OPTIMAL MONETARY POLICY WITH THE STICKY INFORMATION MODEL OF PRICE ADJUSTMENT: INFLATION OR PRICE‐LEVEL TARGETING?

I investigate the optimal monetary policy in a New Keynesian macroeconomic framework with the sticky information model of price adjustment. The model is solved for optimal policy, and welfare implications of three alternative monetary policy regimes under this optimal policy are compared when there is a cost‐push shock to the economy. These monetary policy regimes are the unconstrained policy, price‐level targeting and inflation targeting regimes. The results illustrate that optimal policy depends on the degree of price stickiness and the persistence of the shock. Inflation targeting emerges as the optimal policy if prices are flexible enough or the shock is persistent enough. However, the unconstrained policy or price‐level targeting might be preferable to inflation targeting if prices are not very flexible and the shock is not very persistent. The results also show that as prices become more flexible, the welfare loss usually gets bigger.     

Financial market imperfections and monetary policy strategy

In a model with imperfect money, credit and reserve markets, we examine if an inflation-targeting central bank applying the funds rate operating procedure to indirectly control market interest rates also needs a monetary aggregate as policy instrument. We show that if private agents use information extracted from money and financial markets to form inflation expectations and if interest rate pass-through is incomplete, the central bank can use a narrow monetary aggregate and the discount interest rate as independent and complementary policy instruments to reinforce the credibility of its announcements and the role of inflation target as a nominal anchor for inflation expectations. This study shows how a monetary policy strategy combining inflation targeting and monetary targeting can be conceived to guarantee macroeconomic stability and the credibility of monetary policy. Friedman's k-percent money growth rule, which can generate dynamic instability, and two alternative stabilizing feedback monetary targeting rules are examined.     

Over- and Underbidding in Central Bank Open Market Operations Conducted as Fixed Rate Tender

Abstract. Open market operations play a key role in allocating central bank funds to the banking system and thereby in steering short‐term interest rates in line with the stance of monetary policy. Many central banks apply so‐called ‘fixed rate tender’ auctions in their open market operations. This paper presents, on the basis of a survey of central bank experience, a model of bidding in such tenders. In their conduct of fixed rate tenders, many central banks faced specifically an ‘under‐’ and an ‘overbidding’ problem. These phenomena are revisited in the light of the proposed model, and the more general question of the optimal tender procedure and allotment policy of central banks is addressed.     

Independence Before Conservatism: Transparency, Politics and Central Bank Design

Abstract. The problem of monetary policy delegation is formulated as a two‐stage game between the government and the central bank. In the first stage the government chooses the institutional design of the central bank. Monetary and fiscal policy are implemented in the second stage. When fiscal policy is taken into account, there is a continuum of combinations of central bank independence and conservatism that produce optimal outcomes. This indeterminacy is resolved by appealing to practical considerations. In particular, it is argued that full central bank independence facilitates the greatest degree of policy transparency and political coherence.     

Inflation, government transfers, and optimal central bank independence

The problem of monetary policy delegation is formulated as a two-stage non-cooperative game between the government and the central bank. The solution to this policy game determines the optimal combination of central bank conservatism and independence. The results show that the optimal institutional design always requires some degree of central bank independence and that there is substitutability between central bank independence and conservatism. The results also show that partial central bank independence can be optimal and that there are circumstances under which it is optimal for the government to appoint a liberal central banker.     

Financial imbalances and gradualism

In the last years, in the major OECD economies, while inflation has become lower and more stable, episodes of financial instability and large cycles in asset prices have shown up with (often) non-negligible effects on economic activity. These facts should call for a larger concern with financial imbalances by the central bank. Adapting the model by Caplin and Leahy (1996)—where a central bank, which is uncertain about the state of the economy and its reaction to policy, seeks an optimal search strategy to influence private agents' responses—by substituting the central bank's price stability objective with a financial stability one, we find that the monetary authority should follow a less aggressive policy than the one suggested by the original model. However, initial conditions play a crucial role in determining the degree of gradualism by the policy maker with the policy becoming more and more aggressive as the initial interest rate shrinks.     

Should a central bank react to food inflation? Evidence from an estimated model for Chile

We examine whether food price shocks are a major source of macroeconomic fluctuations. We estimate a small open economy DSGE model using an alternative Taylor rule applied to Chilean data. The empirical evidence suggests that food inflation played a non-trivial role in shaping Chile's de facto monetary policy actions. Consistent with its commitment to price stability, the central bank increases the policy rate in reaction to food inflation. Despite an immediate monetary policy reaction to a food price shock, the policy rate gradually tapers off. This is due to a second-round effect on non-food inflation propagated by the food price shock. A main finding is that monetary policy that targets headline inflation is welfare improving.     

住房价格、消费与中国货币政策最优选择:基于异质性房价预期的视角

在异质性房价预期和流动性约束条件下,本文构建了包括家庭消费决策、企业生产决策以及中央银行货币政策决策的理论模型。在此基础上,本文采用混合的RBC-VAR方法和1998年1季度至2010年3季度的数据模拟分析了住房价格、消费和货币政策选择之间的关系。结果表明:预期房价上涨的家庭越多,住房价格波动对消费波动的影响越大;贷款价值比越高,住房价格波动对消费波动的放大效应越强,但经验证据并没有支持这种放大效应;盯住住房价格的货币政策获益很少,其在减少产出波动的同时增加了通货膨胀波动。因此,中国人民银行应遏制房价偏离均衡的上涨,尤其是房价上涨预期,但货币政策不宜盯住住房价格。     

Optimal monetary policy regime for oil producing developing economies: Implications for post-war Iraq

This paper theoretically investigates optimal monetary policy regime for oil producing developing countries. We analyze credibility and reputation of the Central Bank and macroeconomic dynamics under alternative monetary policy regimes. We construct a detailed and realistic model that can be used to analyze macroecomic structure and expectation dynamics of an oil producing open economy. We take into account the asymmetric information between the public and the central bank and theoretically investigate how this asymmetric information impacts the real economy and the credibility of the central bank. The simulation results indicate that central bank achieves higher credibility and lower inflation under dollarization and higher output levels under currency board regime. The model constructed in this paper has many policy implications for oil producing open economies. Using the implications of the model, we make monetary policy regime recommendations for post-war Iraq.     

INTERACTION BETWEEN MONETARY AND FISCAL AUTHORITIES UNDER INCOMPLETE INFORMATION

This paper analyzes the interaction between monetary and fiscal authorities under incomplete information. The inflation goal of the central bank is assumed to be unknown to the fiscal authority and the public. The central bank signals the goal by choosing the first‐period monetary policy before the fiscal authority joins the policy‐making game. If the central bank would like the fiscal authority and the public to believe that it is wet (dry), the central bank would distort the money supply upward (downward) in order to reveal its actual type.     

中国实行通货膨胀目标制的可行性分析

通货膨胀目标制是一种以保持低而稳定的通货膨胀为首要目标的货币政策框架。本研究参照IMF提出的相关指标,并考虑到中国作为转型国家的经济特征,从中国当前经济运行中控制一般物价水平的必要性、经济结构的完善性、金融市场和银行体系的健全性、中央银行的独立性、货币政策的透明度以及央行准确预测通货膨胀的技术等方面考察了中国实行通货膨胀目标制的可行性,得出中国已经初步具备实施该货币制度的条件。并提出更彻底的制度改革将会确保中国成功实施通货膨胀目标制,从而使得宏观经济运行处于稳定的价格水平因而更有效率。     

Public debt indexation and denomination with an independent central bank

This paper examines the interaction between public debt management and the design of monetary institutions. The analysis shows that delegation of monetary policy to an independent central bank is more effective in containing inflationary expectations than the use of foreign currency or inflation-indexed debt. If delegation of monetary policy is viable, the optimal policy is to issue nominal debt. This increases the sensitivity of taxes and output to unexpected inflation, thus minimizing the inflation needed to offset supply shocks. Evidence on central bank independence, debt composition and output variability suggests that the normative argument has some positive content.     

Price‐level versus inflation targeting under model uncertainty

It has recently been suggested that price‐level targeting (PLT) may be a superior approach to monetary policy than inflation targeting (IT) due to its ability to automatically influence inflation expectations to stabilize the economy. In this paper, I analyze whether PLT dominates IT if the ability of the central bank to influence expectations is limited by model uncertainty. Specifically, I analyze how the characterization and performance of PLT and IT rules are impacted if private agents form expectations according to a model that deviates from the policy‐maker's reference model. Using robust control to derive robust rules in such a situation, I find that the performance of PLT rules deteriorate faster than that of IT rules as the degree of misspecification increases. Nevertheless, the absolute decline in performance of the PLT rules is relatively small across alternative models that are statistically plausible.     

Identifying monetary policy shocks with changes in open market operations

In this paper, we reexamine the effects of monetary policy shocks by exploiting the information contained in open market operations. A sticky price model is developed where money is the counterpart of securities deposited at the central bank. The model's solution reveals that a rise in central bank holdings of open market securities can be interpreted as a monetary expansion. Estimates of vector autoregressions for US data are further provided showing that reactions to an unanticipated rise in open market securities are consistent with common priors about a monetary expansion, i.e., a decline in the federal funds rate, a rise in output, and inertia in price responses. Compared to federal funds rate shocks, prices do not exhibit a puzzling behavior and a larger fraction of the GDP forecast error variance can be attributed to open market shocks. However, the explanatory power of the latter has decreased since federal funds rate targets have been announced.     

Commitment or discretion? An empirical investigation of monetary policy preferences in China

This paper offers a first attempt to estimate the policy preferences of China’s central bank by confronting a small-scale microfounded New Keynesian model in which monetary policy is described by commitment or discretion with the Chinese macroeconomic data over the period from 1992Q2 to 2017Q4. Bayesian model comparison reveals that the data favor discretionary monetary policy. Estimates of the loss function weights under both cases show that the leading policy goal is price stability, followed by output stability and then interest rate smoothing. Finally, through counterfactual analyses we assess how macroeconomic outcomes might improve, had the Chinese central bank been able to commit. These findings shed new light on the opaque Chinese monetary policy, and are robust to subsample analysis.     

ON CENTRAL BANK INDEPENDENCE, WAGE INDEXING AND A MONOPOLY UNION

The Rogoff proposition (Quarterly Journal of Economics, 100 (1985), pp. 1169–90) that it is socially optimal to delegate monetary policy to a central banker that is more inflation‐averse than society has been widely accepted and implemented in practice. However, there is a literature that argues that, if there is an inflation‐averse monopoly union in the economy, it is optimal to delegate monetary policy to an ‘ultra‐liberal’ central banker, i.e., a central banker that is interested only in output. In this paper, we examine whether introducing wage indexing into the latter models has any effect on the optimal degree of central bank conservativeness and find that, once a monopoly‐type labour union is introduced, wage indexing does not matter for the determination of the optimal degree of conservativeness of the monetary authority.     

Impact of asset price fluctuation on China’s monetary policy: An empirical analysis based on quarterly data, 1994–2006

The strenuous fluctuation in global asset price in recent years has had a profound impact on the economic and social development of every country. An empirical analysis indicates that asset prices (the stock price index and real estate prices) are important endogenous variables affecting the interest rate reaction function of central bank monetary policy. With expected inflation as a given, each one percentage point rise in output gap will cause a 0.79 percentage point reduction in interest rates by the central bank and each one percentage point rise in real estate price will result in a 2.2 percentage point rise in interest rates. The stock price index does have an influence on the trends in monetary policy, but it is less salient than the impact of housing prices. We also show that monetary policy that employs asset price as an endogenous variable increases the central bank’s control in seeking to attain its objectives. Therefore we suggest that the central bank should make asset price fluctuation an endogenous variable and incorporate it into its forward-looking interest rate rule, in order to facilitate the healthy development of China’s markets for real estate, stocks and derivatives, energy and bulk commodities and maintain rapid, smooth, sustainable and harmonious economic development.     

CENTRAL BANK INDEPENDENCE AND THE MONETARY INSTRUMENT PROBLEM

We study the monetary instrument problem in a dynamic noncooperative game between separate, discretionary, fiscal and monetary policy makers. We show that monetary instruments are equivalent only if the policy makers' objectives are perfectly aligned; otherwise an instrument problem exists. When the central bank is benevolent while the fiscal authority is short‐sighted relative to the private sector, excessive public spending and debt emerge under a money growth policy but not under an interest rate policy. Despite this property, the interest rate is not necessarily the optimal instrument.     

Hybrid Inflation-Price-Level Targeting in an Economy With Output Persistence

This paper investigates hybrid inflation‐price‐level targeting (HT), employing a Phillips curve with output persistence. By HT we mean that a central bank targets a weighted average of the optimal inflation rate and its corresponding price level. The analysis shows that if output is persistent to some extent, it is desirable to adopt HT because, relative to the case of alternative regimes such as inflation targeting (IT) and price‐level targeting (PT), it will reduce the variability of inflation and thereby social loss. In addition, it is shown that the optimal hybrid‐type target is uniquely determined according to the degree of persistence in output.     

PRICE‐LEVEL DETERMINATION UNDER DISPERSED INFORMATION AND MONETARY POLICY*

This paper considers the determination of aggregate price level under dispersed information. A Central Bank sets policy in response to its noisy measure of the price level, and each agent makes its decisions by observing a subset of data. Information revealed to the agents and the bank is determined endogenously. It is shown that the aggregate state of the economy is not revealed perfectly to anybody but this economy behaves as if it is a representative‐agent economy in which the representative agent has perfect information while the Bank has partial information. The Bank's information set affects fluctuations in the price level through its effect on policy.