Inferring Policy Objectives from Economic Outcomes*

Estimated policy rules are reduced‐form equations that are silent on many important policy questions. However, a structural understanding of monetary policy can be obtained by estimating a policymaker's objective function. The paper derives conditions under which the parameters in a policymaker's policy objective function can be identified and estimated. We apply these conditions to a New Keynesian sticky‐price model of the US economy. The results show that the implicit inflation target and the relative weight placed on interest rate smoothing both declined when Paul Volcker was appointed Federal Reserve chairman.     

Analyzing Fed behavior using a dynamic Taylor-type rule

This paper estimates a dynamic Taylor-type model in order to analyze the behavior of the Federal Reserve under the leadership of three different Fed chairs: Arthur Burns, Paul Volcker, and Alan Greenspan. The model proves useful in distinguishing the conduct of monetary policy under each. Burns is found to have paid little attention to inflation and inflationary pressures. Volcker focused on reducing actual inflation during his first term while turning his attention to the GDP gap and inflationary pressures in his second term. Greenspan emphasized preemptive strikes against inflation as indicated by high weights attributed to the GDP gap and expected inflation.     

International spillovers of (un)conventional monetary policy: The effect of the ECB and the US Fed on non-euro EU countries

We estimate a global vector autoregression model to examine the effects of euro area and US monetary policy stances, together with the effect of euro area consumer prices, on economic activity and prices in non-euro EU countries using monthly data from 2001-2016. Along with some standard macroeconomic variables, our model contains measures of the shadow monetary policy rate to address the zero lower bound and the implementation of unconventional monetary policy by the European Central Bank and the US Federal Reserve. We find that these monetary shocks have the expected qualitative effects but their magnitude differs across countries, with southeastern EU economies being less affected than their peers in Central Europe. Euro area monetary shocks have a greater effect than those that emanate from the US. We also find certain evidence that the effects of unconventional monetary policy measures are weaker than those of conventional measures. The spillovers of euro area price shocks to non-euro EU countries are limited, suggesting that the law of one price materializes slowly.     

How Stable is the Forecasting Performance of the Yield Curve for Output Growth?*

We provide an extensive evaluation of the predictive performance of the US yield curve for US gross domestic product growth by using new tests for forecast breakdown, in addition to a variety of in‐sample and out‐of‐sample evaluation procedures. Empirical research over the past decades has uncovered a strong predictive relationship between the yield curve and output growth, whose stability has recently been questioned. We document the existence of a forecast breakdown during the Burns–Miller and Volker monetary policy regimes, whereas during the early part of the Greenspan era the yield curve emerged as a more reliable model to predict future economic activity.     

Monetary policy shocks: We got news!

We assess the role of monetary policy news shocks in the context of a medium scale DSGE model estimated on US data. We estimate several versions of the model and find decisive evidence in favour of the inclusion of monetary policy news shocks over a two-quarter horizon. According to our results, monetary policy news shocks account for a non-negligible fraction of the variance of real variables, especially at shorter forecast horizons. Further, we document that the importance of monetary policy news shocks goes beyond what was observed in recent years. The historical importance of monetary policy news shocks dates back to the 1999–2006 period when the official FOMC statements provided information about both the current policy setting and the expected future policy path. We also show that adding monetary policy news shocks to the model does not lead to identification problems.     

Inflation Sensitivity To Monetary Policy: What Has Changed since the Early 1980s?

Have conventional monetary policy instruments maintained the same ability to accommodate undesirable effects of shocks throughout the postwar period? Or has the changed economic environment characterizing the last 30 years diminished the sensitivity of macroeconomic volatility to systematic changes in the conduct of monetary policy? The answer is no to the first question and, consequently, yes to the second question. We estimate a medium‐scale New‐Keynesian model in two subsamples, 1955–79 and 1984–2012, and find that the sensitivity of inflation variance to changes in conventional monetary policy has declined. We document that the changed properties of the labour market largely contributed to this decline.     

Nonlinearity in the Fed's monetary policy rule

This paper investigates the nature of nonlinearities in the monetary policy rule of the US Federal Reserve (Fed) using the flexible approach to nonlinear inference. We find that while there is significant evidence of nonlinearity for the period to 1979, there is little such evidence for the subsequent period. Possible asymmetries in the Fed's reactions to inflation deviations from target and the output gap in the 1960s and 1970s may tell part of the story, but do not capture the entire nature of the nonlinearity. The inclusion of the interaction between inflation deviations and the output gap, as recently proposed, appears to characterize the nonlinear policy rule more adequately. Copyright © 2005 John Wiley & Sons, Ltd.     

Financial Depth and the Asymmetric Impact of Monetary Policy

This paper investigates the importance of financial depth in evaluating the asymmetric impact of monetary policy on real output over the course of the US business cycle. We show that monetary policy has a significant impact on output growth during recessions. We also show that financial deepening plays an important role by dampening the effects of monetary policy shocks in recessions. The results are robust to the use of alternative financial depth and monetary policy shock measures as well as to two different sample periods.     

Monetary policy with interest on reserves

I analyze monetary policy with interest on reserves and a large balance sheet. I show that conventional theories do not determine inflation in this regime, so I base the analysis on the fiscal theory of the price level. I find that monetary policy can peg the nominal rate, and determine expected inflation. With sticky prices, monetary policy can also affect real interest rates and output, though higher interest rates raise output and then inflation. The conventional sign requires a coordinated fiscal–monetary policy contraction. I show how conventional new-Keynesian models also imply strong monetary–fiscal policy coordination to obtain the usual signs. I address theoretical controversies. A concluding section places our current regime in a broader historical context, and opines on how optimal fiscal and monetary policy will evolve in the new regime.     

USA

The Federal Reserve, having failed in its attempts to persuade either the Japanese or West German governments to adopt a more expansionary stance, has persisted in its policy of monetary relaxation as a means of boosting domestic: demand and, by way of a lower dollar, improving US competitiveness. In spite of a monetary overshoot, interest rates have been cut repeatedly this year and the current level of the discount rate is the lowest in nearly a decade. The tightening of fiscal policy, which Federal Reserve Chairman Paul Volcker insisted was a pre-requisite of monetary easing, remains elusive. As the "automaticity" element of Gramm-Rudman has been declared unconstitutional, the onus for cutting the budget deficit is once more back on Congress. And while little progress is made on reducing domestic absorption, the trade and current account deficits continue to set new records.     

National natural rates of interest and the single monetary policy in the euro area

We estimate time‐varying national natural real rates of interest (r^?) for the four largest economies of the euro area over 1999–2016. We further derive the associated national real interest rate gaps, which gauge the perceived monetary policy stance in each country. We find that the average r^? have been lower after 2008. Furthermore, national r^? were significantly negative in southern countries during the sovereign crisis. As their effective real rates soared, national rate gaps across the euro area diverged. However, a common policy stance has been restored since 2014 as the European Central Bank's unconventional programs gathered pace.     

In search for yield? Survey-based evidence on bank risk taking

Monetary policy can have an impact on economic and financial stability through the risk taking of banks. Falling interest rates might induce investment into risky activities. This paper provides evidence on the link between monetary policy and bank risk taking. We use a factor-augmented vector autoregressive model (FAVAR) for the US for the period 1997–2008. Besides standard macroeconomic indicators, we include factors summarizing information provided in the Federal Reserve’s Survey of Terms of Business Lending (STBL). These data provide information on banks׳ new loans as well as interest rates for different loan risk categories and different banking groups. We identify a risk-taking channel of monetary policy by distinguishing responses to monetary policy shocks across different types of banks and different loan risk categories. Following an expansionary monetary policy shock, small domestic banks increase their exposure to risk. Large domestic banks do not change their risk exposure. Foreign banks take on more risk only in the mid-2000s, when interest rates were ‘too low for too long’.     

Markov switching causality and the money–output relationship

The causal link between monetary variables and output is one of the most studied issues in macroeconomics. One puzzle from this literature is that the results of causality tests appear to be sensitive with respect to the sample period that one considers. As a way of overcoming this difficulty, we propose a method for analysing Granger causality which is based on a vector autoregressive model with time‐varying parameters. We model parameter time‐variation so as to reflect changes in Granger causality, and assume that these changes are stochastic and governed by an unobservable Markov chain. When applied to US data, our methodology allows us to reconcile previous puzzling differences in the outcome of conventional tests for money–output causality. Copyright © 2005 John Wiley & Sons, Ltd.     

A BUDGET FOR STERLING AND A BUDGET FOR JOBS

In our assessment macroeconomic policy is now tighter as consequence of the Budget than we had assumed in February. We interpret the Budget speech as indicating higher interest rates (tighter monetary policy) and, in consequence, a stronger exchange rate. On this basis we find that the prospects for inflation are slightly better than before, though output is weaker. Additionally we forecast a PSBR in 1985-6 of £ 63/4bn, below the official forecast of £7.1bn but in line with our February forecast. Of £7.1bn but in line with our February forecast. Because output is lower, however, this implies a tighter fiscal policy.
The other main change to our forecast is unemployment. The changes to National Insurance Contribution scales represent a very cheap way of reducing the cost of employing the lower paid, and we estimate that these measures, together with the extension of the Youth Training Scheme and Community Programme, will create an extra 375,000 jobs and training places by 1988. However these effects are partially offset by the effects on output of the higher interest rates and higher exchange rate that we are now forecasting. When account is also taken of the increase in labour supply that follows any increase in employment, the net effect on unemployment is to reduce it by 300,000 by 1988 compared with our February forecast.     

Estimating and Forecasting the Yield Curve Using A Markov Switching Dynamic Nelson and Siegel Model

We estimate versions of the Nelson–Siegel model of the yield curve of US government bonds using a Markov switching latent variable model that allows for discrete changes in the stochastic process followed by the interest rates. Our modeling approach is motivated by evidence suggesting the existence of breaks in the behavior of the US yield curve that depend, for example, on whether the economy is in a recession or a boom, or on the stance of monetary policy. Our model is parsimonious, relatively easy to estimate and flexible enough to match the changing shapes of the yield curve over time. We also derive the discrete time non‐arbitrage restrictions for the Markov switching model. We compare the forecasting performance of these models with that of the standard dynamic Nelson and Siegel model and an extension that allows the decay rate parameter to be time varying. We show that some parametrizations of our model with regime shifts outperform the single‐regime Nelson and Siegel model and other standard empirical models of the yield curve. Copyright © 2014 John Wiley & Sons, Ltd.     

The impact of oil price changes on selected macroeconomic indicators in Azerbaijan

We examine the relationship between oil price fluctuations and economic activity in Azerbaijan using vector autoregressive models for the period 2002Q1–2018Q4. Our key results are as follows. First, growth in the gross domestic product (GDP) decreases after oil price innovations in the oil and gas sector and in the remainder of the economy. Downturns (upswings) in the oil and gas sector also prompt downturns (upswings) in the non-oil sector as fluctuations in oil revenues affect the government's capacity to subsidize the rest of the economy. Second, oil price innovations also lead to higher inflation in Azerbaijan. In response to the required tightening of monetary policy, the manat appreciates against the US dollar. Finally, GDP effects are primarily seen after oil price increases, whereas the interest rate and the exchange rate mainly react to decreases. Inflation increases after both types of shocks, due to either the accommodative monetary policy stance in the case of oil price decreases or the shock itself in the case of increases.     

Monetary policy regimes and the term structure of interest rates

US monetary policy is investigated using a regime-switching no-arbitrage term structure model that relies on inflation, output, and the short interest rate as factors. The model is complemented with a set of assumptions that allow the dynamics of the private sector to be separated from monetary policy. The monetary policy regimes cannot be estimated if the yield curve is ignored during estimation. Counterfactual analysis evaluates importance of regimes in policy and shocks for the great moderation. The low-volatility regime of exogenous shocks plays an important role. Monetary policy contributes by trading off asymmetric responses of output and inflation under different regimes.     

Bayesian counterfactual analysis of the sources of the great moderation

We use counterfactual experiments to investigate the sources of the large volatility reduction in US real GDP growth in the 1980s. Contrary to an existing literature that conducts counterfactual experiments based on classical estimation and point estimates, we consider Bayesian analysis that provides a straightforward measure of estimation uncertainty for the counterfactual quantity of interest. Using Blanchard and Quah's ( 1989 ) structural VAR model of output growth and the unemployment rate, we find strong statistical support for the idea that a counterfactual change in the size of structural shocks alone, with no corresponding change in the propagation of these shocks, would have produced the same overall volatility reduction as what actually occurred. Looking deeper, we find evidence that a counterfactual change in the size of aggregate supply shocks alone would have generated a larger volatility reduction than a counterfactual change in the size of aggregate demand shocks alone. We show that these results are consistent with a standard monetary VAR, for which counterfactual analysis also suggests the importance of shocks in generating the volatility reduction, but with the counterfactual change in monetary shocks alone generating a small reduction in volatility. Copyright © 2007 John Wiley & Sons, Ltd.     

The Impact of the 2008 Crisis on UK Prices: What We Can Learn from the CPI Microdata1

This paper takes the locally collected price quotes used to construct the CPI index in the UK for the period 1996–2013 and explores the impact of the Great Recession (2008‐9) on the pricing behaviour of firms. We develop a time series framework which captures the link between macroeconomic variables and the behaviour of prices in terms of the frequency of price change, the dispersion of price levels and the size, dispersion and kurtosis of price‐growth. We find strong evidence for inflation having an effect, but not output. The change in the behaviour of prices during the Great Recession is largely explained by the changes in inflation and VAT. Nevertheless, the magnitude of the inflation effect is sufficiently small that it need not influence monetary policy.