Noisy information, interest rate shocks and the Great Moderation

In this paper we evaluate the hypothesis that the Great Moderation is partly the result of a less activist monetary policy. We simulate a New Keynesian model in which the central bank can only observe a noisy estimate of the output gap and find that the less pronounced reaction of the Federal Reserve to output gap fluctuations since 1979 can account for a substantial part of the reduction in the standard deviation of GDP associated with the Great Moderation. Our simulations are consistent with the empirically documented smaller magnitude and impact of interest rate shocks since the early 1980s.     

Formal targets, central bank independence and inflation dynamics in the UK: A Markov-Switching approach

We examine inflation and uncertainty in the UK with a version of the Markov Switching model, which allows for changes in the variance as well as in the mean and persistence of a series. We find that the UK’s attempts at exchange rate pegs in the form of shadowing the deutschmark and entering the ERM were ineffective, and in the latter case counterproductive in lowering inflation uncertainty. The 1981 budget, however, greatly lowered uncertainty, and the adoption of a formal inflation target also had a palpable, negative impact on inflation uncertainty. As a suggestive exercise, we examine inflation uncertainty in the US, and find that, over 2005–2008, in the absence of an inflation target, uncertainty rose in the US, while uncertainty remained low in the UK over this period of rising commodity prices and financial turmoil.     

Growth, income taxes and consumption aspirations

In a Barro-type economy with exogenous consumption aspirations, raising income taxes favors growth even in the presence of lump-sum taxes. Such a policy is compatible with the behavior of private consumption, income taxes and growth rates observed in actual economies.     

The recent boom–bust cycle: The relative contribution of capital flows, credit supply and asset bubbles

We use an estimated open economy DSGE model with financial frictions for the US and the rest of the world to evaluate various competing explanations about the recent boom–bust cycle. We find that the savings glut hypothesis is insufficient for explaining all aspects of the boom in the US. Relatively strong TFP growth and expansionary monetary policy are also not able to explain fully the volatility of corporate and in particular residential investment. We identify bubbles in the stock and housing market as crucial. Concerning the downturn in 2008/2009, the fall in house prices and residential investment only plays a minor role. Mortgage defaults have more explanatory power, especially in a specification of the model with a segregated equity market. Finally, the bursting of the stock market bubble was at least as important in this recession as in 2001. Because of various negative shocks hitting the economy at the same time in 2008/2009 and continued positive technology growth, not only the real interest rate declined but inflation fell rapidly and left insufficient room for monetary policy to play a similar stabilising role as in previous recessions.     

Sustainability, flexibility, and inflation targeting

This paper examines sustainability of an inflation-targeting policy regime in terms of sustainable equilibrium using a canonical model in the recent literature. Overly flexible inflation targeting is not sustainable. Strict inflation targeting is sustainable only when shock persistence is high enough.     

Geography, skills or both: What explains Fed watchers’ forecast accuracy of US monetary policy?

The paper shows that there is a substantial degree of heterogeneity in the ability of Fed watchers to forecast US monetary policy decisions. Based on a novel database for 268 individual professional forecasters since 1999, the average absolute forecast error of FOMC decisions varies 5–10 basis points between the best and worst-performers across the sample. This heterogeneity is found to be related to both the skills of analysts – such as their educational and employment backgrounds – and to geography. In particular, forecasters located in regions which experience more idiosyncratic economic conditions perform worse in anticipating monetary policy. This evidence is indicative that limited attention and heterogeneous priors are present even for anticipating important events such as monetary policy decisions.     

Estate taxes, consumption externalities, and altruism

We study how the introduction of consumption externalities affects the optimality of the dynamic equilibrium in an economy displaying dynastic altruism. When the bequest motive is inoperative consumption externalities affect the intertemporal margin between young and old consumption and thus modify the intertemporal path of aggregate consumption and capital. The optimal tax policy that solves this intertemporal suboptimality consists of a tax on capital income and a pay-as-you-go social security system. The latter solves the excess of capital accumulation due to the inoperativeness of the bequest motive and the former solves the suboptimal allocation of consumption due to consumption externalities. When the bequest motive is operative consumption externalities only cause an intratemporal misallocation of consumption but do not affect the optimality of the capital stock level. This suboptimal allocation of consumption implies in turn that the path of bequest deviates also from optimality. The optimal tax policy in this case consists of an estate tax and a capital income tax.     

MONEY, CREDIT, AND BUSINESS CYCLE COMOVEMENT

Abstract.  We developed a two-sector general equilibrium model with money and credit to study cross-sector comovement over the business cycle. Through a working capital channel, both money and productivity shocks can generate procyclicality of sectoral activities and positive cross-sector correlations of output, employment and investment. In our model, firms in each sector borrow in the credit market to finance their purchase of labour inputs, part of which are used in the adjustment process of capital stock. The shocks affect sectoral employment and investment through their impacts on interest rates and external finance premia.     

House price,mortgage premium,and business fluctuations

This paper investigates the transmission mechanism of mortgage premium to characterize the relationship between the housing market and business cycle for the U.S. We find that mortgage premium is crucial for the amplification and propagation of the model to match the main properties of U.S. housing market and business cycles. The counterfactual analysis suggests that had the Federal Reserve raised the interest rate in 2003Q1, it would have curbed the housing market boom before the crisis, yet failed to alleviate the precipitous decline in housing market activity after the crisis. Moreover, the pre-emptive monetary policy aimed to contain the housing market boom can effectively lower volatilities of major economic aggregates; however, it also exerts a significantly negative effect on the levels of these economic aggregates. Thus, using monetary policy to stabilize asset price inflation involves a trade-off between the volatility and the level of economic activity.     

Information acquisition, dissemination, and transparency of monetary policy

Abstract.  This paper examines the role of transparency in a benevolent monetary authority's policies. Each firm's payoff depends on unobservable macroeconomic conditions and firms may incur a cost to acquire private information about macroeconomic conditions. The policy authority attempts to infer the underlying macroeconomic conditions from a noisy measure of aggregate actions and makes a public announcement to inform firms of this inference. High-quality announcements provide firms the incentive not to gather private information and base actions solely on information contained in policy announcements. However, this makes the observed actions of firms less informative to the policy authority.     

Firm-specific capital, nominal rigidities, and the Taylor principle

In the presence of firm-specific capital the Taylor principle can generate multiple equilibria. Sveen and Weinke [New perspectives on capital, sticky prices, and the Taylor principle, J. Econ. Theory 123 (2005) 21-39] obtain that result in the context of a Calvo-style sticky price model. One potential criticism is that the price stickiness which is needed for our theoretical result to be relevant from a practical point of view is somewhat to the high part of available empirical estimates. In the present paper we show that if nominal wages are not fully flexible (which is an uncontroversial empirical fact) then the Taylor principle fails already for some minor degree of price stickiness. We use our model to explain the consequences of both nominal rigidities for the desirability of alternative interest rate rules.     

Credit and inflation under borrower?s lack of commitment

In this paper we study the effects of monetary policy on privately supplied credit in model economies where money is needed for transaction purposes and agents who default on their loans cannot participate in the credit market but are allowed to accumulate money. In our deterministic benchmark economy where agents alternate in productivity, credit has the role of smoothing consumption. We show that deflation crowds out credit completely. The reason is that deflation increases the value of being excluded from the credit market and eliminates the incentive to repay loans. When inflation is positive but low, credit, consumption smoothing and welfare increase with inflation, until inflation reaches a threshold at which the allocation is efficient and money becomes superneutral.     

Liquidity traps, learning and stagnation

We examine global economic dynamics under learning in a New Keynesian model in which the interest-rate rule is subject to the zero lower bound. Under normal monetary and fiscal policy, the intended steady state is locally but not globally stable. Large pessimistic shocks to expectations can lead to deflationary spirals with falling prices and falling output. To avoid this outcome we recommend augmenting normal policies with aggressive monetary and fiscal policy that guarantee a lower bound on inflation. In contrast, policies geared toward ensuring an output lower bound are insufficient for avoiding deflationary spirals.     

Jointly optimal monetary and fiscal policy rules under liquidity constraints

We study the welfare properties of an economy where both monetary and fiscal policies follow simple rules, and where a subset of agents is liquidity constrained. The welfare benefits of optimizing the fiscal rule are far larger than those of optimizing the monetary rule. The optimized fiscal rule implements strong automatic stabilizers that primarily stabilize the income of liquidity-constrained agents, rather than output. Transfers targeted to liquidity-constrained agents are the preferred fiscal instrument. The optimized monetary rule exhibits super-inertia and a weak inflation response. Optimized simple rules perform as well as the optimal policy under the timeless perspective.     

Assessing the effects of financial heterogeneity in a monetary union a DSGE approach

The aim of this article is to analyze how financial heterogeneity can accentuate the cyclical divergences inside a monetary union that faces technological, monetary, budgetary and financial shocks. To this purpose, this study relies on a two-country Dynamic Stochastic General Equilibrium model, where the two countries are supposed to be differently sensitive to the bank capital channel. The model allows us to demonstrate how a given symmetric shock causes cyclical divergences inside a heterogeneous monetary union. On this point, it allows reproducing some stylized facts recently observed in the Euro Area. Moreover, it appears that the more heterogeneous the union, the larger the effects of financial asymmetries on the transmission of shocks. Finally, we show that a common monetary policy contributes to worsen cyclical divergences, in comparison with monetary policies that would be nationally conducted.     

New perspectives on capital, sticky prices, and the Taylor principle

Our main result is that dynamic new-Keynesian (DNK) models with firm-specific capital feature a substantial amount of endogenous price stickiness. We use this insight to assess the desirability of alternative interest rate rules, and make the case for combining active monetary policy with interest rate smoothing and/or some responsiveness of the nominal interest rate to real economic activity. The key mechanism behind our results is also useful from a positive point of view: the feature of firm-specific capital increases the empirical appealingness of DNK models, as documented by a growing body of literature.     

Inflation, unemployment, and the time consistency of the US monetary policy

This paper verifies the performance of the Barro and Gordon (1983) model to explain the US inflation since the early 1950s. We divide the period from 1951:2 to 2010:2 according to each chairman of the Federal Reserve (FED). In addition, we consider aggregated periods, represented by pre-Volcker, Volcker-Greenspan, Greenspan-Bernanke, and whole sample. A genetic algorithm of stochastic search is applied to reduce the sensitivity of the maximum likelihood estimator to the initial parameter values. Surprisingly, our results show that the time consistency problem explains the US inflation during the Greenspan chairmanship at the FED.     

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.     

Forward-looking monetary policy and anticipated shocks to inflation

This paper extends a standard New Keynesian model to describe the effects of anticipated shocks to inflation and forward-looking monetary policy. Using the data generated from this modified model suggests that overlooking these two factors in the standard Cholesky structural vector autoregressive identification scheme will generate a price puzzle. Furthermore, this paper demonstrates that failing to account for these two factors may result in significant estimates of two other explanations of the price puzzle—the cost channel of transmission of monetary policy and indeterminacy due to violation of the Taylor principle—even though neither features in the data generating process.