PPP test for Asian countries and regions: new evidence from a wild bootstrap AESTAR test

This article investigates the effects of time-varying variance on the asymmetric exponential smooth transition autoregressive (AESTAR) unit root test. We propose a wild bootstrap-based implementation of the test, which is asymptotically valid under time-varying variance. We apply our proposed method to test the Purchasing Power Parity (PPP) hypothesis for Asian countries and regions, and find that our proposed test provides stronger evidence against the PPP hypothesis than the conventional AESTAR test.     

Asymmetric monetary policy rules for the euro area and the US

We analyse the implications of asymmetric monetary policy rules by estimating Markov-switching DSGE models for the euro area (EA) and the US. The estimations show that until mid-2014 the ECB’s response to inflation was more forceful when inflation was above than below the central bank’s aim. Since then, the ECB’s policy can be characterised as symmetric, and we quantify the macroeconomic implications of this policy change. We uncover asymmetries also in the Fed’s policy, which has responded more strongly in times of crisis. We compute optimal simple rules for the EA and the US in an environment with the effective lower bound and a low neutral real rate, and find that it prescribes a stronger response to inflation and the output gap when inflation is below target compared to when it is above target. We document its stabilisation properties had this optimal rule been implemented over the last two decades.     

LINKAGES BETWEEN EXCHANGE RATE POLICY AND MACROECONOMIC PERFORMANCE

Using a sample of 104 countries, we study macroeconomic performance from 1973 to 2007. We examine GDP growth, inflation rate, growth volatility and inflation volatility, and their response to a ‘words versus deeds’ measure of exchange‐rate policy, which is obtained by interacting a country's de jure and its de facto policy. For non‐industrialized countries, the highest growth rates and the lowest inflation volatility are associated with countries that pursue fear of floating policy, whereas countries that pursue a matched float policy (de jure and de facto floating) have the highest inflation rates but the lowest GDP volatility.     

Selecting Your Inflation Targeters: Background and Performance of Monetary Policy Committee Members

Abstract. This paper starts by describing the composition of monetary policy committees (MPCs) in inflation‐targeting and non‐targeting countries. The experience of MPC members on their inflation performance is then compared, opposing inflation targeters with non‐targeters. Our sample covers the major Organization for Economic Cooperation and Development countries, in the period 1999–2008. Our results first show that MPCs are different in inflation‐targeting (versus non‐targeting) countries. They also reveal that policy‐makers' backgrounds influence inflation, and that the influence of MPCs' experience is much greater in inflation‐targeting countries, while size effects are more important for committees that do not target inflation.     

Asymmetric monetary policy rules in Australia

In this study, the hypothesis that the Reserve Bank of Australia (RBA) implements an asymmetric monetary policy rule is tested. We estimate both linear and asymmetric monetary policy reaction functions for the period before inflation targeting was adopted, for the period when inflation targeting was explicitly adopted and for the full sample period. The results of the linear monetary policy rules are consistent with the estimates reported from other studies that estimate linear monetary policy rules for Australia. On the other hand, the results of estimating the asymmetric monetary policy rules for the pre-inflation targeting period shows that the RBA had reacted symmetrically, suggesting that it had acted with the same aggressiveness towards both inflation and output gaps of the same magnitude, over both phases of the business cycle. However, for the inflation targeting period, the results show that the RBA had reacted asymmetrically in its policy response to the inflation gap, output gap or both. A similar result is found for the full sample period. This asymmetric response supports the view that a non-linear monetary policy rule emanated from asymmetric preferences, rather than from the existence of a non-linear Phillips curve.     

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.     

More effective than we thought: Central bank independence and inflation in developing countries

This study examines the effect of legal central bank independence on inflation in developing countries. In spite of the policy consensus suggesting that central bank independence is an effective tool to control inflation, the evidence is still limited, particularly for developing countries. Using a novel dataset, we analyze the effect of central bank independence on inflation for a sample of 118 developing countries between 1980 and 2013. We find that higher central bank independence is associated with lower inflation rates. This effect on inflation is stronger the more democratic a country is, but it is also present in non-democratic countries. Our results are robust to different specifications and methodologies. Furthermore, we find that all dimensions included in the measurement of central bank independence (objectives, personnel, policy, and financial independence) contribute to curb inflation. Our results shed light on which types of reforms may be more effective at fighting inflation in developing countries.     

Asymmetric Monetary Policy in Australia*

We find evidence for asymmetric behaviour in Australian monetary policy. During 1984–1990, the Reserve Bank of Australia acted with considerable discretion yielding poor performance of an interest rate rule. However, it behaved asymmetrically to inflation and the output gap in downturns and upturns. On embracing inflation targeting from 1991, it enhanced its credibility by anchoring inflation expectations. Not only did its actions become more predictable in 1991–2002, it responded asymmetrically only to output, switching to act more acutely in downturns. Although its asymmetric behaviour could result from asymmetric preferences or non‐linear aggregate supply, our results support the former explanation.     

The evolution of inflation expectations in Canada and the US

We model inflation forecasts as monotonically diverging from an estimated long‐run anchor point towards actual inflation as the forecast horizon shortens. Fitting the model with forecaster‐level data for Canada and the US, we identify three key differences between the two countries. First, the average estimated anchor of US inflation forecasts has tended to decline gradually over time in rolling samples, from 3.4% for 1989–1998 to 2.2% for 2004–2013. By contrast, it has remained close to 2% since the mid‐1990 for Canadian forecasts. Second, the variance of estimates of the long‐run anchor is considerably lower for the panel of Canadian forecasters than US ones following Canada's adoption of inflation targets. And third, forecasters in Canada look much more alike than those in the US in terms of the weight that they place on the anchor. One explanation for these results is that an explicit inflation‐targeting regime (Canada) provides for less uncertainty about future monetary policy actions than a monetary policy regime where there was no explicit numerical inflation target (the US before 2012) to anchor expectations.     

Optimal monetary policy reaction function in a model with target zones and asymmetric preferences for South Africa

This paper estimates the optimal response of the SARB to deviations of inflation and output from their target values over the inflation targeting era. This is achieved using an empirical framework that allows the central bank's policy preferences to be zone-like and asymmetric. The first major finding is that the monetary authorities' response towards inflation is zone symmetric. That is, they react in a passive manner when inflation is within the target band whereas they become increasingly aggressive when it deviates from the target band. The monetary authorities also react with the same level of aggressiveness regardless of whether inflation overshoots or undershoots the inflation target band. The second major finding is that the monetary authorities' response to output fluctuations is asymmetric. That is, they react more aggressively to negative deviations of output from the potential so that they weigh business cycle recessions more than expansions.     

CREDIBILITY, MACROECONOMIC FUNDAMENTALS AND MARKOV REGIME SWITCHES IN THE EMS

The main objective of this paper is to use the Markov regime‐switching modelling framework to describe and analyse the credibility of a number of countries participating in the European Monetary System during 1980–1998. Our credibility indicator, based on Hughes Hallet et al.'s (1997) methodology, is subject to discrete regime shifts and is made dependent on macroeconomic fundamentals. We carry out extensive testing to assess the specification of the Markov regime‐switching model and the potential existence of permanent breaks. A contribution of our paper is the specification of a multivariate Markov switching model that allows us to examine whether macroeconomic variables have asymmetric effects on credibility. Another contribution is the specification of a regime‐switching model with time‐varying transition probabilities, which enables us to determine whether changes in macroeconomic variables can trigger switches between the low and high credibility regimes. We find strong evidence of regime switching behaviour in all countries. Both the level of credibility and the transition probabilities display an asymmetric response to changes in macroeconomic variables, with the stance of fiscal policy exerting the most systematic influence in all countries.     

Optimal monetary policy revisited: does considering US real-time data change things?

The primary goal of this article is to investigate whether properly modelling real-time data and optimal real-time decision-making of a monetary planner provides new insights into monetary policy behaviour and outcomes. This article extends a variant of the asymmetric preference model suggested by Ruge-Murcia to investigate the use of real-time data available to policymakers when making their decisions and revised data which more accurately measure economic performance, but is only available much later. In our extended model, the central banker targets a weighted average of revised and real-time inflation together with a weighted average of revised and real-time output. Moreover, we allow for an asymmetric central bank response to real-time data depending on whether the unemployment rate is high or low. Our model identifies several new potential sources of inflation bias due to data revisions. Our empirical results suggest that the Federal Reserve Bank focuses on targeting revised inflation during low unemployment periods, but it weighs heavily real-time inflation during high unemployment periods. The inflation bias due to data revisions is comparable in magnitude to the bias from asymmetric central banker preferences with the bias being somewhat larger during high unemployment.     

Fiscal Transfers in a Monetary Union with Exit Option

It is widely debated whether a monetary union has to be accompanied by a fiscal transfer scheme to accommodate asymmetric shocks. We build a model of a monetary union with a central bank and two heterogeneous countries that are linked by a fiscal transfer scheme with repercussions on monetary policy. A central bank aiming at securing the existence of a monetary union in the presence of asymmetric shocks has to compensate single countries for the tax distortions arising from fiscal transfers. Monetary policy may become more expansionary or restrictive depending on asymmetries between member countries' inflation aversion and exit costs.     

Monetary Policy Delegation and Transparency of Policy Targets: A Positive Analysis

Abstract. We show that, in a two‐stage model of monetary policy with stochastic policy targets and asymmetric information, the transparency regime chosen by the central bank does never coincide with the regime preferred by society. Independent of society's endogenous choice of delegation, the central bank reveals its inflation target and conceals its output target. In contrast, society would prefer either transparency or opacity of both targets. As a conclusion, the choice of the transparency regime should be part of the optimal delegation solution.     

Inflation Targeting and Inflation Persistence

This paper argues that the adoption of an inflation target reduces the persistence of inflation.We develop the theoretical literature on inflation persistence by introducing a Taylor Rule for monetary policy into a model of persistence and showing that inflation targets reduce inflation persistence.We investigate changes in the time series properties of inflation in seven countries that introduced inflation targets in the late 1980s or early 1990s.We find that the persistence of inflation is greatly reduced or eliminated following the introduction of inflation targets.     

China's regime-switching monetary policy

To understand Chinese monetary policy, we estimate a forward-looking Taylor-type monetary policy reaction function. The novelty of our paper lies in two aspects. The first is to use a composite overall indicator (the Sun-MP index) to tackle the measurement uncertainty and hence the model selection problem (i.e., a Taylor versus McCallum rule). The second is to capture nonlinearities in the PBC's policy responses with the multiple-regime threshold regression model. We find strong evidence that the PBC's policy reaction function is asymmetric during the post-2000 period and switches across three different regimes. When expecting high inflation, the PBC tightens by adjusting various policy tools; while facing an expected economic slowdown, it eases. However, it is tolerant to low inflation and economic overheating; it barely reacts to them. These findings highlight the importance of allowing for regime switches in modelling the policy response function of a “young” and fast evolving central bank in emerging countries like China.     

Is There a Trade‐Off Between Inflation Variability and Output‐Gap Variability in the EMU Countries?

This paper examines the performance of monetary policy in eleven EMU countries for the whole period of the EMS. This is based on the trade‐off between inflation variability and output‐gap variability. To this end, we examine whether the introduction of an implicit inflation targeting by the EMU member countries after the Maastricht Treaty, changed the trade‐off between inflation variability and output‐gap variability. We employ a stochastic volatility model for two sub‐periods of the EMS (i.e. before and after the Maastricht Treaty). We find that the trade‐off varies amongst EMU countries. The implication of these findings is that there are asymmetries in the euro area, due to different economic structures among the member countries of the EMU.     

Time Series Analysis of Inflation Targeting in Selected Countries

Abstract

We analyze a set of countries which adopted inflation targeting (IT) as a policy tool. We model the pre‐IT period with ARMA and GARCH methods, and conduct the one‐step ahead forecasting for the remainder of the times series data. The actual and forecasted inflation levels are compared for each country. We find that even though the actual inflation levels are lower than the forecasted ones, there is no statistical evidence to suggest that the adoption of IT causes a structural break in the inflation levels of the countries which adopt IT.     

Downward nominal wage rigidity in Canada: Evidence against a “greasing effect”

The existence of downward nominal wage rigidity (DNWR) has often been used to justify a positive inflation target. It is traditionally assumed that positive inflation could “grease the wheels” of the labour market by putting downward pressure on real wages, easing labour market adjustments during a recession. A rise in the inflation target would attenuate the long‐run level of unemployment and hasten economic recovery after an adverse shock. Following Daly and Hobijn (2014), we re‐examine these issues in a model that accounts for precautionary motives in wage‐setting behaviour. We confirm that DNWR generates a long‐run negative relationship between inflation and unemployment, in line with previous contributions to the literature. However, we also find that the increase in the number of people bound by DNWR following a negative demand shock rises with the inflation target, offsetting the beneficial effects a higher inflation target has on closing the unemployment gap. As an implication, contrary to previous contributions that neglected precautionary behaviour, the speed at which unemployment returns back to pre‐crisis levels during recessions is relatively unaffected by variations in the inflation target.     

Cross‐country asymmetries in monetary policy transmission: evidence from EMU members

This paper analyzes monetary policy asymmetries in EMU participating countries. In particular, we use a structural dynamic modelling approach to investigate asymmetric monetary transmission in Europe. Asymmetries are investigated in two different ways. First, we restrict the estimated structural models reflecting the monetary constraints each country faced during the EMS period. We obtain well‐behaved and comparable effects of monetary policy shocks. Second, efficiency frontiers for the selected EMU countries are estimated. In computing the optimal combinations of output gap and inflation volatility we use a weighted average of interest rate and exchange rate, i.e. the Monetary Condition Index (MCI), as a policy instrument. The impulse response analysis implemented with the MCI shows relatively small differences in the responses of the real economy to monetary policy shocks. Altogether the results suggest that, no matter which policy instrument is used, output gap and inflation respond to identical monetary shocks with a similar speed and movement, albeit with a different degree of effect.