Rational expectations and the role of monetary policy: A generalization

This paper investigates the effects of introducing the following two alterations into a multimarket, partial information, rational expectations model; (1) individuals in any market may sample currently more prices than just the current price on their own market; (2) they choose the amount of their current information so as to minimize the sum of the costs of getting information and of being off their full information demand and supply curves. Under those circumstances any change in the variance of aggregate excess demand shocks (whether caused by real or monetary elements) affects the equilibrium level of information in the economy, in addition to its other direct effects previously recognized in the literature. Among the issues dealt with are the implications of these alterations for the following: (1) the Lucas hypothesis on the slope of the Phillips curve; (2) the optimal monetary variance and the optimal money feedback rule; (3) the effect of the level of information and of aggregate variance on the distribution of relative prices and related issues.     

The expectations theory works for monetary policy shocks

In practice, the expectations theory of the term structure is employed extensively in monetary policy analysis despite its empirical failure. This paper performs a conditional test of the theory that is directly relevant to monetary theory and policy. It finds that the theory holds quite well conditional on identified monetary policy shocks, but fails conditional on aggregate supply shocks that prompt an immediate jump in prices. It also finds that policy responses to movements in the term structure play an important role in uncovering evidence for the theory as predicted by McCallum [1994. Monetary policy and the term structure of interest rates. NBER Working Paper Series, no. 4938].     

Rational expectations and corporate dividend policy

The problem of expectations formation has been either ignored or treated with very restrictive assumptions in traditional dividend adjustment models. Since these models are typically used to explain the dividend decisions of individual firms, a more satisfactory treatment of the process of expectations formation is needed. In order to analyze the dynamic dividend adjustment process, this article proposes a model, more general than previous ones, that is consistent with the rational expectations hypothesis. A nonlinear regression method is used to estimate the parameters of the model and to test the validity of the rational expectations hypothesis in dividend decisions making. The partial adjustment model with rational expectations explains dividend adjustments reasonably well. The overall results suggest that firms make use of available earnings information to form optimal future earnings forecasts; specifically, a firm's dividend adjustment process is completed in about two and a half quarters. This article also finds that the fourth-order serial correlation problem disappears after a generalized Tobit model is used for the parameter estimation.     

Option-implied expectations in commodity markets and monetary policy

In this paper we estimate the dynamic interactions between option-implied variance and skewness in agricultural commodity markets and monetary policy. Using a structural vector autoregressive (SVAR) framework, we find that an expansionary (contractionary) monetary policy upwardly (downwardly) revises commodity markets’ expectations about the price and volatility path of agricultural products. On the other hand, our empirical analysis reveals that monetary policy does not have a systematic and timely response to sudden changes in option implied expectations of commodity investors. In addition, we provide empirical evidence showing the robust forecasting power of agricultural option-implied information on monetary policy with R² values reaching almost 52%.     

Monetary policy and inferential expectations of exchange rates

We present a macroeconomic market experiment to isolate the impact of monetary shocks on the exchange rate, as an alternative to SVAR identification. In a non-stochastic treatment, covered interest rate parity holds and predicted exchange rates are tracked well. In a stochastic treatment, we model expectations using a Neyman–Pearson hypothesis test (inferential expectations) and find evidence of belief conservatism and uncovered interest rate parity failure. The market environment magnifies belief conservatism, which is opposite to the standard claim that markets tend to eliminate individual choice anomalies.     

The signaling role of policy actions

In an economy affected by shocks that are imperfectly known, the monetary instrument takes on a dual stabilizing role: as a policy response that directly influences the economy and as a vehicle for information that reveals the central bank's assessment to firms. Because mark-up shocks cannot be neutralized by monetary policy, providing firms with more information about these shocks exacerbates their reaction and creates a larger distortion. Recognizing the signaling role of its instrument, the central bank distorts its policy response in order to optimally shape firms’ beliefs. While providing firms with more information is always detrimental to the output gap, it has a more subtle effect on price dispersion depending on whether information is provided through the transparency channel or through the signaling channel. Although more transparency is always detrimental to welfare, the information that is conveyed by the monetary instrument improves welfare when firms’ coordination is highly valuable.     

Aggregation and stabilization policy in a multi-contract economy

This paper presents a model of a multi-sector economy in which each sector is characterized by a different type of wage or price stickness. The various sectors experience the same exogenous shocks and have the same money supply. The analysis shows that demand shocks pose no serious problems for stabilization policy. In contrast, supply shocks may force the policymaker to choose between stability in one sector and stability in another. The analysis also shows that the economist as to the economy's underlying structure and obscures the tradeoffs the policymaker must confront. In particular, a feedback rule chosen on the basis of an aggregate model could be either better or worse than a passive policy.     

Monetary instruments and policy rules in a rational expectations environment

This paper explores the implications of rational expectations and the aggregate supply theory advanced by Lucas (1973) and Barro (1976) for analysis of optimal monetary policy under uncertainty along the lines of Poole (1970), returning to a topic initially treated by Sargent and Wallace (1975). Not surprisingly, these two ‘classical’ concepts alter both the menu of feasible policy choice and the desirability of certain policy actions. In our setup, unlike that of Sargent and Wallace (1975), the systematic component of monetary policy is a relevant determinant of the magnitude of ‘business fluctuations’ that arise from shocks to the system. Central bank behavior — both the selection of monetary instruments and the framing of overall policy response to economic conditions — can work to diminish or increase the magnitude of business fluctuations. However, the ‘activist’ policies stressed by the present discussion bear little (if any) relationship to the policy options rationalized by the conventional analysis of monetary policy under uncertainty. In particular, in contrast to Poole's analysis, money supply responses to the nominal interest rate are not important determinants of real economic activity. Rather, the central bank should focus on policies that make movements in the general price level readily identifiable by economic agents.     

Optimal monetary policy,endogenous supply and rational expectations

In this paper we demonstrate that the choice of monetary policy regime will affect the variability of output when private agents, in forming their supply decisions, take into account the authority's selection of a policy rule. A striking feature of the analysis is that the choice between policy rules in Sargent-Wallace (1975) framework, but with endogenous aggregate supply, depends only on the variability of aggregate demand under each rule and not on the variability of aggregate supply. It follows that the choice of monetary policy rules reduces to the problem analyzed by Poole (1970) in the stochastic Keynesian structure.     

The role of financial journalists in the expectations channel of the monetary transmission mechanism

Monetary policy relies on managing the inflation expectations of the public in order to influence prices (inflation). Relying on the South African experience, we argue that most of the general public are exposed to the communication of the South African Reserve Bank (SARB) only via the media. This state of affairs is fairly typical around the globe. We explored the role and biases of the journalists in transmitting the SARB’s communications to the rationally inattentive general public. Our aim was to obtain insights about the factors that influence media articles that deal with monetary policy issues. Using interviews and qualitative content analysis, we explored the extent of the journalists’ knowledge about inflation and monetary policy, their views concerning the credibility of the SARB, the sources of information they use, and the constraints and incentives they face in writing their articles.     

The role of time value in convertible bond call policy

Since the seminal work of Ingersoll (1977b) the optimal time in which a firm should redeem its outstanding convertible bonds has received large attention by the financial literature. Several studies have put forward a number of possible costs and benefits for a firm if it interrupts the life of its convertible bonds prior to their contractual maturity. However, in this paper we argue that the managerial decision to call back a convertible bond is mainly driven by a fundamental variable almost neglected up until now: the time value extraction from bondholders’ conversion option. Accordingly, we propose a measure for the effective convenience of calling—which we define as net time value advantage—and we show, using a survival analysis, that it is more effective than previously proposed measures in explaining the firms’ observed call policy.     

The role of market expectations in commodity price dynamics: Evidence from oil data

This paper examines the contribution of market expectations to commodity price dynamics. It proposes a dynamic competitive storage framework with an explicit expectations shock along with concurrent shocks to study the commodity price movements. This allows for a refined analysis of the expectations’ effect on price and inventory and the estimation of the expectations. Applied to the world crude oil market, it finds that the contribution of market expectations to the crude oil spot price movements is limited from 1987 to 2014.     

Unemployment and monetary policy under rational expectations: Some Canadian evidence

The policy implications of combining rational expectations with the natural rate of unemployment hypothesis are reviewed. A monetary policy feedback rule is estimated on Canadian data for the period 1927–1972. The residuals from the regression serve as the unanticipated components of monetary policy while predicted values serve as expected monetary growth. An unemployment equation is then developed in which the unemployment rate is allowed to be influenced by expected and unexpected monetary policy and fiscal and foreign spending. The evidence confirms the hypothesis that it is unanticipated monetary policy that affects unemployment and that anticipated monetary growth plays no significant role.     

The evolution of emissions trading in the European Union – The role of policy networks,knowledge and policy entrepreneurs

This paper starts with a recapitulation of how emissions trading became a cornerstone of the European Union’s climate policy. While a whole bouquet of reasons can be identified the major reasons why the EU Commission decided to pursue the establishment of an emissions trading scheme within the EU are: (1) the integration of international emissions trading into the Kyoto Protocol; (2) the failure of the 6th Conference of the Parties to the United Nations Framework Convention on Climate Change (UNFCCC) and the withdrawal of the United States from the Kyoto Protocol negotiations; and (3) the unsuccessful attempt to introduce an EU-wide CO₂-tax. Other reasons were the fact that emissions trading did not need unanimity in the European Council like the CO₂-tax; the economic efficiency of emissions trading which appealed not only to the Commission but also to industry and Member States; the danger of a fragmented carbon market as the United Kingdom and Denmark had already set up domestic emissions trading schemes that were incompatible; the incentive a European emissions trading scheme would be for the formation of a global carbon market; and the possibility to influence investment strategies of power companies towards a sustainable modernisation of the EU’s power generation infrastructure.Drawing upon these preconditions, this paper analyses the development of the European Union Emissions Trading Scheme (EU ETS). Based on the fact that the EU is embedded in a multi-level policy-making architecture which encourages the emergence of policy networks it is argued that the EU ETS has been shaped by an (informal) issue-specific policy network established by some staff members from DG Environment, including individuals knowledgeable on emissions trading – such as experts from consultancies, environmental NGOs and the business sector. It is argued that within this European policy network on emissions trading the European Emissions Trading Directive – as adopted on 13 October 2003 – has been negotiated and developed. It is concluded that the sharing of knowledge about this relatively new and largely unknown regulatory instrument and about design options for a potential European emissions trading scheme was the key momentum for the establishment and continuity of this policy network and that the ability of managing knowledge generation processes was the main factor to allow for a few staff members from DG Environment to play a dominant role as policy entrepreneurs in developing the European Emissions Trading Directive, even beyond their formal role of proposing the scheme as representatives from the EU Commission.     

The Netherlands: An employment policy role model?

Conclusion While in recent years the level of social security benefits in the Netherlands has been reduced somewhat —whereby to some extent this involved the employers shouldering additional costs (e.g. for disability pensions) —the benefits for unemployment and other social bene-fits remain high in international comparative terms. Despite a slight decline in social benefits as a share of GDP, public sector spending as a whole is, at around 50%, slightly higher than in Germany, although the Netherlands has not had to cope with extraordinary burdens such as have resulted from German unification. The successes achieved by the Netherlands on the labour market have been exaggerated. Firstly, the real level of unemployment is likely to be actually rather high in international terms, at least once one dispenses with a narrow definition and takes account, in particular, of the large number of occupationally disabled. Secondly, the fall in the unemployment rate is far from spectacular. Although the increase in the number of wage and salary earners has been substantially higher in the Netherlands than in west Germany, this in no way represents a comparable increase in the volume of employment—measured in working hours—as the incidence of part-time employment has increased far faster there than in west Germany. The Netherlands has achieved-slightly-higher growth than west Germany. This success is largely due to a very moderate growth of wages and salaries, amounting to a real depreciation of the guilder against the D-Mark, an economic policy strategy that can be successful in a small country, but one which, if applied by a large country such as Germany, would merely initiate a beggar-thy-neighbour race to lower real exchange rates.     

Price level determinacy with an interest rate policy rule and rational expectations

This paper reconsiders a result obtained by Sargent and Wallace namely, that price level indeterminacy obtains in their model if the monetary authorities adopt a feedback rule for the interest rate rather than the money stock. It is shown that the indeterminacy vanishes if the interest rate rule is chosen so as to have a desired effect on the expected quantity of money demanded. This holds even if considerable weight is given, in the choice of a rule, to the aim of smoothing interest rate fluctuations.     

Rational expectations,changing monetary policy rules,and real exchange rate dynamics

This paper reexamines the explanatory power of Taylor rule fundamentals for real exchange rate determination. We assume the agents know the time-varying parameters in central bank policy rules. The empirical results suggest that a monetary policy rule with regime switching is better able to explain the real Deutschemark/dollar exchange rate from 1976 to 1998 compared with a fixed-regime monetary policy rule. The findings show the importance of accounting for the expectation formation effect in changing policy rules as emphasized by the Lucas critique. Ignoring these effects can undermine the value of the rational expectations models.