Discretionary monetary policy and inflation persistence

Rational expectations models of staggered price/wage contracts have failed to replicate the observed persistence in inflation and unemployment during disinflationary periods. The current literature on this persistency puzzle has focused on augmenting the nominal contract model with imperfect credibility and learning. In this paper, I re-examine the persistency puzzle by focusing on the discretionary nature of monetary policy. I show that when the central bank is allowed to re-optimize a quadratic loss function each period, imperfect credibility and learning, even in the absence of staggered contracts, can generate a significant amount of inflation persistence and employment losses during a disinflationary period.     

Inflation targeting,credibility, and non-linear Taylor rules

In this paper we systematically evaluate how central banks respond to deviations from the inflation target. We present a stylized New Keynesian model in which agents' inflation expectations are sensitive to deviations from the inflation target. To (re-) establish credibility, monetary policy under discretion sets higher interest rates today if average inflation exceeded the target in the past. Moreover, the central bank responds non-linearly to past inflation gaps. This is reflected in an additional term in the central bank's instrument rule, which we refer to as the ”credibility loss.” Augmenting a standard Taylor (1993) rule with the latter term, we provide empirical evidence for the interest rate response for a sample of five inflation targeting (IT) economies. We find, first, that past deviations from IT feed back into the reaction function and that this influence is economically meaningful. Deterioration in credibility (ceteris paribus) forces central bankers to undertake larger interest rate steps. Second, we detect an asymmetric reaction to positive and negative credibility losses, with the latter dominating the former.     

Deconstructing credibility: The breaking of monetary policy rules in Brazil

Can political interference deconstruct credibility that was hardly-earned through successful stabilization policy? We analyze the recent switch in the conduct of monetary policy by the Central Bank of Brazil (BCB). Brazil is the largest Emerging Market Economy to formally target inflation, having adopted the Inflation Targeting (IT) regime in 1999. In the early years of IT, the BCB engaged in constructing credibility with price setting agents and succeeded to anchor inflation expectations to its target even under adverse conditions such as exchange rate crises. We argue that this effort to maintain IT rules-based policy ended in 2011, as a new country president and BCB board came to power. We then discuss the consequences of this credibility loss. Our main results can be summarized as follows: (i) we provide strong empirical evidence of the BCB’s shift toward looser, discretionary policy after 2011; (ii) preliminary evidence suggests that this shift has affected agents’ inflation expectations generating social and economic costs.     

The Value of Interest Rate Stabilization Policies When Agents Are Learning

We examine the expectational stability (E-stability) of rational expectations equilibrium in the "New Keynesian" model where monetary policy is optimally derived and interest rate stabilization is added to the central bank's traditional objectives of inflation and output stabilization. We consider both the case where the central bank lacks a commitment technology and the case of full commitment. We show that for both cases, optimal policy rules yield rational expectations equilibria that are E-stable for a wide range of empirically plausible parameter values. These findings stand in contrast to Evans and Honkapohja's findings for optimal monetary policy rules in environments where interest rate stabilization is not a central bank objective.     

Using a long-term interest rate as the monetary policy instrument

Using a short-term interest rate as the monetary policy instrument can be problematic near its zero bound constraint. An alternative strategy is to use a long-term interest rate as the policy instrument. We find when Taylor-type policy rules are used by the central bank to set the long rate in a standard New Keynesian model, indeterminacy—that is, multiple rational expectations equilibria—may often result. However, a policy rule with a long-rate policy instrument that responds in a “forward-looking” fashion to inflation expectations can avoid the problem of indeterminacy.     

Taylor rules and the term structure

The expectations model of the term structure has been subjected to numerous empirical tests and almost invariably rejected, with the failure generally attributed to systematic expectations errors or to shifts in risk premia. Rules for monetary policy designed along the lines of Taylor [1993. Discretion versus policy rules in practice. Carnegie-Rochester Conference Series on Public Policy 39, 195-214] specify that the central bank adjusts short-term yields in response to deviations of inflation and output gaps from target level. Such rules give a good empirical account of the behavior of the short-term interest rate. Combining the Taylor rule and expectations theory, it is possible to generate—along lines pioneered by Campbell and Shiller [1987. Cointegration and tests of present value models. Journal of Political Economy 95, 1062-1088]—a series of theoretical long-term interest rates. When such theoretical rates are calculated for the US over 1980-2004, considerable support for the expectations theory emerges.     

Survey forecasts in Brazil: A prismatic assessment of epidemiology,performance, and determinants

This paper assesses the behavior of survey forecasts in Brazil during the inflation targeting regime, when managing expectations is one of the cornerstones of the conduct of monetary policy. The distinctive database of the survey conducted by the Central Bank of Brazil (BCB) among professional forecasters allows for a thorough investigation of the epidemiology, determinants, and performance of forecasts. The main results are: i) top performing forecasters are influential to other forecasters; ii) survey forecasts perform better than vector autoregressive model-based forecasts; iii) common forecast errors prevail over idiosyncratic components across respondents; iv) inflation targets play an important role in inflation expectations; and v) agents perceive the BCB as following a Taylor rule consistent with inflation targeting. The last two suggest high credibility of the monetary authority.     

How Disaggregation Enhances the Credibility of Management Earnings Forecasts

An important problem facing managers is how to enhance the credibility, or believability, of their earnings forecasts. In this paper, we experimentally test whether a characteristic of a management earnings forecast—namely, whether it is disaggregated—can affect its credibility. We also test whether disaggregation moderates the relation between managerial incentives and forecast credibility. Disaggregated forecasts include an earnings forecast as well as forecasts of other key line items comprising that earnings forecast. Our results indicate that disaggregated forecasts are judged to be more credible than aggregated ones and that disaggregation works to counteract the effect of high incentives. We also develop and test an original model that explains how disaggregation positively impacts three factors that, in turn, influence forecast credibility: perceived precision of management's beliefs, perceived clarity of the forecast, and perceived financial reporting quality. We show that forecast disaggregation works to remedy incentive problems only via its effect on perceived financial reporting quality. Overall, our study adds to our understanding of how managers can credibly communicate their expectations about the future to market participants.     

通胀目标调整、政策可信度与宏观调控效应北大核心

本文通过构建包含范式转变特征的DSGE模型,对通胀目标调整过程中的结构性变化以及政策可信度如何影响这一结构转变进行研究,并在此基础上分析通胀目标调整过程中政策可信度对宏观经济波动的调控效应。本文分析得到:在政策当局做出政策目标调整后,如果市场预期这一政策可信,那么主要经济变量将会在政策调整期内达到目标均衡水平;反之,如果市场预期这一政策不可信,那么市场预期和政策目标之间的分歧将使得主要经济变量偏离目标均衡水平,导致政策调整无法实现其既定目标。同时,政策可信度不仅有助于实现既定的政策目标,还能降低政策实施过程中的经济波动,具有较好的宏观调控效应,从而降低政策实施成本。特别是,政策可信度对宏观经济波动的这一稳定效应在中长期内更为明显。本文分析为理解经济结构性转变过程中的政策信用和预期管理等问题提供了一些新的思路和方法。     

An investigation of the gains from commitment in monetary policy

We propose a simple framework for analyzing a continuum of monetary policy rules characterized by differing degrees of credibility, in which commitment and discretion become special cases of what we call quasi-commitment. The monetary policy authority is assumed to formulate optimal commitment plans, to be tempted to renege on them, and to succumb to this temptation with a constant exogenous probability known to the private sector. By interpreting this probability as a continuous measure of the (lack of) credibility of the monetary policy authority, we investigate the welfare effect of a marginal increase in credibility. Our main finding is that, in a simple model of the monetary transmission mechanism, most of the gains from commitment accrue at relatively low levels of credibility.     

Price‐Level Targeting and Stabilization Policy

We construct a dynamic stochastic general equilibrium model to study optimal monetary stabilization policy. Prices are fully flexible and money is essential for trade. Our main result is that if the central bank pursues a price‐level target, it can control inflation expectations and improve welfare by stabilizing short‐run shocks to the economy. The optimal policy involves smoothing nominal interest rates that effectively smooths consumption across states.     

A quantitative exploration of the opportunistic approach to disinflation

Under a conventional policy rule, a central bank adjusts its policy rate linearly according to the gap between inflation and its target, and the gap between output and its potential. Under “the opportunistic approach to disinflation” a central bank controls inflation aggressively when inflation is far from its target, but concentrates more on output stabilization when inflation is close to its target, allowing supply shocks and unforeseen fluctuations in aggregate demand to move inflation within a certain band. We use stochastic simulations of a small-scale rational expectations model to contrast the behavior of output and inflation under opportunistic and linear rules.     

Unstable Inflation Targets

This paper studies long‐run inflation targets and stability in an imperfect information environment. When central banks set an inflation target that is not fully communicated, agents draw inferences about inflation from recent data and remain alert to structural change by forming expectations from a forecasting model that is estimated via discounted least squares. Inflation targets can lead agents' beliefs to depart from rational expectations through two channels. First, implementing a higher inflation target can lead to overshooting. Second, there can be nearly self‐fulfilling inflation, disinflation, or deflation that arises as an endogenous response to shocks. Policy implications for implementing a higher target without deanchoring expectations are discussed.     

Monetary Policy with Heterogeneous and Misspecified Expectations

In the recent literature on monetary policy and learning, it has been suggested that private sector's expectations should play a role in the policy rule implemented by the central bank, as they could improve the ability of the policymaker to stabilize the economy. Private sector's expectations, in these studies, are often taken to be homogeneous and rational, at least in the limit of a learning process. In this paper, instead, we consider the case in which private agents are heterogeneous in their expectations formation mechanisms and hold heterogeneous expectations in equilibrium. We investigate the impact of this heterogeneity in expectations on central bank's policy implementation and on the ensuing economic outcomes, and the general result that emerges is that the central bank should disregard inaccurate private sector expectations and solely base its policy on the accurate ones.     

经常账户冲击、资本账户管理与中央银行货币政策操作

经常账户负向冲击及引发的宏观变量联动性通常对各经济体央行货币政策操作构成挑战。本文构建了融入经常账户冲击的小型开放经济DSGE模型,比较了采取不同资本账户管理工具(数量型和价格型)情景下,央行执行数量型货币政策规则、盯住CPI通胀泰勒规则、盯住PPI通胀泰勒规则下,经常账户负向冲击对货币政策操作的异质性影响及传导机制,并进行了福利分析。主要结论如下：第一,经常账户负向冲击将对本国央行货币政策操作构成一定影响;第二,资本账户管理可以成为缓冲经常账户负向冲击的防火墙,价格型资本账户管理工具与盯住PPI通胀泰勒规则相结合造成的福利损失较小;第三,经常账户贸易端与收益端双重负向冲击对一国货币政策操作的影响更大,但公众预期到的经常账户恶化对货币政策操作的影响将有所减弱。本文认为,转型经济体央行应倾向于执行价格型货币政策规则,最优货币政策应在稳定价格水平与缓释风险方面进行权衡,适度降低对名义汇率的关注度,稳慎推进资本账户开放进程,并可优先选择价格型资本账户管理工具。     

The learning cost of interest rate reversals

Many central banks in many time periods have sought to avoid interest rate reversals, but at present there is no good explanation of this phenomenon. Our analysis identifies a new learning cost associated with reversing the interest rate. In a standard monetary model with forward-looking expectations, data uncertainty and parameter uncertainty, a policy that frequently reverses the interest rate makes learning the key parameters of the model more difficult. Optimal monetary policy internalises this learning cost and therefore has a lower number of interest rate reversals.     

Are inflation expectations rational?

Several recent papers report evidence of an apparent statistical bias in inflation expectations and interpret these findings as overturning the rational expectations hypothesis. In this paper, we investigate the validity of such an interpretation. We present a computational dynamic general equilibrium model capable of generating aggregate behavior similar to the data along several dimensions. By construction, model agents form “rational” expectations. We run a standard regression on equilibrium realizations of inflation and inflation expectations over sample periods corresponding to those tests performed on actual data and find evidence of an apparent bias in inflation expectations. Our experiments suggest that this incorrect inference is largely the product of a small sample problem, exacerbated by short-run learning dynamics in response to infrequent shifts in monetary policy regimes.     

Inflation Announcements and Social Dynamics

We propose a new framework for understanding the effectiveness of central bank announcements when firms have heterogeneous inflation expectations. Expectations are updated through social dynamics and, with heterogeneity, not all firms choose to operate, putting downward pressure on realized inflation. Our model rationalizes why countries stuck at the zero lower bound have had a hard time increasing inflation without being aggressive. The same model also predicts that announcing an abrupt target to disinflate will cause inflation to undershoot the target, whereas announcing gradual targets will not. We present new empirical evidence that corroborates this prediction.