MACROECONOMIC VOLATILITY AND COUNTERFACTUAL INFLATION‐TARGETING IN HONG KONG

The present paper evaluates macroeconomic adjustment in Hong Kong with an estimated dynamic stochastic general equilibrium (DSGE) model under a fixed exchange rate regime. We find that exports and world inflation shocks are the dominant sources of GDP volatility, with the risk premium taking on importance during the Asian crisis after 1997. A counterfactual simulation, assuming a flexible exchange rate regime with inflation targeting, shows that inflation would have decreased slightly, but interest‐rate volatility would have increased significantly. The welfare gains from switching out of the currency board system appear to be marginal.     

ADAPTIVE LEARNING AND MONETARY POLICY IN AN OPEN ECONOMY: LESSONS FROM JAPAN

Abstract. Motivated by Japan's economic experiences in recent decades, we incorporate adaptive learning into an open economy dynamic stochastic general equilibrium model to examine the volatility and welfare impact of alternative monetary policies. Comparing four Taylor‐styled policy rules that reflect Japan's monetary policy debates, we first show that imperfect knowledge and the associated learning process induce higher volatility in the economy and that explicit exchange rate stabilization is unwarranted. Moreover, contrary to results under the rational expectation paradigm, we find that while tight inflation controls raise output volatility, they can improve overall welfare under learning by smoothing inflation fluctuations.     

Exchange Rate Regimes and Welfare Losses from Foreign Crises: The Impact of the US Financial Crisis on Mexico

We modify the Gali and Monacelli small open economy dynamic stochastic general equilibrium (DSGE) model, calibrate to Mexican data and simulate the impact of the financial crisis on Mexico, under floating and counter factual fixed exchange rates. The floating exchange rate ameliorates welfare losses for Mexico. They are greater under fixed exchange rates because the return paths to equilibrium are more volatile (higher variance) and output, consumption and employment impulse response functions (IRFs) overshoot. Monetary policy, inflation targeting with floating exchange rates, clearly reduced the welfare costs vis‐à‐vis other counter factual policies including consumer price index‐based Taylor rule, domestic inflation Taylor rule and fixed exchange rates.     

Foreign output shock in small open economies: A welfare evaluation of monetary policy regimes

We examine the impact of negative foreign output shocks, which entail negative demand side effects by lowering exports and positive supply side effects by lowering oil prices, on the welfare of non-oil producing, small open economies under five exchange rate and monetary policy regimes. We use a dynamic stochastic general equilibrium model with parameter values calibrated for Hong Kong, Israel, Singapore, South Korea and Taiwan. We find that welfare levels among the five policy regimes depend on the economy's share of oil imports in world oil consumption. Hong Kong, Singapore and Israel, which have smaller shares, maximize welfare under the Taylor rule, which targets both CPI inflation and real output. South Korea, with higher shares, and Taiwan, with more rigid prices, maximize welfare under real output targeting. CPI inflation targeting, nominal output growth targeting and fixed exchange rate regimes generate lower welfare. However, optimal monetary policy, which generates the highest welfare, gives greater weight on real output than CPI inflation.     

Welfare cost of inflation in a stochastic balanced growth model

There is a large and growing literature on the welfare cost of inflation. However, work in this area tend to find moderate estimates of welfare gains. In this paper we reexamine welfare costs of inflation within a stochastic general equilibrium balanced growth model paying a particular attention to recursive utility, portfolio balance effects, and monetary volatility and monetary policy uncertainty. Our numerical analysis shows that a monetary policy that brings down inflation to the optimum level can have substantial welfare effects. Portfolio adjustment effects seem to be the dominant factor behind the welfare gains.     

External Debt and Taylor Rules in a Small Open Economy

We develop a dynamic stochastic general equilibrium model of a small open economy in which both price rigidity and financial friction exist. We compare two cases featuring different interest rate rules. Both cases use the standard Taylor‐type interest rate rules, but the second case also considers external debt levels. We find that when friction in foreign borrowing is large, adding an external debt level to Taylor rules improves welfare. The welfare curve, however, exhibits a hump shape because excessive reactions to changes in external debt reduce welfare.     

Gains from commitment in monetary policy: Implications of the cost channel

Many empirical studies find robust evidence that marginal cost of production directly depends on the nominal rate of interest. This relationship induces a cost channel for monetary policy transmission. Although the empirical literature provides ample evidence for a cost channel, studies that evaluate the welfare gains from monetary policy commitment have so far entirely ignored its presence. This study shows that, overlooking the cost channel, one significantly underestimates the welfare gains from monetary policy commitment. I find that there is a robust positive relationship between the size of the cost channel and welfare gains from monetary policy commitment. Using a version of the new Keynesian model calibrated to the US economy, I find that failure to take into account the presence of a cost channel leads to an understatement of the gains from monetary policy commitment by an amount equivalent to a 0.48 percentage points permanent cut in quarterly inflation.     

Unveiling the objectives of central banks: Tales of four Latin American countries

We estimate the stabilization objectives of four Latin American countries that have implemented a flexible inflation targeting regime recently: Brazil, Chile, Colombia and Peru. In doing so, we develop a New Keynesian dynamic stochastic general equilibrium model for these economies and estimate their structural parameters through Bayesian methods. To infer the stabilization objectives in each country, we assume that central banks set monetary policy optimally. Our main results highlight that the central banks in these four countries have a high preference for stabilizing inflation, but do not have the systematic objective of stabilizing the exchange rate. This result is robust to assuming either commitment or discretion in the optimal policy. Also, in contrast to the case of commitment, assuming discretion in the optimal monetary policy increases the preference for interest rate smoothing, making it comparable to a preference for inflation stabilization. Finally, except for the case of Peru, the monetary policy under discretion has a better empirical fit in these countries than the one under commitment.     

Household debt,macroprudential rules,and monetary policy

Today's Canadian economy features a historic high of household debt and persistently low growth rate. The average debt-to-GDP ratio has reached the level experienced in the U.S. just prior to the recent financial crisis. In this paper, we ask whether monetary policy should lean against the household indebtedness or macroprudential policies are better suited for the task. To provide a quantitative answer, we develop a small open economy dynamic stochastic general equilibrium model featuring a micro-founded banking sector. We estimate the model using Canadian data and conduct policy experiments. Our findings favor macroprudential approach to reining in indebtedness: using monetary policy that reacts to household debt increases inflation volatility and lowers borrowers' welfare, while using macroprudential policies such as lowering the loan-to-value ratio limit increases borrowers' welfare.     

A policy model to analyze macroprudential regulations and monetary policy

We construct a small‐open‐economy, new Keynesian dynamic stochastic general‐equilibrium model with real financial linkages to analyze the effects of financial shocks and macroprudential policies on the Canadian economy. The model incorporates rich interactions between the balance sheets of households, firms and banks, long‐term household and business debt, macroprudential policy instruments and nominal and real rigidities and is calibrated to match dynamics in Canadian macroeconomic and financial data. We study the transmission of monetary policy and financial and real shocks in the model economy and analyze the effectiveness of various policies in simultaneously achieving macroeconomic and financial stability. We find that, in terms of reducing household debt, more targeted tools such as loan‐to‐value regulations are the most effective and least costly, followed by bank capital regulations and monetary policy, respectively.     

Does wage-inflation targeting complement foreign exchange intervention? An evaluation of a multi-target,two-instrument monetary policy framework

We assess the inclusion of wage inflation as an intermediate target of an emerging central bank using a dynamic stochastic general equilibrium model with sticky wages and prices calibrated for the South Korean economy. The model includes wage inflation as an additional target jointly with domestic price inflation and the output gap in a Taylor- type interest rate rule operating with a sterilized foreign exchange (FX) intervention rule. Our results show a complementary relationship between wage inflation targeting and price inflation targeting. That is, by supplementing price inflation targeting with wage inflation targeting, welfare improves for cases with and without sterilized FX intervention. When intervention is in place, wage inflation targeting has the added advantage of reducing the volatilities of nominal exchange rate and foreign exchange reserves thereby promoting a more sustainable conduct of FX intervention.     

Budgetary policies in a DSGE model with finite horizons

This paper presents a dynamic stochastic general equilibrium model with nominal rigidities, capital accumulation and finite horizons. Our New Keynesian framework exhibits intergenerational wealth effects and is intended to investigate the macroeconomic implications of fiscal policy, which is specified by either a debt-based tax rule or a balanced-budget rule allowing for temporary deficits. The model predicts that fiscal expansions generate a trade-off in output dynamics between short-term gains and medium-term losses. It is shown that the effects of fiscal shocks crucially depend upon the conduct of monetary policy. Simulation analysis suggests that balanced-budget requirements enhance the determinacy properties of feedback interest rate rules by guaranteeing inflation stabilization.     

STATIC AND DYNAMIC EFFECTS OF CENTRAL BANK TRANSPARENCY

Using a New Keynesian framework, this paper shows that, under optimal discretion and optimal pre‐commitment in a timeless perspective, imperfect transparency about the relative weight assigned by the central bank to output‐gap stabilization generally reduces the average reaction of inflation to inflation shocks and the volatility of inflation, but increases those of the output gap in static and dynamic terms, and more so when inflation shocks are highly persistent. When inflation shocks are moderately persistent, opacity could improve social welfare if the weight assigned to output‐gap stabilization is low and this is more likely under pre‐commitment than under discretion.     

ACCOUNTABILITY AND TRANSPARENCY ABOUT CENTRAL BANK PREFERENCES FOR MODEL ROBUSTNESS

Using a New Keynesian model subject to misspecifications, we examine the accountability issue in a framework of delegation where government and private agents are uncertain about the central bank's preference for model robustness. We show that, in the benchmark case of full transparency, the optimal inflation targeting weight (or penalty) is decreasing with the preference for robustness. Departing from the benchmark equilibrium, the central bank has then incentive to be less transparent in order to reduce the optimal inflation targeting weight and thus to become more independent vis‐à‐vis the government. We also find that greater opacity will increase the sensibility of inflation and model misspecification to the inflation shock but will decrease that of output‐gap. Since macroeconomic volatility could be increased or decreased under more opacity, there could exist in some cases a trade‐off between the level and the variability of inflation (and output gap). Persistent inflation shocks could be associated with a higher inflation targeting weight as well as a higher sensibility of inflation and output gap to the inflation shock but a lower sensibility of model misspecification.     

INTEREST RATE RULES AND WELFARE IN OPEN ECONOMIES

This paper analyses the welfare performance of a set of five alternative interest rate rules in an open economy stochastic dynamic general equilibrium model with nominal rigidities. A rule with a lagged interest rate term, high feedback on inflation and low feedback on output is found to yield the highest welfare for a small open economy. This result is robust across different degrees of openness, different sources of home and foreign shocks, alternative foreign monetary rules and different specifications for price-setting behaviour. The same rule emerges as both the Nash and cooperative equilibria in a two-country version of the model.     

A graphical exposition of a more complete Keynesian system

This paper uses an expanded version of the widely cited Smith model to show the classical natural rate of interest and employment results as a special case of a more general Keynesian model. The model's equilibrium level of employment and real interest rate depend on the inflation rate. The classical results apply to changes in the price level while the Keynesian results apply to changes in the inflation rate. The model assumes inflation is anticipated in equilibrium. Violation of the classical results does not depend on market imperfections such as sticky prices or information costs.     

The welfare cost of imperfect competition and distortionary taxation

The welfare cost of imperfect competition in the product and labor markets in the United States is quantified in a dynamic general equilibrium model. We find that the welfare cost of imperfect competition in the product market is 3.62 percent while it is 0.58 percent in the labor market, taking the transition path from the distorted to the optimal steady state into account. If we also take into account that the US economy is characterized by distortionary taxation, the welfare cost of the product market distortion increases to 13.51 percent and the labor market distortion to 4.35 percent.     

Welfare costs of shifting trend inflation

This paper studies the welfare consequences of exogenous variations in trend inflation in a New Keynesian economy. Consumption and leisure respond asymmetrically to a rise and a decline in trend inflation. As a result, an increase in the variance of shocks to the trend inflation process decreases welfare not only by increasing the volatilities of consumption and leisure, but also by decreasing their average levels. I find that the welfare cost of drifting trend inflation is modest and that it comes mainly from reduced average levels of consumption and leisure, not from their increased volatilities.     

中国经济的最优通货膨胀

制定一个适宜的长期通胀目标对于提高社会经济福利具有重要意义。本文构建了一个代表性的DSGE模型,用贝叶斯方法对模型进行了参数估计,并估算了在各种不同的货币政策规则下,中国经济所应选择的最优通胀目标。研究结果表明从短期看3%左右的通胀目标是最优的,而从中长期看低通胀目标(0.5%—1%)是最优的。本文的政策建议是盯住低通胀目标有利于长期社会经济福利,管住货币,看紧通胀仍应是中国央行货币政策制定的首要考量。     

Sectoral inflation persistence and optimal monetary policy

This paper examines optimal monetary policy in a new Keynesian model with sectoral inflation persistence. It focuses on the welfare differential between timeless perspective (TP) and a purely discretionary monetary policy. Sectoral inflation persistence renders the central bank’s optimization problem more complicated under both cases of constant elasticity of substitution consumption index and generalized rule-of-thumb price setting. We find that there are substantial gains from employing a TP policy. This paper addresses the fact that this gain is robust with any changes in key structural parameters.