The effectiveness of monetary reform under rational expectations

Automatic monetary stabilizers based on interest rate information are analyzed in a rational expectations framework. Their impact on price level variability is studied, and their effectiveness is compared to optimal decentralized monetary instruments.     

Confident expectations, rational expectations and the optimal conduct of monetary policy

Under what conditions central banks can afford to deviate from announced targets without losing their reputation is analyzed. For this, the public must have something like ‘confident expectations' vis-a-vis monetary policy and central banks have to behave accordingly. The paper shows that it can be rational for the public and welfare-increasing for the society to retain ‘confident expectations' instead of switching to rational expectations, when central banks have gained long-run reputation. At the end of the paper, alternative optimal money supply rules are compared in a dynamic optimization framework. © 1998 Elsevier Science B.V. All rights reserved.     

Learning rational expectations: The finite state case

This paper is devoted to the question of whether traders can learn rational expectations from repeated observations of market data in a stationary environment with finitely many exogenous states of the world. The learning problem is placed in the context of an iterative adjustment process which achieves equilibrium if traders have rational expectations. The main result is that even if traders begin with no knowledge of their environment, there exists an estimation procedure which converges to rational expectations when the environment satisfies a certain regularity condition. The regularity condition is shown to be generic.     

Variance-minimizing monetary policies with lagged price adjustment and rational expectations

This paper considers a macroeconomic model with rational expectations in which prices are incompletely flexible. Markets therefore fall to clear. In such a model monetary policy is not neutral. The variance of real and nominal quantities and interest rates is sensitive to the parameters of the feedback rule that determines the money supply. The monetary policy that achieves the goal of minimizing the steady-state variance of real output is characterized. We also examine monetary policies that are restricted in their generality and derive ‘second-best’ variance-minimizing feedback rules.     

The lucas supply function and the feasibility of monetary stabilization policy with rational expectations

Zusammenfassung Die vorliegende Arbeit untersucht die Effektivität systematischer (d. h. regelgebundener) Geldpolitik in einem makroökonomischen Modell mit einer Lucas-Angebotsfunktion, rationalen Erwartungen und asymmetrischer Information. InMcCallum (1980) wurde dieses Modell anhand der Methode der unbestimmten Koeffizienten gelöst und gezeigt, daß die Notenbank die Varianz des Outputs durch die Wahl des Politikparameters in einer einfachen Geldmengenregel (autoregressiver Prozeß erster Ordnung) beeinflussen kann. Die Auswirkungen von monetären Schocks können dabei zwar gedämpft, aber nicht vollständig eliminiert werden.In der vorliegenden Arbeit wird das Modell anhand der Methode der forward looking solutions gelöst und gezeigt, daß esunendlich viele Geldmengenregeln gibt, welche den Output von Geldangebots- und Güternachfrageschocksperfekt abschirmen. Produktivitätsschocks können hingegen nur kurzfristig neutralisiert werden.

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I am indebted to H. Frisch, Ch. Peutl, and unknown referees for their valuable comments and suggestions.     

Exchange rate models and exchange rate expectations: an empirical investigation

A non parametrictest of popular modern exchange rate models under alternative expectation specifications is presented. It is found that there is little difference in the predictive success of the alternative exchange rate models, however, there are significant differences in the performance of a model depending upon the expectations mechanism specified. Our most important finding is that the flexible price monetary model, the portfolio balance model and a hybrid model under extrapolative and adaptive expectations mechanisms provide statistically significant information about the direction of exchange rate movements. By contrast, the same models when employing static, regressive and rational expectation mechanisms do not provideany satistically significant information.     

Exchange rate expectations and economic policy uncertainty

This study provides a new angle on the relationship between political decisions and exchange rates. We link a conventional exchange rate modeling approach to the literature on the political economy of exchange rates and studies dealing with the role of policy announcements for financial market expectations by addressing the impact of policy uncertainty on exchange rate expectations and forecast errors of professionals. Our results show that expectations are not only affected by announcements but also by the degree of uncertainty regarding the future stance of economic policy. We find that forecast errors are strongly affected by policy uncertainty compared to expectations, suggesting that the effect of uncertainty is not efficiently accounted for in market expectations. Our main findings hold for economic policy uncertainty, fiscal policy uncertainty and monetary policy uncertainty. In addition, the estimates for the Japanese yen suggest a safe haven role of the yen since higher policy uncertainty in the US results in an expected appreciation of the yen.     

Price instability in a rational expectations model: The mexican case

The purpose of this paper was twofold: (1) to develop an open-economy-rational-expectations model to test the theoretical relationship between the price level and expectations about money and the exchange rate; and (2) based on the empirical results of the model, prescribe policy rules aimed at stabilizing inflationary expectations in Mexico. The major empirical findings were that the price formation in Mexico is positively related to both subjective money and exchange-rate expectations formed at period t. The correction path suggested by the empirical results is the implementation of an “activist” policy aimed at reducing both the ratio of real fiscal deficit and external debt to real gross domestic product from their current levels to the “ideal” levels of 1.6 and 11.3 percent of GDP, respectively.     

Exchange rate pass-through: The case of China

This paper studies the degree of the exchange rate pass-through (ERPT) to import and consumer prices in China with both the ratio of China’s imports to GDP and domestic prices of China’s main trade partners going up. Statistic results show that the degree of ERPT is somehow less than the degree of marginal cost plus mark-up pass-through of exporters, and econometric analyses reach the same conclusion. Besides, the ERPT to import prices is found to be high while the ERPT to CPI is low owing to some factors that obstruct the import prices pass-through channel to domestic CPI. But this situation has been changing significantly since August 2005. Thus, a more flexible exchange rate system is needed for China to absorb the price shock from aboard efficiently.     

Backward looking and forward looking solutions to monetary models of inflation with rational expectations

We show that an indeterminacy problem, noted by Blanchard, concerning monetary models of inflation with rational expectations may be resolved by requiring solutions for real variables in such models to be invariant to the choice of accounting unit.     

Money demand, the Cagan model, testing rational expectations vs adaptive expectations: The case of Turkey

This paper estimates the Cagan type demand for money function for Turkish economy during the period 1986:1–1995:3 and tests whether Cagan's specification fits the Turkish data using an econometric technique assuming that forecasting errors are stationary. This paper also tests the hypothesis that monetary policy was implemented in aiming to maximize the inflation tax revenue. Finally, the Cagan model is estimated with the additional assumption of rational expectations for Turkey for the considered period. First version received: March 1998/final version received: October 1998     

Exchange rate movements and monetary policy in Brazil: Econometric and simulation evidence

The literature on monetary economy has aroused growing interest in macroeconomics. Due to computational advancements, models have become increasingly more complex and accurate, allowing for an in-depth analysis of the relationships between real economic variables and nominal variables. Therefore, using a dynamic stochastic general equilibrium (DSGE) model, based on Gali and Monacelli (2005), we propose and estimate a model for the Brazilian economy by employing Bayesian methods so as to assess whether the Central Bank of Brazil takes exchange rate fluctuations into account in the conduct of monetary policy. The most striking result of the present study is that the Central Bank of Brazil does not directly change the interest rate path due to exchange rate movements. A simulation exercise is also used. Our conclusion is that the economy quickly accommodates shocks induced separately on the exchange rate, on the terms of trade, interest rate, and global inflation.     

The generic existence of rational expectations equilibrium in the higher dimensional case

The study of the generic existence of rational expectations equilibrium has concentrated on three cases, according to whether the space of “states of private information” has dimension less than, equal to, or greater than the price space. Previous results have shown that in the first case fully revealing equilibria exist generically and in the second case there are open sets of environments with no equilibrium. This paper shows that in the third case there is a residual set of environments which permits equilibria which are arbitrarily close to fully revealing.     

Exchange rate models and parameter variation: The case of the Dollar-Mark exchange rate

This paper is drawn from Chapter 3 of the author's doctoral dissertation at the University of Chicago (Wolff, 1985). He is very grateful to the members of his dissertation committee — Michael Mussa (Chairman), Joshua Aizenman, Robert Aliber, Jacob Frenkel, David Hsieh, John Huizinga, and Arnold Zellner — and to seminar participants at the University of Chicago, the London Business School and INSEAD for many helpful comments.     

Exchange rate pass-through in deflation: The case of Taiwan

This paper incorporates deflation in an analysis of the relationship between the exchange rate pass-through and inflation. Using a nonlinear model based on monthly data of Taiwan's import prices from 1981 to 2008, we find that the degree of exchange rate pass-through is increasing in deflation. The increase becomes smaller when the price of oil is excluded. Evidence for pass-through increasing in deflation has not previously been found in the existing literature and presents a new understanding of the pricing behavior of firms. Poor profits in deflation cause firms to pass through most of the cost of exchange rate changes to their products to avoid exiting the market.     

Exchange rate management when sterilized interventions represent signals of monetary policy

The signalling channel of foreign exchange market interventions suggests that sterilized interventions represent signals of future monetary policy and thus affect exchange rate expectations. Within a two-country game-theoretic framework, which incorporates two novel factors—partial credibility and non-rational expectations—that reduce the exchange rate effects of intervention operations, I derive non-cooperative and cooperative policies of exchange rate management. To retain credibility in the future, sterilized interventions must be accomodated by corresponding subsequent changes in the money supply. Thus, interventions do not represent an instrument independent from general monetary policy. It is shown that the implied tradeoff between internal and external policy objectives makes the coordination of intervention operations advantageous, even in the case of conflicting exchange rate targets.     

Inflationary expectations and monetary policy: evidence from Bangladesh

This article first estimates inflationary expectations using a Blanchard–Quah VAR model by decomposing the nominal interest rate into expected inflation and the ex ante real interest rate. Then I utilize this expected inflation along with other macroeconomic variables as inputs to the monetary policy function in a recursive VAR model to identify exogenous policy shocks. To calculate inflationary expectations, I assume that ex ante real interest rate shocks do not have a long-run effect on the nominal interest rate. This article finds that the public expects lower inflation for the future during periods of high inflation. Estimated results from the recursive VAR suggest that a contractionary policy shock increases the real interest rate, appreciates domestic currency, and lowers inflationary expectations and industrial output. However, I find a lagged policy response from Bangladesh Bank to higher inflationary expectations.     

Exchange rate devaluation,monetary policy and wages: A general equilibrium analysis for Chile

A range of devaluation, monetary and wage policy mixes are analysed for the Chilean economy using a 10 sector comparative static model built along neoclassical lines. The model, while focusing on the real side of the economy, also contains a simple monetary sector. Quantifying the short-run implications of each policy mix for key macroeconomic and sectoral variables enables judgements to be made about the effectiveness of each mix in reaching specified targets and their feasibility. Money wage flexibility downwards is crucial if balance of trade and employment targets are to be achieved with lower domestic inflation and a smaller nominal devaluation.