The role of fiscal policy in the St. Louis model: Nonparametric estimates for a small open economy

This paper reevaluates the efficacy of monetary and fiscal policies and bidirectional causality between income and each of the policy instruments used in the St. Louis model for aggregate demand using nonparametric (or infinite parametric) spectral methods. We proceed by estimating the strength of the correlations (or partial coherences) between income and each of the policy instruments over various frequencies. Then we obtain the corresponding band regression and Hannan's efficient estimates of both the lead and lag coefficients in the St. Louis model. The analysis is carried out with seasonally adjusted quarterly data and is divided into the flexible, fixed, and managed flexible exchange rate regimes. We find that while estimates from parametric regressions yield the standard conclusions for the St. Louis model, results from the nonparametric analysis are quite different. Specifically, the results of our analysis reveal that (i) both monetary and fiscal instruments are strongly correlated with income over cycles of 10 quarters or longer for the most recent period of the managed flexible exchange rate regime, and (ii) bidirectional causality exists between income and the fiscal policy instrument. These results suggest that both monetary and fiscal policy have a long-lasting effect on aggregate demand and that bidirectional causality exists between income and policy instruments. An explanation for the existence of bidirectional causality might be that the Canadian government generally pursued a purposeful discretionary fiscal policy during the post-World War II period. Furthermore, it appears that discretionary policy action may have been anticipated by rational, farsighted, and forward-looking economic agents. Finally, our results for the flexible exchange rate and fixed rate regimes are in agreement with the Mundell-Fleming view of the role of monetary fiscal policy in an open economy.     

MACROECONOMIC POLICY AND ELECTIONS IN OECD DEMOCRACIES*

The purpose of this paper is to test for evidence of opportunistic “political business cycles” in a large sample of 18 OECD economies. Our results can be summarized as follows: 1) We find very little evidence of pre-electoral effects on economic outcomes, in particular, on GDP growth and unemployment; 2) We see some evidence of “political monetary cycles,” that is, expansionary monetary policy in election years; 3) We also observe indications of “political budget cycles,” or “loose” fiscal policy prior to elections; 4) Inflation exhibits a post-electoral jump, which could be explained by either the pre-electoral “loose” monetary and fiscal policies and/or by an opportunistic timing of increases in publicly controlled prices, or indirect taxes.     

Growth and welfare effects of monetary policy with endogenous fertility

This paper investigates the economic growth and social welfare implications of monetary policy in an endogenous growth model with endogenous fertility. We show that, in the money-in-the-utility-function framework, endogenous fertility governs the validity of money superneutrality, the transitional dynamics of an anticipated monetary policy, and the optimal monetary policy. Along a balanced growth path, monetary growth increases fertility and reduces the economic growth rate if consumption and real balances are complements or are independent. However, monetary expansion may decrease fertility and increase economic growth if consumption and real balances are substitutes. Generally speaking, the superneutrality of money does not hold in the presence of endogenous fertility. More importantly, with endogenous fertility, the Friedman (1969) rule is no longer a welfare-maximizing monetary policy. We also show that an anticipated inflation induces the transitional dynamics of fertility and the economic growth rate even though the intertemporal elasticity of substitution equals unity. This differs from the conventional notion in the existing literature.     

Price stabilizing, Pareto improving policies

One possible justification for a stabilization policy is that there is volatility in macro variables that individual agents cannot insure against. We study the simplest possible extension of the stochastic two-period, one agent and one commodity OLG model, where we have added one more period, with only one potential activity, namely, trading of contingent commodities. We assume, however, that markets are incomplete. In this case the Monetary equilibrium is not Pareto Optimal and for an open set of economies an allocation where fluctuations in realized savings are removed, Pareto dominates the monetary equilibrium. This allocation may be implemented by means of a monetary/fiscal policy. The policy considered has a simple rationale, namely that it removes some of the uncertainty that agents face by reducing price, i.e interest rate volatility. We consider two fundamental sources of such volatility, namely, respectively an objective and a subjective signal about the distribution of future endowments. The first case is when agents have rational expectations while the second case is studied in the context of agents having rational beliefs, beliefs which are consistent with empirical observations but not (necessarily) correct.     

THE EFFECTS OF NEWS WHEN LIQUIDITY MATTERS

We analyze the impact of news (information shocks) in economies where liquidity matters, including those with endogenous credit limits, and those with assets serving as collateral or media of exchange. Although we also consider news about productivity and credit conditions, a leading case concerns monetary policy announcements. Real or monetary news has big effects on markets, potentially causing cyclic or boom–bust responses, even though we focus on the unique transition consistent with stationarity after shocks. In particular, policy announcements may induce instead of reduce volatility. We also discuss the implications for the inflation puzzle, forward-guidance puzzle, and other apparent anomalies.     

Monetary policy and heterogeneous expectations

This paper studies the implications for monetary policy of heterogeneous expectations in a New Keynesian model. The assumption of rational expectations is replaced with parsimonious forecasting models where agents select between predictors that are underparameterized. In a Misspecification Equilibrium agents only select the best-performing statistical models. We demonstrate that, even when monetary policy rules satisfy the Taylor principle by adjusting nominal interest rates more than one for one with inflation, there may exist equilibria with Intrinsic Heterogeneity. Under certain conditions, there may exist multiple misspecification equilibria. We show that these findings have important implications for business cycle dynamics and for the design of monetary policy.     

The inequality channel of monetary transmission

We examine optimal monetary policy in the presence of inequality by introducing unskilled agents with no access to the financial system into a DSGE model with sticky prices. Our main results are: (i) a contractionary interest rate shock increases inequality, while inflation and the output gap fall; (ii) the welfare-based objective of monetary policy includes inequality stabilization; (iii) as the proportion of unskilled agents increases, welfare decreases; and (iv) under scarcity of skilled agents, monetary policy is weakened, while fiscal policy produces a more relevant impact on the economy.     

Is the relationship between monetary policy and house prices asymmetric across bull and bear markets in South Africa? Evidence from a Markov-switching vector autoregressive model

This paper examines asymmetries in the impact of monetary policy on the middle segment of the South African housing market from 1966:M2 to 2011:M12. We use Markov-switching vector autoregressive (MS-VAR) model in which parameters change according to the phase of the housing cycle. The results suggest that monetary policy is not neutral as house price growth decreases substantially with a contractionary monetary policy. We find that the impact of monetary policy is larger in bear regime than in bull regime; indicating the role of information asymmetry in reinforcing the financial constraint of economic agents. As expected, monetary policy reaction to a positive house price shock is found to be stronger in the bull regime. This suggests that the central bank reacts more in bull regime in order to prevent potential crisis related to the subsequent bust in house prices bubbles which are more prominent in bull markets. These results substantiate important asymmetries in the dynamics of house prices in relation to monetary policy, vindicating the advantages of generating regime dependent impulse response functions.     

Housing market dynamics and macroprudential policies

In this paper, we analyze the implications of macroprudential and monetary policies for credit cycles, housing market stability and spillovers to consumption. We consider a countercyclical loan‐to‐value (LTV) policy that responds to a credit‐to‐income ratio, and we compare its effectiveness with a permanent tightening of the LTV ratio and a monetary policy rule that responds to credit. To this end, we construct a dynamic stochastic general equilibrium model with housing market, household debt and collateral constraints, and we estimate it with Canadian data using Bayesian methods. Our study suggests that a countercyclical LTV ratio is a useful policy to reduce spillovers from the housing market into consumption and to lean against housing market boom–bust cycles. It performs better than the permanent tightening of the LTV ratio—a policy that has been used in a number of countries—and the monetary policy rule, both in terms of the stabilization of household indebtedness and spillovers into consumption. Monetary policy that leans against the wind is the least desirable due to its large adverse consequences on the real economy.     

Liquidity risk, economic development, and the effects of monetary policy

Empirical evidence indicates that monetary policy is not super-neutral in many countries. In particular, in high inflation economies, inflation is negatively related to economic activity. By comparison, inflation may be positively correlated with output in low inflation countries. We present a neoclassical growth model with money in which the incidence of liquidity risk is inversely related to aggregate capital formation. Interestingly, there may be multiple monetary steady-states where the effects of monetary policy vary. In poor economies, the financial system is highly distorted and higher rates of money growth are associated with less capital formation. In contrast, in advanced economies, a Tobin effect is observed. Since inflation exacerbates distortions from a coordination failure in the low-capital steady-state, individuals become much more exposed to liquidity risk. Consequently, optimal monetary policy depends on the level of development.     

Corruption,intrinsic motivation,and the love of praise

Do higher wages prevent corruption (bribe taking)? We investigate a setting where individuals who apply for public sector jobs are motivated not just by monetary incentives but also by intrinsic motivation and concern for the collective reputation of their profession. We show that an increase in monetary compensation may cause reputation‐concerned individuals to be more prone to participate in corruption due to an “overjustification” effect. The overall effect of monetary incentives on fighting corruption crucially depends on the composition of the pool of public sector workers for two reasons: first, different types of workers react differently to the same policy; second, the composition of the pool of workers affects individual behavior through its effect on collective reputation. These results imply in particular that policies to fight corruption should focus more on increasing the collective reputation of the public sector rather than using monetary incentives, which have perverse effects on some agents.     

Credit Constraint and the Asymmetric Monetary Policy Effect on House Prices

We study the possible asymmetric effect of monetary policy on house prices under different credit regimes. We first derive the implications of a theoretical model in which agents may be collateral‐constrained. We then empirically examine the implications of the model using the threshold vector autoregression model. Two different measures reflecting the tightness of the credit market are computed to serve as the threshold variable. We find that house prices react to a monetary shock initially more strongly but the effect is less persistent in a credit boom regime than in a normal credit regime. This result is consistent with the findings of our theoretical model.     

The effects of economic policy uncertainty on China’s economy: evidence from time-varying parameter FAVAR

ABSTRACT

This article explores the effects of China’s economic policy uncertainty (EPU) on its fiscal policy, monetary policy and a wide range of macro-economic variables using a time-varying parameter FAVAR model. Based on monthly data from 07/2003 to 08/2017, the time-varying structure of the model allows us to capture the time-varying characteristics of the macro-economic variables and which channel is relevant. Empirical results reveal that the reaction of monetary and fiscal policies to EPU is highly asymmetric across macro-economic circumstances. Loose monetary and fiscal policies are adopted in response to EPU shocks during the financial crisis, while policies are moderately tightened after the crisis. The China Interbank Offered Rate (Chibor) responds more sensitively and severely than M2 to EPU shocks. Additionally, EPU shocks have a significant and negative impact on economic growth, consumption, exchange rates, bonds and the stock market, but showing a positive impact on credit, real estate and fixed asset investment (which might be due to China’s special economic market environment and the high investment return). The results indicate that EPU shocks significantly affect macroeconomic fundamentals through precautionary savings and financial market channels but lose their effectiveness through a ‘real options’ effect.     

Money growth,uncertainty and macroeconomic activity: a multivariate GARCH analysis

The impact uncertainty has on money growth has received much attention in recent years and is an issue of critical importance to central banks, particularly for those, such as the European Central Bank (ECB), which place a strong emphasis on monetary analysis in monetary policy formulation. Some recent papers examining this issue use ad hoc estimates and measure variability rather than uncertainty. We employ a multivariate GARCH model, which measures uncertainty by the conditional variance of the data series, to investigate whether macroeconomic uncertainty and monetary uncertainty Granger-cause changes in real money. The estimated model also allows us to investigate how monetary uncertainty impacts economic activity. We find that macroeconomic uncertainty impacts positively on US real M2 growth over a two-year horizon but that monetary uncertainty does not cause changes in real M2. Instead, our results indicate that real money growth causes monetary uncertainty. Monetary uncertainty is found to have a negative effect on real economic activity and on macroeconomic uncertainty. We conclude by discussing the implications of these results and the methodological approach used for institutions such as the ECB that give monetary analysis a prominent role in their monetary policy strategy.     

Collateral fluctuations in a monetary economy

This paper studies economy-wide fluctuations that occur endogenously in the presence of monetary and real assets. Using a standard monetary search model, we consider an economy in which agents can increase consumption, over and above what their liquid monetary asset holdings would allow, pledging real assets as collateral for monetary loans. It is shown that, if the liquidation value of real assets is below full market value, a stable cyclical equilibrium can emerge in consumption and capital around the unstable steady state. We also provide conditions for the existence of cycles of higher order, chaos and sunspot equilibria.     

POLITICAL MONETARY CYCLES UNDER ALTERNATIVE INSTITUTIONS: THE INDEPENDENT TREASURY AND THE FEDERAL RESERVE

The theory of opportunistic political business cycles predicts incumbent politicians will alter their economic policies to spur short-run growth to attract additional votes for the upcoming election. There has not been much emphasis on the possibility of historical political business cycles prior to the Keynesian Revolution. No study has yet undertaken a systematic approach to testing for policy cycles during this period. Our study will bridge this gap by considering cycles in monetary policy for the periods of 1879–1914 until the start of Fed operations, and 1914–1932 until abandonment of the gold standard. To properly test for political cycles, it is necessary to develop reaction functions for the Treasury and compare against the reaction function later held by the Fed. This also reveals that creation of an independent monetary authority to be insulated from political pressures changed the manner in which policy was directed, aside from political issues. The evidence is not consistent, however, with monetary cycles closely tied to electoral concerns.     

Testing Commitment Models of Monetary Policy in China

In the past decade Chinese inflation was not high on average, but it was quite volatile. Back in the 1980s and 1990s, high inflation was a very real problem. What explains the inflationary dynamics in China? In particular, does monetary policy account for the substantial run-ups of inflation, followed by the equally substantial dis-inflation? In the absence of commitment technologies, the monetary authorities may create surprise inflation to achieve higher growth, while private agents would anticipate that and adjust their decisions accordingly, leading to accelerated inflation without a real impact. Do these types of simple time-inconsistency models of monetary policy explain the dynamic pattern of inflation in China? I show that the long-run and short-run restrictions imposed by discretionary policy, when the time-inconsistent policymaker has a desire to push output above potential, are largely rejected by the data. The estimates of the inflation bias under discretion when the policymaker is asymmetrically averse to recessions are not statistically significant either. The analysis contributes to the understanding of Chinese monetary policy and its inflationary implications and also points to the need of further investigation of inflationary behavior during the economic transition.     

货币政策、金融周期及其宏观经济效应

本文综合金融市场的多维信息,利用主成分分析法合成我国的金融周期指数。在此基础上,构建TVP SV VAR模型研究2003—2017年间我国货币政策、金融周期及宏观经济变量间的时变互动关系。研究发现：（1）我国货币政策、金融周期和宏观经济变量之间存在显著的时变互动关系。（2）金融传导渠道可能扭曲货币政策效力,通过金融传导渠道,货币政策不仅会抑制经济增长,还可能加剧通货膨胀。（3）金融周期对货币政策产出效应的影响滞后于对价格效应的影响。短期来看,货币政策产出效应的时变特征与金融传导渠道无太大关联,但随时间推移,金融繁荣对产出的负面影响可能最终使货币政策产出效应发生反转。货币当局应警惕金融繁荣对货币政策效力的扭曲,审慎操作,且不宜承担过多刺激产出的任务。     

Monetary Policy Transparency in the UK: The Impact of Independence and Inflation Targeting

There is a widespread belief that the transparency of UK monetary policy has increased substantially as a result of the introduction of inflation targeting in 1992 and a number of procedural and institutional reforms which accompanied and followed it. Here, money market responses (and other data) are used to test the possibility that improved anticipation of policy moves may be the result of developments other than the institutional reforms popularly cited. We find overwhelming evidence that the switch to inflation targeting itself significantly reduced monetary policy surprises, while subsequent reforms have contributed little. Where we advance substantially on earlier work is to look at the cross‐sectional dispersion of agents’ anticipation. If the benefit of transparency is the elimination of policy surprise, there is little benefit if the averagely correct anticipations of agents conceal a wide dispersion of view.     

IDENTIFYING THE EFFECTS OF SIMULTANEOUS MONETARY POLICY SHOCKS

Many central banks, particularly in the developing world, aim for exchange rate stability as a macroeconomic goal. However, most are reluctant to relinquish monetary policy autonomy, so they end up operating through both interest rate and foreign exchange interventions. But the use of multiple policy instruments does not necessarily equip monetary authorities with better tools to achieve their targets. On the contrary, their effects can potentially offset each other. Using daily data from the Central Bank of Colombia during the period of 1999–2012, I study the effects of simultaneous policies by first deriving new measures of monetary shocks and then determining their impact on economic activity. The main findings indicate that (a) while interest rate interventions have a significant impact on real and nominal variables, foreign exchange interventions tend to have limited effects; and (b) empirical anomalies, such as the positive relationship between output growth, inflation, and the policy rate are eliminated when properly accounting for the systematic responses of policy. (JEL E43, E52, E58, F31)