The Value of Interest Rate Stabilization Policies When Agents Are Learning

We examine the expectational stability (E-stability) of rational expectations equilibrium in the "New Keynesian" model where monetary policy is optimally derived and interest rate stabilization is added to the central bank's traditional objectives of inflation and output stabilization. We consider both the case where the central bank lacks a commitment technology and the case of full commitment. We show that for both cases, optimal policy rules yield rational expectations equilibria that are E-stable for a wide range of empirically plausible parameter values. These findings stand in contrast to Evans and Honkapohja's findings for optimal monetary policy rules in environments where interest rate stabilization is not a central bank objective.     

Are inflation expectations rational?

Several recent papers report evidence of an apparent statistical bias in inflation expectations and interpret these findings as overturning the rational expectations hypothesis. In this paper, we investigate the validity of such an interpretation. We present a computational dynamic general equilibrium model capable of generating aggregate behavior similar to the data along several dimensions. By construction, model agents form “rational” expectations. We run a standard regression on equilibrium realizations of inflation and inflation expectations over sample periods corresponding to those tests performed on actual data and find evidence of an apparent bias in inflation expectations. Our experiments suggest that this incorrect inference is largely the product of a small sample problem, exacerbated by short-run learning dynamics in response to infrequent shifts in monetary policy regimes.     

Using a long-term interest rate as the monetary policy instrument

Using a short-term interest rate as the monetary policy instrument can be problematic near its zero bound constraint. An alternative strategy is to use a long-term interest rate as the policy instrument. We find when Taylor-type policy rules are used by the central bank to set the long rate in a standard New Keynesian model, indeterminacy—that is, multiple rational expectations equilibria—may often result. However, a policy rule with a long-rate policy instrument that responds in a “forward-looking” fashion to inflation expectations can avoid the problem of indeterminacy.     

Optimal Monetary Policy in a Small Open Economy with Home Bias

We analyze optimal monetary policy in a small open economy characterized by home bias in consumption. Peculiar to our framework is the application of a Ramsey-type analysis to a model of the recent open-economy New Keynesian literature. We show that home bias in consumption is a sufficient condition for inducing the monetary policymaker of an open economy to deviate from a strategy of strict markup stabilization and contemplate some (optimal) degree of exchange rate stabilization. We focus on the optimal setting of policy both in the case of firms setting prices one period in advance and in a gradual fashion subject to adjustment costs. While the first setup allows us to analytically highlight home bias as an independent source of equilibrium markup variability, the second setup allows to study the effects of future expectations on the optimal policy problem and the effect of home bias on optimal inflation volatility. The latter, in particular, is shown to be related to the degree of trade openness in a U-shaped fashion, whereas exchange rate volatility is monotonically decreasing in openness.     

Robust monetary policy with imperfect knowledge

We examine the performance and robustness properties of monetary policy rules in an estimated macroeconomic model in which the economy undergoes structural change and where private agents and the central bank possess imperfect knowledge about the true structure of the economy. Policymakers follow an interest rate rule aiming to maintain price stability and to minimize fluctuations of unemployment around its natural rate but are uncertain about the economy's natural rates of interest and unemployment and how private agents form expectations. In particular, we consider two models of expectations formation: rational expectations (RE) and learning. We show that in this environment the ability to stabilize the real side of the economy is significantly reduced relative to an economy under RE with perfect knowledge. Furthermore, policies that would be optimal under perfect knowledge can perform very poorly if knowledge is imperfect. Efficient policies that take account of private learning and misperceptions of natural rates call for greater policy inertia, a more aggressive response to inflation, and a smaller response to the perceived unemployment gap than would be optimal if everyone had perfect knowledge of the economy. We show that such policies are quite robust to potential misspecification of private sector learning and the magnitude of variation in natural rates.     

The Formation of Inflation Expectations: Microdata Evidence from Japan

We propose a novel approach for measuring inflation expectations, which can alleviate the rounding number problem. Furthermore, we examine how consumers form inflation expectations. We find that consumers heterogeneously update their information sets on prices; 46% of the consumers collect information about the consumer price index at least once a quarter, while the remaining consumers less frequently or never obtain this information. We also find that forecast revisions are sensitive to a change in food prices. More than half of consumers are attentive only to a change in food prices and may form their inflation expectations using food price changes as a signal of fluctuations in the overall inflation rates. The existence of consumers who are inattentive to aggregate inflation casts doubt on the transmission of monetary policy through the management of expectations.     

Deconstructing credibility: The breaking of monetary policy rules in Brazil

Can political interference deconstruct credibility that was hardly-earned through successful stabilization policy? We analyze the recent switch in the conduct of monetary policy by the Central Bank of Brazil (BCB). Brazil is the largest Emerging Market Economy to formally target inflation, having adopted the Inflation Targeting (IT) regime in 1999. In the early years of IT, the BCB engaged in constructing credibility with price setting agents and succeeded to anchor inflation expectations to its target even under adverse conditions such as exchange rate crises. We argue that this effort to maintain IT rules-based policy ended in 2011, as a new country president and BCB board came to power. We then discuss the consequences of this credibility loss. Our main results can be summarized as follows: (i) we provide strong empirical evidence of the BCB’s shift toward looser, discretionary policy after 2011; (ii) preliminary evidence suggests that this shift has affected agents’ inflation expectations generating social and economic costs.     

Global liquidity trap

How should monetary policy respond to a “global liquidity trap,” where the two countries may fall into a liquidity trap simultaneously? Using a two-country New Open Economy Macroeconomics model, we first characterize optimal monetary policy, and show that the optimal rate of inflation in one country is affected by whether or not the other country is in a liquidity trap. We next examine how well the optimal monetary policy is approximated by relatively simple monetary policy rules. The interest-rate rule targeting the producer price index performs well in this respect.     

Price‐Level Targeting and Stabilization Policy

We construct a dynamic stochastic general equilibrium model to study optimal monetary stabilization policy. Prices are fully flexible and money is essential for trade. Our main result is that if the central bank pursues a price‐level target, it can control inflation expectations and improve welfare by stabilizing short‐run shocks to the economy. The optimal policy involves smoothing nominal interest rates that effectively smooths consumption across states.     

Inflation Targeting,Recursive Inattentiveness,and Heterogeneous Beliefs

We consider a monetary authority that provides an explicit inflation target in order to align expectations with the policy objective. However, biased perceptions of the target may arise due to imperfect information flows. We allow agents to revise expectations over time and we model their recursive choice among prediction strategies as an optimization problem under rational inattention. We then investigate whether a simple policy rule can steer the economy toward the targeted equilibrium. Our findings suggest that determinacy under rational expectations may not be sufficient to reach the target. Instead, monetary policy should be fine‐tuned to correct agents' biased beliefs.     

A quantitative exploration of the opportunistic approach to disinflation

Under a conventional policy rule, a central bank adjusts its policy rate linearly according to the gap between inflation and its target, and the gap between output and its potential. Under “the opportunistic approach to disinflation” a central bank controls inflation aggressively when inflation is far from its target, but concentrates more on output stabilization when inflation is close to its target, allowing supply shocks and unforeseen fluctuations in aggregate demand to move inflation within a certain band. We use stochastic simulations of a small-scale rational expectations model to contrast the behavior of output and inflation under opportunistic and linear rules.     

Optimal monetary policy with the cost channel

In the standard new Keynesian framework, an optimizing policy maker does not face a trade-off between stabilizing the inflation rate and stabilizing the gap between actual output and output under flexible prices. An ad hoc, exogenous cost-push shock is typically added to the inflation equation to generate a meaningful policy problem. In this paper, we show that a cost-push shock arises endogenously when a cost channel for monetary policy is introduced into the new Keynesian model. A cost channel is present when firms’ marginal cost depends directly on the nominal rate of interest. Besides providing empirical evidence for a cost channel, we explore its implications for optimal monetary policy. We show that its presence alters the optimal policy problem in important ways. For example, both the output gap and inflation are allowed to fluctuate in response to productivity and demand shocks under optimal monetary policy.     

Monetary conservatism and fiscal policy

Does an inflation conservative central bank à la Rogoff (1985) remain desirable in a setting with endogenous fiscal policy? To provide an answer we study monetary and fiscal policy games without commitment in a dynamic, stochastic sticky-price economy with monopolistic distortions. Monetary policy determines nominal interest rates and fiscal policy provides public goods generating private utility. We find that lack of fiscal commitment gives rise to excessive public spending. The optimal inflation rate internalizing this distortion is positive, but lack of monetary commitment generates too much inflation. A conservative monetary authority thus remains desirable. When fiscal policy is determined before monetary policy each period, the monetary authority should focus exclusively on stabilizing inflation. Monetary conservatism then eliminates the steady state biases associated with lack of monetary and fiscal commitment and leads to stabilization policy that is close to optimal.     

中国通货膨胀预期及其影响因素分析——基于混频无套利Nelson-Siegel利率期限结构扩展模型

综合国债市场的利率期限结构信息以及不同频率的宏观信息,本文构建混频无套利Nelson-Siegel利率期限结构扩展模型,在对不同期限债券进行一致性定价理论约束下,提取了中国通货膨胀预期的期限结构并对其进行影响因素分析。研究结果表明,本文模型提取的通胀预期期限丰富、结果稳健,具有较好的参考价值。通胀预期水平和变动响应主要受货币增长率、通胀率及全球食品价格变动等国内外相关宏观变量的影响,与国债收益率因子之间的关系不显著;国债收益率因子对中长期通胀预期的方差波动具有较强解释力,表明国债定价反映了未来通胀的不确定性。本文研究有助于充分利用我国宏观与金融市场信息条件,有效发现和锚定通胀预期,一方面,研究结果可为政策制定者和市场投资者提供科学的决策参考,另一方面,研究方法对丰富宏观金融领域的分析框架具有参考价值。     

中国通货膨胀预期及其影响因素分析——基于混频无套利Nelson-Siegel利率期限结构扩展模型

综合国债市场的利率期限结构信息以及不同频率的宏观信息,本文构建混频无套利Nelson-Siegel利率期限结构扩展模型,在对不同期限债券进行一致性定价理论约束下,提取了中国通货膨胀预期的期限结构并对其进行影响因素分析。研究结果表明,本文模型提取的通胀预期期限丰富、结果稳健,具有较好的参考价值。通胀预期水平和变动响应主要受货币增长率、通胀率及全球食品价格变动等国内外相关宏观变量的影响,与国债收益率因子之间的关系不显著;国债收益率因子对中长期通胀预期的方差波动具有较强解释力,表明国债定价反映了未来通胀的不确定性。本文研究有助于充分利用我国宏观与金融市场信息条件,有效发现和锚定通胀预期,一方面,研究结果可为政策制定者和市场投资者提供科学的决策参考,另一方面,研究方法对丰富宏观金融领域的分析框架具有参考价值。     

Optimal monetary policy in a small open economy with staggered wage and price contracts

We study optimal monetary policy for a small open economy in a model where both domestic prices and wages are sticky due to staggered contracts. The simultaneous presence of the two forms of nominal rigidities introduces an additional trade-off between domestic inflation and the output gap. We derive a second-order approximation to the average welfare losses that can be expressed in terms of the unconditional variances of the output gap, domestic price inflation, and wage inflation. As a consequence, the optimal policy seeks to minimize a weighted average of these variances. We analyze welfare implications of several alternative simple policy rules, and find that domestic price inflation targeting generates relatively large welfare losses, whereas CPI inflation targeting performs nearly as well as the optimal rule.     

Banking Competition,Collateral Constraints,and Optimal Monetary Policy

We analyze optimal monetary policy in a model with two distinct financial frictions: monopolistically competitive banks that charge endogenous lending spreads, and collateral constraints. We show that welfare maximization is equivalent to stabilization of four goals: inflation, output gap, the “consumption gap” between borrowers and savers, and a “housing gap” that measures the distortion in the distribution of the collateralizable asset between both groups. Collateral constraints create a trade‐off between stabilization goals. Following both productivity and financial shocks, and relative to strict inflation targeting, the optimal policy implies sharper movements in the policy rate, aimed primarily at reducing fluctuations in asset prices and hence in borrowers' net worth. The policy trade‐offs become amplified as banking competition increases, due to the fall in lending spreads and the resulting increase in borrowers' leverage.     

Learning about the Term Structure and Optimal Rules for Inflation Targeting

In this paper, we incorporate the term structure of interest rates in the New Keynesian model and analyze optimal policy under uncertainty about private sector expectations and the degree of inflation persistence. The novel result of our paper is that for large deviations of inflation from its target, the active learning policy is less activist—in the sense of responding less aggressively to the state of the economy—than a myopic policy, which ignores the learning channel. Moreover, for most initial beliefs, the incentive for active learning increases as monetary policy’s leverage over the long‐term interest rate increases.     

Do Actions Speak Louder Than Words? Household Expectations of Inflation Based on Micro Consumption Data

Survey data on household expectations of inflation are routinely used in economic analysis, yet it is not clear how accurately households are able to articulate their expectations in survey interviews. We propose an alternative approach to recovering households' expectations of inflation from their consumption expenditures. We show that these expectations measures have predictive power for consumer price index (CPI) inflation. They are better predictors of CPI inflation than household survey responses and more highly correlated with professional inflation forecasts, except for highly educated consumers, consistent with the view that more educated consumers are better able to articulate their expectations. We also document that households' inflation expectations respond to inflation news, as measured by the unpredictable component of inflation predictions in the Survey of Professional Forecasters. The response to inflation news tends to increase with households' level of education, consistent with the existence of constraints on household's ability to process this information.     

Effective Use of Survey Information in Estimating the Evolution of Expected Inflation

The evolution of the term structure of expected U.S. inflation is modeled using survey data to provide timely information on structural change not contained in lagged inflation data. To capture shifts in subjective perceptions, the model is adaptive to long‐horizon survey expectations. However, even short‐horizon survey expectations inform shifting‐endpoint estimates that capture the lag between inflation and the perceived inflation target, which anchors inflation expectations. Results show movements of the perceived target are an important source of inflation persistence and suggest historical U.S. monetary policy was not fully credible for much of the postwar sample.