Model Uncertainty, Optimal Monetary Policy and the Preferences of the Fed

Monetary policy in the US is characterized by a substantial degree of inertia. While in principle this may well be the outcome of an optimizing central bank behaviour, the ability of any derived policy rule to match the data relies on so large weights for interest rate smoothing into policy makers' preferences as to be theoretically flawed. In this paper we investigate whether such a puzzle can be interpreted as resulting from the concern of monetary authorities for potential misspecifications of the macroeconomic dynamics. Accordingly, we propose a novel thick modelling approach that incorporates model uncertainty into the identification of central bank's preferences. The thick robust policy rule shows the kind of smoothness observed in the data without resorting to implausible values for the preference parameters.     

What does a Monetary Policy Shock Do? An International Analysis with Multiple Filters*

What does a monetary policy shock do? We answer this question by estimating a new‐Keynesian monetary policy dynamic stochastic general equilibrium model for a number of economies with a variety of empirical proxies of the business cycle. The effects of two different policy shocks, an unexpected interest rate hike conditional on a constant inflation target and an unpredicted drift in the inflation target, are scrutinized. Filter‐specific Bayesian impulse responses are contrasted with those obtained by combining multiple business cycle indicators. Our results document the substantial uncertainty surrounding the estimated effects of these two policy shocks across a number of countries.     

Yield Curve and Financial Uncertainty: Evidence Based on US Data

How do short‐ and long‐term interest rates respond to a jump in financial uncertainty? We address this question by conducting a local projections analysis with US monthly data, period: 1962–2018. The state‐of‐the‐art financial uncertainty measure proposed by Ludvigson, Ma and Ng (2019) is found to predict movements in interest rates at different maturities. In particular, an increase in financial uncertainty is found to trigger a negative and significant response of both short‐ and long‐term interest rates. The response of the short end of the yield curve (i.e., of short‐term interest rates) is found to be stronger than that of the long end (i.e., of long‐term ones). In other words, a financial uncertainty shock causes a temporary steepening of the yield curve. This result is consistent, among other interpretations, with medium‐term expectations of a recovery in real activity after a financial uncertainty shock.     

Tracking U.S. inflation expectations with domestic and global indicators

Are foreign variables important for tracking U.S. inflation expectations? This paper estimates a reduced-form model that takes both domestic and global indicators of economic slack and inflationary pressures into account. Our main findings point towards the instability of the estimated parameters over the last four decades. In particular, global indicators appear to have played a statistically significant role in shaping forecasters’ expectations until the mid-1980s. By contrast, the U.S. monetary policy stance turns out to be relevant in the 1980s and 1990s. We relate this finding to the more aggressive monetary policy conduct implemented by the Fed since the end of the Volcker experiment.     

Testing the Structural Interpretation of the Price Puzzle with a Cost‐Channel Model*

We estimate a variety of small‐scale new‐Keynesian DSGE models with the cost channel to assess their ability to replicate the ‘price puzzle’, i.e. the inflationary impact of a monetary policy shock typically arising in vector autoregression (VAR) analysis. To correctly identify the monetary policy shock, we distinguish between a standard policy rate shifter and a shock to ‘trend inflation’, i.e. the time‐varying inflation target set by the Fed. Our estimated models predict a negative inflation reaction to a monetary policy tightening. We offer a discussion of the possible sources of mismatch between the VAR evidence and our own.     

On the dynamics of international inflation

We investigate the dynamic properties of inflation in 20 OECD countries with a novel approach based on the autocorrelation function. We find evidence in favor of long memory and nonlinearity. Linear autoregressive models are shown to be misspecified.     

What does Monetary Policy Reveal about a Central Bank's Preferences?

The design of monetary policy depends on the targeting strategy adopted by the central bank. This strategy describes a set of policy preferences, which are actually the structural parameters to analyse monetary policy making. Accordingly, we develop a calibration method to estimate a central bank's preferences from the estimates of an optimal Taylor–type rule. The empirical analysis on US data shows that output stabilization has not been an independent argument in the Fed's objective function during the Greenspan's era. This suggests that the output gap has entered the policy rule only as leading indicator for future inflation, therefore being only instrumental (to stabilize inflation) rather than important per se .
(J.E.L.: C61, E52, E58).