paper documents that inflation forecasts of the Federal Reserve systematically under-predicted inflation before Volker's appointment as Chairman and systematically over-predicted it afterward. It also documents that, under quadratic loss, commercial forecasts have information not contained in the forecasts of the Federal Reserve. It demonstrates that this evidence leads to a rejection of the joint hypothesis that the Federal Reserve has rational expectations and quadratic loss. To investigate the causes of this failure, this paper uses moment conditions derived from a model of an inflation targeting central bank to back out the loss function implied by the forecasts of the Federal Reserve. It finds that the cost of having inflation above the target was larger than the cost of having inflation below it for the post-Volker Federal Reserve, and that the opposite was true for the pre-Volker era. Once these asymmetries are taken into account, the Federal Reserve is found to be rational and to efficiently incorporate the information contained in forecasts from the Survey of Professional Forecasters |
| Keywords: | Asymmetric loss function, Inflation forecasts, Forecast Evaluation |
| JEL: | C53 E52 |
| Date: | 2005–11–11 |
| URL: | http://d.repec.org/n?u=RePEc:sce:scecf5:127&r=cba |
| By: | Daniel Leigh (European International Monetary Fund) |
| Abstract: | This paper proposes a new method of estimating the Taylor rule with a time-varying implicit inflation target and a time-varying natural rate of interest. The inflation target and the natural rate are modelled as random walks and are estimated using maximum likelihood and the Kalman filter. I apply this method to U.S. monetary policy over the last 25 years to understand how the Federal Reserve’s target has varied during this broadly successful period. Stability tests indicate significant time variation in the implicit target. In the early 1980s, during the Volcker disinflation, the inflation target is near 3%. In the late 1980s and early 1990s, the target is close to actual inflation of 3-4% and only declines once the 1990-91 recession reduces inflation to 1-2%, corroborating historical evidence of an “opportunistic approach to disinflation.†Finally, over 2001-2004, the target rises to 2-3%, behaviour that can be interpreted as a response the risks of hitting the zero bound on nominal interest rates |
| Keywords: | Taylor rule, time-varying parameters, Kalman filter |
| JEL: | C22 E31 E52 |
| Date: | 2005–11–11 |
| URL: | http://d.repec.org/n?u=RePEc:sce:scecf5:177&r=cba |
| By: | Marco Raberto; Andrea Teglio |
| Abstract: | This paper presents a model of a monetary production economy with non-Walrasian good, labor and money markets. In the non-Walrasian approach, transactions occur at non clearing prices and agents's demand and supply are affected by quantity constraints in the opposite side of the market. The model is characterized by a representative firm, which maximize profits subject to a production technology, a representative consumer, which maximize utility subject to a budget constraint, and by a central bank which provide liquidity. The consumer provides the labor force and owns all the equities of the firm. The main result of the model is the existence of non-Warlasian equilibria which are suboptimal with respect to Warlasian ones. Furthermore, non-Warlasian equilibria are characterized by money non-neutrality and proper monetary policies are found to be able to bring the system near to the Walrasian point |
| Keywords: | disequilibrium economics; economic dynamics, monetary policy |
| JEL: | D92 E12 E37 E5 |
| Date: | 2005–11–11 |
| URL: | http://d.repec.org/n?u=RePEc:sce:scecf5:320&r=cba |
| By: | Arup Daripa (Birkbeck College) |
| Abstract: | A repo auction is a multi-unit common value auction in which bidders submit demand functions. Such auctions are used by the Bundesbank as well as the European Central Bank as the principal instrument for implementing monetary policy. In this paper, we analyze a repo auction with a uniform pricing rule. We show that under a uniform pricing rule, the usual intuition about the value of exclusive information can be violated, and implies free riding by uninformed bidders on the information of the informed bidders, lowering payoff of the latter. Further, free riding can distort the information content of auction prices, in turn distorting the policy signals, hindering the conduct of monetary policy. The results agree with evidence from repo auctions, and clarifies the reason behind the Bundesbank's decision to switch away from the uniform price format. Our results also shed some light on the rationale behind the contrasting switch to the uniform price format in US Treasury auctions. |
| Keywords: | Repo auction, Informational Free Riding, Monetary Policy Signals |
| JEL: | D44 E50 |
| Date: | 2005–11–17 |
| URL: | http://d.repec.org/n?u=RePEc:wpa:wuwpma:0511019&r=cba |
| By: | Giorgio Basevi (University of Bologna - Department of Economics); Lorenzo Pecchi (University of Rome II; University of Rome II) |
| Abstract: | In 1975 Niels Thygesen, together with eight other economists - one of us among them - published in The Economist a "manifesto" proposing a new common currency for Europe (Basevi et al., 1975). His co-operation on this subject was pursued within a smaller group, and resulted in the publication of two reports for the EU Commission (Optica Report '75, Optica Report 1976). The proposal in the "manifesto" was ironically re-titled, by The Economist, "The All Saints' day manifesto for European monetary union". In fact it had been published on 1st November, and the "Saints" should have been, according to The Economist, the European Governments if they had adopted and adhered to the proposal. This amounted to launching a new currency that should have circulated in parallel to the national ones, related to them by flexible exchange rates, due to the constraint that such new currency, the "Europa", had to be kept by an automatic formula at fixed purchasing power. In fact the Europa was to be indexed to the inflation rates in the participating countries, according to the weights of their national currencies in what at that time was called the European Unit of Account. As for the two other reports, Optica '75 proposed again a parallel currency, but less than fully inflation-proof, since its standing in terms of purchasing power would have been the same as that of the currency of the member country with the lowest inflation rate. In the Optica 1976 Report, while reiterating the proposal of a parallel currency along the lines of Optica '75, the focus was on designing a joint management of intra-European exchange rates on the basis of inflation differentials. The proposals contained in the three documents where premature, perhaps visionary. On 7 July 1978 the European Council met in Bremen and drew the lines of the European Monetary System, which started on 13 March 1979, on the basis, among other things, of a new quasi-currency - the European Currency Unit (ECU) - composed of a basket of national currencies. Since then, it took almost twenty years before the euro was introduced, replacing the ECU on 1st January 1999. Comparing the euro to such proposals, we note at least two differences. The euro (a) did not start as a parallel currency, but replaced with a pre-announced schedule the national currencies of the countries participating in the monetary union, and (b) it was not conceived as an automatically inflation-proof currency, but one issued by a Central Bank bound by a monetary policy aimed at price stability. |
| Date: | 2005–04–04 |
| URL: | http://d.repec.org/n?u=RePEc:rtv:ceisrp:68&r=cba |
| By: | Jorg Bibow (The Levy Economics Institute) |
| Abstract: | This paper assesses the contribution of the European Central Bank (ECB) to Germany’s ongoing economic crisis, a vicious circle of decline in which the country has become stuck since the early 1990s. It is argued that the ECB continues the Bundesbank tradition of asymmetric policymaking: the bank is quick to hike, but slow to ease. It thereby acts as a brake on growth. This approach has worked for the Bundesbank in the past because other banks behaved differently. Exporting the Bundesbank “success story” to Euroland has undermined its working, however; given its sheer size, Euroland simply cannot freeload on external stimuli forever. While Euroland cannot do without proper demand management, the Maastricht regime and especially the ECB are firmly geared against it. The ECB’s monetary policies have been biased against growth and have thus proved bad for Euroland as a whole. Meanwhile, the German disease of protracted domestic demand weakness has spread across much of Euroland. Yet, by pursuing its peculiar traditions of wage restraint and procyclical public thrift, the ECB’s policies have had even worse results for Germany. Fragility and divergence undermine the euro’s long-term survival. |
| Keywords: | German unification, Bundesbank, policy inconsistency, stability culture, ECB, EMU |
| JEL: | E31 E42 E58 E61 E63 E65 E66 H62 |
| Date: | 2005–11–17 |
| URL: | http://d.repec.org/n?u=RePEc:wpa:wuwpma:0511018&r=cba |
| By: | Ali Dib; Ian Christensen |
| Abstract: | This paper estimates a sticky-price DSGE model with a financial accelerator to assess the importance of financial frictions in the amplification and propagation of the effects of transitory shocks. Structural parameters of two models, one with and one without a financial accelerator, are estimated using a maximum-likelihood procedure and post-war US data. The estimation and simulation results provide some quantitative evidence in favour of the financial accelerator model. The financial accelerator appears to play an important role in investment fluctuations, but its importance for output depends on the nature of the initial shock |
| Keywords: | Monetary policy, Financial accelerator, DSGE estimation |
| JEL: | E31 E44 E51 |
| Date: | 2005–11–11 |
| URL: | http://d.repec.org/n?u=RePEc:sce:scecf5:314&r=cba |
| By: | Matthew Brzozowski |
| Abstract: | This paper examines the effectiveness of the CPI as a measure of inflation faced by Canadian seniors. I construct a democratic price index and show that the average inflation rate (average when measured by the CPI) is often a very poor measure of inflation rates relevant to individual households. The proportion of individual, household specific price indexes falling more then one percentage point above or more then one percentage point below the CPI often remains high regardless of how closely the mean democratic index approximates the CPI. Further, I demonstrate that the CPI has considerably overstated the inflation faced by Canadian seniors during 1970s and 1980s while more or less accurately capturing inflation during the 1990s. I show that the limitations of the CPI apply to both the senior and the non-senior Canadians in a nearly equal manner. The proportion of individual inflation rates falling significantly above or below the CPI is similar for both segments of the society and so is the time pattern of overstating the average inflation rate. |
| Keywords: | Consumer Price Index, Inflation |
| JEL: | C1 D1 D12 |
| Date: | 2005–09 |
| URL: | http://d.repec.org/n?u=RePEc:mcm:sedapp:130&r=cba |