A Macroeconomic Perspective on Reserve Accumulation

This paper nests the buffer stock model within a standard open-economy model to capture two motives for international reserves accumulation—the insurance motive and the export-led growth motive. The model is solved for two exchange-rate policies, discretion and a rule with escape clause. It illustrates the behavior of international reserves and other macroeconomic variables when the policymaker pursues output and inflation stabilization and recognizes the supply of reserves can constrain the choice of exchange rate and the choice of exchange rate affects the supply of reserves. When output is below potential, it is optimal under both discretion and the rule to adopt a weak currency and promote export-led growth to achieve output and inflation stabilization. This policy leads to reserve accumulation and is consistent with the behavior of China. When reserves are low initially, welfare is higher when the policymaker follows a rule.     

A dynamic Nelson-Siegel yield curve model with Markov switching

This paper proposes a model to better capture persistent regime changes in the interest rates of the US term structure. While the previous literature on this matter proposes that regime changes in the term structure are due to persistent changes in the conditional mean and volatility of interest rates we find that changes in a single parameter that determines the factor loadings of the model better captures regime changes. We show that this model gives superior in-sample forecasting performance as compared to a baseline model and a volatility-switching model. In general, we find compelling evidence that the extracted factors from our term structure models are closely related with various economic variables. Furthermore, we investigate and find evidence that the effects of macroeconomic phenomena such as monetary policy, inflation expectations, and real economic activity differ according to the particular regime realized for the term structure. In particular, we identify the periods where monetary policy appears to have a greater effect on the yield curve, and the periods where inflation expectations seem to have a greater effect in yield determination. We also find convincing evidence of a relationship between the regimes estimated by the various switching models with economic activity and monetary policy.     

The effects of the monetary policy regime shift to inflation targeting on the real interest rate in the United Kingdom

This paper studies the effects of the monetary policy regime shift to inflation targeting on the stochastic properties of the real interest rate in the U.K. The empirical analysis suggests a constant mean of the real interest rate that shifts with the monetary policy regime change to inflation targeting in October 1992. The mean-reverting level of the real interest rate has decreased from 5.1% to 2.3% per annum with the change in monetary policy to inflation targeting. In addition, the shift in monetary policy regime to inflation targeting has reduced the volatility of the real interest rate and increased the persistence of real interest rate deviations from the mean. The results suggest that the central bank can affect the stochastic properties of the real interest rate through the choice of monetary policy regime over a long period of time.     

Asymmetric monetary policy and the effective lower bound

We use the canonical New Keynesian model to study optimal discretionary policy when the nominal interest rate is constrained by the effective lower bound (ELB). We show that policymakers who seek to minimize a (symmetric) quadratic loss function involving deviations of inflation and output from targets will achieve an average inflation rate below target due to the contractionary effects associated with hitting the ELB. We also characterize optimal discretionary policy for policymakers who view output losses as asymmetric: they place weight on the output gap when output is below potential but place little or no weight on the gap when output is above potential. In comparison to optimal policy using the symmetric loss function, the average inflation rate is higher and closer to the central banks target. Moreover, in response to contractionary demand shocks that push the nominal interest rate to the effective lower bound, policymakers with an asymmetric loss function adopt a policy rate path that remains at the ELB longer but eventually rises more quickly than the path adopted by a policymaker with a symmetric loss function.     

Fiscal limits and monetary policy: default vs. inflation

This paper studies the monetary policy trade-off between low inflation and low sovereign risk in the environment where fiscal authorities fail to fully ensure the sustainability of government debt. Building on the Fiscal Theory of Price Level (FTPL) and the Fiscal Theory of Sovereign Risk (FTSR), this paper differs in its baseline assumption about the monetary policy objective, which is neither to rule out defaults regardless of inflation costs (as in FTPL), nor to follow inflation targeting regardless of associated sovereign risk (as in FTSR). Instead, we study the case in which the central bank controls the risky interest rate to minimize the probability of default while ruling out large inflation hikes. We show that this policy regime can mitigate default risks only when the central bank is expected to allow sufficient increases in inflation. When agents believe that the central bank's tolerance toward inflation hikes has increased, equilibrium risk premium goes down, suggesting that information concerning changes in the central bank's preferences over inflation directly impacts default risks.     

Testing Commitment Models of Monetary Policy in China

In the past decade Chinese inflation was not high on average, but it was quite volatile. Back in the 1980s and 1990s, high inflation was a very real problem. What explains the inflationary dynamics in China? In particular, does monetary policy account for the substantial run-ups of inflation, followed by the equally substantial dis-inflation? In the absence of commitment technologies, the monetary authorities may create surprise inflation to achieve higher growth, while private agents would anticipate that and adjust their decisions accordingly, leading to accelerated inflation without a real impact. Do these types of simple time-inconsistency models of monetary policy explain the dynamic pattern of inflation in China? I show that the long-run and short-run restrictions imposed by discretionary policy, when the time-inconsistent policymaker has a desire to push output above potential, are largely rejected by the data. The estimates of the inflation bias under discretion when the policymaker is asymmetrically averse to recessions are not statistically significant either. The analysis contributes to the understanding of Chinese monetary policy and its inflationary implications and also points to the need of further investigation of inflationary behavior during the economic transition.     

Inflation targeting and the need for a new central banking framework

This article critically analyzes inflation targeting (IT) both theoretically and empirically. IT came into prominence in the 1990s and 1 central bank after another adopted this regime in the 1990s and 2000s. Proponents of IT mainly argued that IT regime was successful on the grounds that it resulted in lower inflation rates and hence better economic performances. However, inflation rates in the world were in a downward trend from the 1980s well into the 2000s, and both IT and non-IT regimes managed to decrease their inflation rates. In addition, focusing too much on price stability through IT paved the way for permanently higher than necessary interest rates and disinflationary “tight” monetary policy periods when inflation rate was above an arbitrarily targeted level. Tight monetary policy can and do affect the real economy negatively and overemphasizing price stability may hurt the economy in terms of lower potential output, decreasing investment and more unequal income distribution. Post Keynesians offer valuable alternatives within the framework of parking-it approach to the existing monetary policy paradigm. Our main conclusion is that central banks should set the policy interest rate as low as possible and keep it there, in line with Keynesian “cheap money” policy.     

A small-scale DSGE-VAR model for the Romanian economy

This paper describes the theoretical structure and the estimation results for a DSGE-VAR model for the Romanian economy, an inflation targeting country since 2005. Having as benchmark the New-Keynesian model of Rabanal and Rubio-Ramirez (2005), the main additional feature introduced refers to the extension to a small open economy setting in order to account for this specific aspect of the Romanian economy.Within the inflation targeting monetary policy regime, forecasts of central macro variables, inflation in particular, play an important part. Because inflation reacts to monetary measures with a considerable lag, the central bank's policy has to be forward-looking. Based on univariate measures of forecast performance, it is shown that the VAR with DSGE model prior produces forecasts that improve on those obtained using an unrestricted VAR model and the popular Minnesota prior in case of inflation, real exchange rate and nominal interest rate. Moreover, the DSGE-VAR model is informative about the structure of the economy and can help the “story-telling” in the central banks.     

Competing for Attention: Lobbying Time‐Constrained Politicians

We develop a model of lobbying in which a time and resource constrained policymaker first chooses which policy proposals to learn about, before choosing which to implement. The policymaker reviews the proposals of the interest groups who provide the highest contributions. We study how policy outcomes and contributions depend on policymaker constraints and the design of the “Contest for Attention.” Among other results, awarding attention to the highest contributors generally guarantees the first best policy outcome. It can also lead to the highest possible contributions, suggesting that a policymaker may not need to sacrifice policy in order to maximize contributions. Our results also give insight into other settings where agents compete for a decision maker's attention.     

Optimal versus realized policy rules in a regime-switching framework

In this paper we compare a deterministic model and a Markov switching model to analyze the behavior of the US economy and the Federal Reserve. We examine both optimal and empirical monetary policies for the US Federal Reserve between 1960 and 2008. We compare the optimal monetary policy to the actual interest rates and to the empirical reaction function. We also evaluate the sensitivity of the results to the preferences assigned to each objective. We find that there is no unique optimal solution that fits the Federal Reserve behavior over the entire period. The best fit to the actual interest rates is obtained by an optimal policy with preference switches following the rule: a high-volatility regime coincides with a priority on inflation alone while in a low-volatility regime there is equal policy priority on output stabilization and inflation.     

Rationalizing the Political Business Cycle: A Workhorse Model

An incumbent policymaker has incentives to expand the money supply prior to elections to stimulate the economy and thereby further her chances of re-election. In its original formulation, the Nordhaus political business cycle hypothesis relies on adaptive inflation expectations and naive retrospective voting.
This article develops a simple model of a political cycle in inflation and output growth, assuming rational inflation expectations and rational retrospective voting. Voter scrutiny of the incumbent's economic performance has policy and selection effects, with ambiguous consequences for welfare: the policymaker manipulates the money supply for electoral purposes, but an incumbent of above average quality is more likely to remain in office.     

The evolution of the monetary policy regimes in the U.S.

The existing literature on U.S. monetary policy provides no sense of a consensus regarding the existence of a monetary policy regime. This article explores the evolution of U.S. monetary policy regimes via the development of a Markov-switching model predicated on narrative and statistical evidence of a monetary policy regime. We identified five regimes for the period spanning 1956:I?C2005:IV and they roughly corresponded to the Chairman term of the Federal Reserve, except for the Greenspan era. More importantly, we demonstrate that the conflicting results regarding the response to inflation for the pre-Volcker period in the existing literature is not attributable to the different data but due to different samples, and also provided an insight regarding the Great Inflation??namely, that the near non-response to inflation in the early 1960s appears to have constituted the initial seed of the Great Inflation. We also find via analysis of the Markov-switching model for the U.S. real interest rate, that the regime changes in the real interest rate follow the regime changes in monetary policy within 2?years and that the evolution of real interest rate regimes provides a good explanation for the conflicting results regarding the dynamics of real interest rate.     

Monetary control uncertainty and inflation bias

This paper offers an alternative explanation for the occurrence of an inflation bias with and without an output goal exceeding natural output. A monetary game model is developed from which an inflation bias emerges because the policymaker increases money growth in order to avoid a recession due to a possible negative control error. Whereas higher additive instrument uncertainty increases the inflation bias, higher multiplicative uncertainty decreases it. Delegating monetary policy to an independent and conservative central banker decreases the inflation bias for all types of control errors.     

MISPERCEPTIONS AND MONETARY POLICY IN A NEW-KEYNESIAN MODEL

This paper studies the consequences for the monetary policy design of information shortages on the part of the private sector. We model these shortages as exogenous shocks to expected income, which through an IS curve, disturb aggregate demand. We constrain policymakers to follow Taylor‐like rules but allow them to optimise coefficients: we find that the presence of misperceptions makes the optimised Taylor rule respond more aggressively to inflation and the output gap. We also find that if the policymaker is uncertain about misperceptions, then it is less costly to assume they are pervasive when they are not than the reverse. In other words, setting policy on the basis that the private sector is subject to misperceptions is a ‘robust’ policy.     

Bank lending and interest on excess reserves: An empirical investigation

This paper econometrically tests for effects on bank lending of the Federal Reserve’s policy of paying interest on excess reserves (IOER). Following the 2008 financial crisis, US banks decreased their loan allocations and increased holdings of excess reserves. A model of bank asset allocation shows that when the rate of IOER is higher than other short-term rates, banks will switch from zero excess reserves to a regime with higher excess reserves and lower lending. Using a sample of panel data on US banks from 2000 through 2018, we find evidence of a switch to a positive excess reserve regime in the post-crisis period. Controlling for market interest rates, loan demand, and economic activity, we find that IOER accounts for the majority of the decline in bank lending after the financial crisis.     

The link between the federal funds rate and banking system distress: An empirical investigation

We investigate the association between deviations of the monetary policy rate from its benchmark, and systemic risk between 2001 and 2017. We adopt an impulse response function framework that uses the local projections method model proposed by Jorda (2005). We find that paying interest on reserves by the Fed beginning in 2008 introduced a monetary policy regime shift between the period that the Fed did not pay interest on reserves and the period that it did. Consequently, while we identify a positive and significant link between deviations of the policy rate from its benchmark and systemic risk in the former period, this link was broken in the latter period. During the former period, upsurges in the fed funds rate raised bank costs and increased bank distress. In contrast, during the latter period, interest payment on reserves exceeded the policy rate, except for 2009Q1, and as a result, banks did not expand lending in response to the Fed's reserve injections, instead, holding large amounts of excess reserves. This practice produced greater bank profitability and reduced bank liquidity risk and credit risk, without increasing systemic risk.     

Optimal interest rate rule in a DSGE model with housing market spillovers

This paper studies the optimal interest rate rule in a DSGE model with housing market spillovers (Iacoviello and Neri, 2010). We find that the optimal rule responds to house price inflation even when the stabilization of house price is not among the objectives of the policymaker, and that the strength of the response depends crucially on a few structural parameters.     

Inflation Expectations and Monetary Policy Surprises*

We estimate monetary policy surprises for European consumers over time, based on monetary policy changes that were unanticipated according to consumers’ stated beliefs. We find that such monetary policy surprises have the opposite impact on inflation expectations from the impact found when assuming that consumers are well informed. Relaxing the latter assumption by focusing on consumers’ stated beliefs, unanticipated increases in the interest rate raise inflation expectations before the 2008 financial crisis. This is consistent with imperfect information theoretical settings where interest rate hikes are interpreted as positive news about the state of the economy by consumers who know that policymakers have relatively more information.