Labor market reform and price stability: An application to the Euro Area

Central bankers frequently suggest that labor market reform may be beneficial for inflation management. This paper investigates this topic by simulating the effects of reductions in firing costs and unemployment benefits on inflation volatility in the Euro Area, using an estimated New Keynesian model with search and matching frictions. Qualitatively, changes in labor market policies alter the volatility of inflation in response to shocks, by affecting the volatility of the three components of real marginal costs (hiring costs, firing costs and wage costs). Quantitatively, we find, however, that neither policy is likely to have an important effect on inflation volatility, due to the small contribution of hiring and firing costs to inflation dynamics.     

Search and matching frictions and optimal monetary policy

A recent literature has merged the New Keynesian and the search and matching frameworks, which has allowed the former to analyze the joint dynamics of unemployment and inflation. This paper analyzes optimal monetary policy in this kind of hybrid framework. I show that zero inflation is optimal when all wages are Nash bargained in every period and the economy's steady state is efficient. In the more realistic case in which nominal wage bargaining is staggered, a case against price stability arises: in response to real shocks, the central bank should use price inflation so as to avoid excessive unemployment volatility and excessive dispersion in hiring rates. For a plausible calibration, the welfare loss under the zero inflation policy is about three times as large as under the optimal policy.     

Flexible inflation targeting and financial stability: Is it enough to stabilize inflation and output?

We investigate empirically whether a central bank can promote financial stability by stabilizing inflation and output, and whether additional stabilization of asset prices and credit growth would enhance financial stability in particular. We employ an econometric model of the Norwegian economy to investigate the performance of simple interest rate rules that allow a response to asset prices and credit growth, in addition to inflation and output. We find that output stabilization tends to improve financial stability. Additional stabilization of house prices, equity prices and/or credit growth enhances stability in both inflation and output, but has mixed effects on financial stability. In general, financial stability as measured by e.g., asset price volatility improves, while financial stability measured by indicators that depend directly on interest rates deteriorates, mainly because of higher interest rate volatility owing to a more active monetary policy.     

Optimal monetary policy with distinct core and headline inflation rates

In a stylized DSGE model with an energy sector, the optimal policy response to an adverse energy supply shock implies a rise in core inflation, a larger rise in headline inflation, and a decline in wage inflation. The optimal policy is well approximated by policies that stabilize the output gap, but also by a wide array of “dual mandate” policies that are not overly aggressive in stabilizing core inflation. Finally, policies that react to a forecast of headline inflation following a temporary energy shock imply markedly different effects than policies that react to a forecast of core, with the former inducing greater volatility in core inflation and the output gap.     

On the financial market impact of euro area monetary policy: A comparative study before and after the Global Financial Crisis

Using daily data from thirteen euro area and four non-euro countries covering the years 2000 to 2018, we explore whether the Global Financial Crisis 2008–2010 and the introduction of unconventional monetary policy measures has led to a change in the financial market impact of euro area monetary policy. For this purpose, we construct a conservative measure of monetary policy innovations based on the heteroscedasticity-approach of Rigobon and Sack (2004), and investigate the response of national and euro-wide equity indices, derived volatility indices, as well as of government bond yields. We find that financial market participants respond more strongly to monetary policy after the Global Financial Crisis. Moreover, we find that cross-country differences in the responsiveness of government bond yields correlate with average national unemployment rates and with inflation rates, suggesting that monetary policy communication was more effective in countries that had faced a severe economic downturn.     

Optimal fiscal and monetary policy with sticky prices

In this paper I consider the role of state-contingent inflation as a fiscal shock absorber in an economy with nominal rigidities. I study the Ramsey equilibrium in a monetary model with distortionary taxation, nominal non-state-contingent debt, and sticky prices. With sticky prices, the Ramsey planner must balance the shock absorbing benefits of state-contingent inflation against the associated resource misallocation costs. For government spending processes resembling post-war experience, introducing sticky prices generates striking departures in optimal policy from the case with flexible prices. For even small degrees of price rigidity, optimal policy displays very little volatility in inflation. Tax rates display greater volatility compared to the model with flexible prices. With sticky prices, tax rates and real government debt exhibit behavior similar to a random walk. For government spending processes resembling periods of intermittent war and peace, optimal policy displays extreme inflation volatility even when the degree of price rigidity is large. As the variability in government spending increases, smoothing tax distortions across states of nature becomes increasingly important, and the shock absorber role of inflation is accentuated.     

Monetary policy and macroeconomic stability in Latin America: The cases of Brazil, Chile, Colombia and Mexico

In 1999, new monetary policy regimes were adopted in Brazil, Chile, Colombia and Mexico, combining inflation targeting with floating exchange rates. These regime changes have been accompanied by lower volatility in the monetary stance in Brazil, Colombia and Mexico, despite higher inflation volatility in Brazil and Colombia. This paper estimates a conventional New Keynesian model for these four countries and shows that: i) the post-1999 regime has been associated with greater responsiveness by the monetary authority to changes in expected inflation in Brazil and Chile, while in Colombia and Mexico monetary policy has become less counter-cyclical, ii) lower interest-rate volatility in the post-1999 period owes more to a benign economic environment than to a change in the policy setting, and iii) the change in the monetary regime has not yet resulted in a reduction in output volatility in these countries.     

Asymmetric Labor Market Institutions in the EMU and the Volatility of Inflation and Unemployment Differentials

How does the asymmetry of labor market institutions affect the adjustment of a currency union to shocks? To answer this question, this paper sets up a dynamic currency union model with monopolistic competition and sticky prices, hiring frictions, and real wage rigidities. In our analysis, we focus on the differentials in inflation and unemployment between countries, as they directly reflect how the currency union responds to shocks. We highlight the following three results. First, we show that it is important to distinguish between different labor market rigidities as they have opposite effects on inflation and unemployment differentials. Second, we find that asymmetries in labor market structures tend to increase the volatility of both inflation and unemployment differentials. Finally, we show that it is important to take into account the interaction between different types of labor market rigidities. Overall, our results suggest that asymmetries in labor market structures worsen the adjustment of a currency union to shocks.     

The Impact of the Volatility of Monetary Policy Shocks

This paper studies the impact of the volatility of monetary policy using a structural vector auroregression (SVAR) model enriched along two dimensions. First, it allows for time‐varying variance of monetary policy shocks via a stochastic volatility specification. Second, it allows a dynamic interaction between the level of the endogenous variables in the VAR and the time‐varying volatility. The analysis establishes that the nominal interest rate, output growth, and inflation fall in reaction to an increase in the volatility of monetary policy. The analysis also develops a dynamic stochastic general equilibrium model enriched with stochastic volatility to monetary policy that generates similar responses and provides a theoretical underpinning of these findings.     

Changing Monetary Policy Rules, Learning, and Real Exchange Rate Dynamics

When the exchange rate is priced by uncovered interest parity and central banks set nominal interest rates according to a reaction function such as the Taylor rule, the real exchange rate will be determined by expected inflation and the output gap or the unemployment gap of the home and foreign countries. This paper examines the implications of these Taylor rule fundamentals for real exchange rate determination. Because the true parameters in central bank policy rules are unknown to the public and change over time, the model is presented in the context of a least squares learning environment. This simple learning model captures the volatility and the major swings in the real deutschemark/euro–dollar exchange rate from 1976 to 2007.     

How to Weigh Unemployment Relative to Inflation in Monetary Policy?

The monetary policy mandate for the Federal Reserve and of the Riksbank are essentially the same and boil down to stabilizing inflation around the inflation target and employment or unemployment around a long‐run sustainable rate. The relative weight on stabilizing unemployment or employment versus stabilizing inflation may be close to one. A positive unemployment‐gap forecast normally calls for a positive inflation‐gap forecast.     

A Phillips Curve with Anchored Expectations and Short‐Term Unemployment

This paper examines the behavior of U.S. core inflation, as measured by the weighted median of industry price changes. We find that core inflation since 1985 is well‐explained by an expectations‐augmented Phillips curve in which expected inflation is measured with professional forecasts and labor‐market slack is captured by the short‐term unemployment rate. We also find that expected inflation was backward‐looking until the late 1990s, but then became strongly anchored at the Federal Reserve's target. This shift in expectations changed the relationship between inflation and unemployment from an accelerationist Phillips curve to a level‐level Phillips curve. Our specification explains why high unemployment during the Great Recession did not reduce inflation greatly: partly because inflation expectations were anchored, and partly because short‐term unemployment rose less sharply than total unemployment.     

中国通货膨胀的波动性与杠杆效应研究——基于条件异方差模型的实证分析

利用条件异方差模型对我国居民消费价格指数建模,并基于此展开对中国通货膨胀的一般特征进行分析、研究。实证结果表明,我国的通货膨胀具有强惯性、波动集群性、杠杆效应等特征。依据我国通货膨胀的动态特征和机制来制定相应的货币政策将有助于缩短货币政策的时滞和合理疏导微观主体的通胀预期,也有利于正确地引导和稳定市场经济,并最终能提高货币政策的有效性。所以,我国通货膨胀治理过程中必须充分考虑我国通货膨胀特征的影响,及时采取措施消除那些与市场制度逻辑不一致的政策传导因素以及对政策信号不能作出理性反应的市场因素。     

Ramsey monetary policy with labor market frictions

Traditional New Keynesian models prescribe that optimal monetary policy should aim at price stability. In the absence of a labor market frictions, the monetary authority faces no unemployment/inflation trade-off. The design of optimal monetary policy is analyzed here for a framework with sticky prices and matching frictions in the labor market. Optimal policy features deviations from price stability in response to both productivity and government expenditure shocks. When the Hosios [1990. On the efficiency of matching and related models of search and unemployment. Review of Economic Studies 57 (2), 279-298] condition is not met, search externalities make the flexible price allocation unfeasible. Optimal deviations from price stability increase with workers’ bargaining power, as firms incentives to post vacancies fall and unemployment fluctuates above the Pareto efficient one.     

The Structural Dynamics of U.S. Output and Inflation: What Explains the Changes?

We examine the dynamics of U.S. output and inflation using a structural time-varying coefficients vector autoregression. There are changes in the volatility of both variables and in the persistence of inflation, but variations are statistically insignificant. Technology shocks explain changes in output volatility; real demand disturbances variations in the persistence and volatility of inflation. We detect important time variations in the transmission of technology shocks to output and demand shocks to inflation and significant changes in the variance of technology and of monetary policy shocks.     

Optimal inflation persistence: Ramsey taxation with capital and habits

Ramsey models of fiscal and monetary policy featuring time-separable preferences and a fixed supply of capital predict highly volatile inflation with no serial correlation. In this paper, we show that an otherwise-standard Ramsey model that incorporates capital accumulation and habit persistence predicts highly persistent inflation. The result depends on increases in either the ability to smooth consumption or the preference for doing so. The effect operates through the Fisher relationship: a smoother profile of consumption implies a more persistent real interest rate, which in turn implies persistent optimal inflation. Our work complements a recent strand of the Ramsey literature based on models with nominal rigidities. In these latter models, inflation volatility is lower than in the baseline model but continues to exhibit little persistence. We quantify the effects of habit and capital on inflation persistence and also relate our findings to recent work on optimal fiscal policy with incomplete markets.     

Resuscitating the wage channel in models with unemployment fluctuations

Higher wages all else equal translate into higher inflation. More rigid wages imply a weaker response of inflation to shocks. This view of the wage channel is deeply entrenched in central banks’ views and models of their economies. In this paper, we present a model with equilibrium unemployment which has three distinctive properties. First, using a search and matching model with right-to-manage wage bargaining a proper wage channel obtains. Second, accounting for fixed costs associated with maintaining an existing job greatly magnifies profit fluctuations for any given degree of wage fluctuations, which allows the model to reproduce the fluctuations of unemployment over the business cycle. And third, the model implies a reasonable elasticity of steady state unemployment with respect to changes in benefits. The calibration of the model implies low profits, but does not require a small gap between the value of working and the value of unemployment for the worker.     

Monetary policy when potential output is uncertain: Understanding the growth gamble of the 1990s

The Fed kept interest rates low and essentially unchanged during the late 1990s despite a booming economy and record-low unemployment. These interest rates were accommodative by historical standards. Nonetheless, inflation remained low. How did the Fed succeed in sustaining rapid economic growth without fueling inflation and inflationary expectations? In retrospect, it is evident that the productive capacity of the economy increased. Yet as events unfolded, there was uncertainty about the expansion of the capacity of the economy and therefore about the sustainability of the Fed's policy.This paper provides an explanation for the success of the Fed in accommodating growth with stable inflation in the late 1990s. It shows that if the central bank is committed to reverse policy errors it makes because of unwarranted optimism, inflation can remain in check even if the central bank keeps interest rates low because of this optimism. In particular, a price level target—which is a simple way to model a commitment to offset errors—can serve to anchor inflation even if the public does not share the central bank's optimism about shifts in potential output. The paper shows that price level targeting is superior to inflation targeting in a wide range of situations. The paper also provides econometric evidence that, in contrast to earlier periods, the Fed has recently put substantial weight on the price level in setting interest rates. Moreover, it shows that CPI announcement surprises lead to reversion in the price level. Finally, it provides textual evidence that Alan Greenspan puts relatively more weight on the price level than inflation.     

Estimating Monetary Policy Rules When Nominal Interest Rates Are Stuck at Zero

Did the Federal Reserve's response to economic fundamentals change with the onset of the Global Financial Crisis? Estimation of a monetary policy rule to answer this question faces a censoring problem since the interest rate target has been set at the zero lower bound since late 2008. Surveys by forecasters allow us to sidestep the problem and to use conventional regressions and break tests. We find that, in the opinion of forecasters, the Fed's inflation response has decreased and the unemployment response has increased, which suggests that the Federal Reserve's commitment to stable inflation has become weaker in the eyes of the professional forecasters.