Animal spirits and monetary policy

I develop a behavioral macroeconomic model in which agents have cognitive limitations. As a result, they use simple but biased rules (heuristics) to forecast future output and inflation. Although the rules are biased, agents learn from their mistakes in an adaptive way. This model produces endogenous waves of optimism and pessimism (??animal spirits??) that are generated by the correlation of biased beliefs. I identify the conditions under which animal spirits arise. I contrast the dynamics of this model with a stylized DSGE-version of the model and I study the implications for monetary policies. I find that strict inflation targeting is suboptimal because it gives more scope for waves of optimism and pessimism to emerge thereby destabilizing output and inflation.     

Financial frictions and optimal stabilization policy in a monetary union

Financial frictions differ across countries and thus cause international differences in the transmission of shocks. This paper shows how the optimal mix of monetary and fiscal policy depends on these country-specific financial frictions. To this end, we build a two-country DSGE-model of a monetary union. Financial frictions are captured by the cost channel approach. We show that the traditional solution to the assignment problem – the common central bank stabilizes the inflation rate at the union level and the national fiscal authorities stabilize the national economies – does not hold in a world with financial frictions. The cost channel decreases the efficiency of monetary policy and increases the need for fiscal stabilization even at the union level. Moreover, the more heterogeneous the union, the more important is fiscal policy in stabilizing shocks. Finally, we evaluate the scenarios in terms of welfare of the representative household.     

Macroeconomic policy lessons of labor market frictions

The paper explores the consequences of macroeconomic policy for labor market outcomes in the presence of frictions. It shows how policy may be useful in over-riding frictions, as well as how it might generate adverse outcomes. A partial-equilibrium, empirically grounded model is used to simulate policy effects.The key results are that policy has effects on the stochastic behavior of key variables - measures that reduce unemployment also reduce its persistence and increase the volatility of vacancies. Hiring subsidies and unemployment benefits have substantial effects on labor market outcomes, while employment subsidies or wage tax reductions are not very effective policy instruments.     

Unions, monetary shocks and the labour market cycle

This paper provides a new growth model by considering strategic behaviour in the supply of labour. Workers form a labour union with the aim of manipulating wages for their own benefit. We analyse the implications on labour market dynamics at business cycle frequencies of getting away from the price-taking assumption. A calibrated monetary version of the union model does quite a reasonable job in replicating the dynamic features of labour market variables observed in post-war U.S. data.     

Bond risk premiums and optimal monetary policy

The bond yield dynamics implied by a welfare-maximizing monetary policy and its credibility are explored in general equilibrium. Credibility is captured by a regime change from discretion to commitment. The policy determines the optimal output and inflation responses to a source of inflation risk. Bond yields contain compensations for this risk that depend on the policy. Credibility improvements reduce the exposure to inflation risk and bond risk premiums decline. A model calibration implies lower yield spreads, less volatile yields, and reduced deviations from the expectations hypothesis under commitment. The model suggests an explanation for changes in yield dynamics in the U.S. across different policy regimes.     

Sectoral inflation persistence and optimal monetary policy

This paper examines optimal monetary policy in a new Keynesian model with sectoral inflation persistence. It focuses on the welfare differential between timeless perspective (TP) and a purely discretionary monetary policy. Sectoral inflation persistence renders the central bank’s optimization problem more complicated under both cases of constant elasticity of substitution consumption index and generalized rule-of-thumb price setting. We find that there are substantial gains from employing a TP policy. This paper addresses the fact that this gain is robust with any changes in key structural parameters.     

Financial market imperfections and monetary policy strategy

In a model with imperfect money, credit and reserve markets, we examine if an inflation-targeting central bank applying the funds rate operating procedure to indirectly control market interest rates also needs a monetary aggregate as policy instrument. We show that if private agents use information extracted from money and financial markets to form inflation expectations and if interest rate pass-through is incomplete, the central bank can use a narrow monetary aggregate and the discount interest rate as independent and complementary policy instruments to reinforce the credibility of its announcements and the role of inflation target as a nominal anchor for inflation expectations. This study shows how a monetary policy strategy combining inflation targeting and monetary targeting can be conceived to guarantee macroeconomic stability and the credibility of monetary policy. Friedman's k-percent money growth rule, which can generate dynamic instability, and two alternative stabilizing feedback monetary targeting rules are examined.     

Asset bubbles,labour market frictions and R&D‐based growth

Employing an overlapping generations model of R&D‐based growth with labour market frictions, this paper examines how employment changes induced by labour market frictions influence asset bubbles and long‐run economic growth. Asset bubbles can (cannot) exist when the employment rate is high (low), which leads to higher (lower) economic growth through labour market efficiency. We also explore the steady state and transitional dynamics of bubbles, economic growth and employment. Furthermore, we show that policy or parameter changes with a negative influence on the labour market can lead to a bubble burst.     

Government debt and optimal monetary and fiscal policy

How do different levels of government debt affect the optimal conduct of monetary and fiscal policies? And what do these optimal policies imply for the evolution of government debt over time? To provide an answer, this paper studies a standard monetary policy model with nominal rigidities and monopolistic competition and adds to it a fiscal authority that issues nominal non-state contingent debt, levies distortionary labor income taxes and determines the level of public goods provision. Higher government debt levels make it optimal to reduce public spending, so as to dampen the adverse incentive effects of distortionary taxes, but also strongly influence the optimal stabilization response following technology shocks. In particular, higher debt levels give rise to larger risks to the fiscal budget and to tax rates. This makes it optimal to reduce government debt over time. The optimal speed of debt reduction is missed when using first-order approximations to optimal policies, but is shown to be quantitatively significant in a second-order approximation, especially when technology movements are largely unpredictable in nature.     

Implementing optimal monetary policy: Objectives and rules

The inconsistency of optimal policy comes from inconsistency between the social loss function and the economic structure. Accordingly, this paper designs a central bank loss function, which proves consistent with the economic structure. Under the designed central bank loss function discretionary policy proves optimal for social welfare. Optimal discretionary policy emerges because the implied behavioral equation is identical with that under commitment to the social loss function. Consequently, this paper also designs policy rules. To some extent, policy rules appear more basic, flexible, and operational than social and central bank loss functions, but the social loss function serves as an ultimate objective and the central bank loss function explicitly identifies the attainable targets and appropriate weight to achieve the social optimum.     

Active labour market policy in East Germany

We investigate the effects of the most important East German active labour market programmes on the labour market outcomes of their participants. The analysis is based on a large and informative individual database derived from administrative data sources. Using matching methods, we find that over a horizon of 2.5 years after the start of the programmes, they fail to increase the employment chances of their participants in the regular labour market. However, the programmes may have other effects for their participants that may be considered important in the especially difficult situation experienced in the East German labour market.     

Income determination in market disequilibrium: The implications of spillover for the design of monetary policy

This paper specifies and analyzes a generalized disequilibrium macroeconomic model that explicitly includes the concept of spillover in nontatonnement financial and real markets. It is shown that the dynamic quantity and expenditure theories of income determination are special cases of the model which depend upon the degree of spillover from the bond to the commodity market. Simulation experiments designed to produce a vigorous monetary shock to the system clearly show that national product is very sensitive to the degree of spillover, and thus, the design of monetary policy within the context of gradual market clearing should consider the size of spillover.     

Real-sector parameter instability and the optimal choice of monetary policy

In this paper we consider the effects of uncertainty upon the optimum choice of monetary policy instrument. Specifically we extend the work of Poole (1970), and others, to allow for the existence of multiplicative as well as additive stochastic coefficients in the structural equations of the standard IS-LM macroeconomic model. We demonstrate that the commonly accepted notion that money-stock control is superior to interest-rate control when the IS schedule is stochastic is not always valid.     

Financial market segmentation,stock market volatility and the role of monetary policy

We study a segmented financial markets model where only the agents who trade stocks encounter financial income risk. In such an economy, the welfare-maximizing monetary policy attains the novel role of redistributing the traders' financial market risk among all agents in the economy. In order to do that, optimal monetary policy reacts to financial market movements; it is expansionary in bad times for the financial markets and contractionary in good ones. In our quantitative exercise, a dividend shock generates different policy responses and consumption paths among the optimal and the 2% inflation targeting policy. The latter implies large distributional welfare losses and risk sharing losses of similar magnitude with those generated by business cycle fluctuations. In addition, the optimal monetary policy does not minimize stock price volatility and implies lower inflation volatility than other commonly used policies.     

Optimal monetary policy in the presence of food price subsidies

Food price subsidies are a prevalent means by which fiscal authorities may counteract food price volatility in middle-income countries (MIC). We develop a DSGE model for a MIC that captures this key channel of a policy induced price smoothing mechanism that is different to, yet in parallel with, the classic Calvo price stickiness approach, which can have consequential effects for monetary policy. We then use the model to address how the joint fiscal and monetary policy responds to an increase in inflation driven by a food price shock can affect welfare. We show that, in the presence of credit constrained households and households with a significant share of food expenditures, a coordinated reaction of fiscal and monetary policies via subsidized price targeting can improve aggregate welfare. Subsidies smooth prices and consumption, especially for credit constrained households, which can consequently result in an interest rate reaction less intensely with subsidized price targeting compared with headline price targeting.     

资本市场发展与我国货币政策的有效传导

货币政策传导机制描述了货币政策如何借助于货币冲击来影响实际经济的变动及其实施影响所依赖的路径(传导渠道),它是货币政策有效运作的基础。传统的货币政策传导机制理论着重分析两种渠道:货币渠道和信贷渠道。但在金融市场日益发达的今天,资本市场对实际经济生活的影响不断增强,特别是股票收益、股票价格与实际经济活动的内在联系越来越紧密,股票市场对货币政策指标变化的反应变得相当灵敏。资本市场的规模和结构的不断变化影响着货币的供给和需求,从而影响货币政策的传导机制以及货币政策的工具,其发展变化影响着货币政策的制定、实施和传导效应。     

A note on the optimal choice of monetary and fiscal policy

This paper studies the instrument-target problem associated with a simple macroeconomic model with conditions of uncertainty. The purpose of the paper is to demonstrate that if a model is linear with nonstochastic coefficients and with additive disturbances and if the policy objective is to maximize the expected value of the quadratic loss function, then it is the choice of endogenous variables that alters the expected loss value. This contrasts with the findings of Poole, Sargent, Turnovsky, et al., in which the expected losses are compared for different instruments while endogenous variables are changed at the same time. Thus, if basic model specifications are unchanged, an important cause for different expected losses under different policy instruments is seen to lie in the choice of endogenous variables.     

Determinacy, stock market dynamics and monetary policy inertia

We study equilibrium determinacy in a New-Keynesian model where the Central Bank responds to asset prices growth. Unlike Taylor-type rules that react to asset prices, the proposed alternative does not harm dynamic stability and in certain cases promotes determinacy by inducing interest-rate inertia.     

Equity market valuation,systematic risk and monetary policy

This study examines the relationship between equity market valuation and risk indicators that portend economic downswings. The indicators are implied options volatility, Treasury-Eurodollar (TED) spread and exchange rate. While implied volatility captures market risk in that it reflects the fear factor embedded in the price of an option, TED spread reflects the default risk premium that is priced into a key short-term credit instrument. Equity markets often show a tendency to reflect the incidence of these risk factors. And because they provide valuable information about the health of the economy, many have argued that equity market valuation be taken into account in the formulation of monetary policy. Results of this study not only show a statistically significant inverse relationship between the stock market and these risk factors, but also evidence of a cointegration. In a variance decomposition of the series, we find that equity valuation is a major contributor to the forecast error variances of each of the risk indicators, a finding that lends tacit support to the argument that risk indicators associated with the equity market be considered in monetary policy decisions.     

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.