Dove or Hawk? Characterizing monetary policy regime switches in India

The past two decades have witnessed a worldwide move by emerging markets to adopt explicit or implicit inflation targeting regimes. A notable and often discussed exception to this trend, of course, is China which follows a pegged exchange rate regime supported by capital controls. Another major exception is India. It is not clear how to characterize the monetary regime or identify the nominal monetary anchor in India. Is central bank policy in India following a predictable rule that is heavily influenced by a quasi inflation target? And how has the monetary regime been affected by the gradual process of financial liberalization in India? To address these points, we investigate monetary policy regime change in India using a Markov switching model to estimate a time-varying Taylor-type rule for the Reserve Bank of India. We find that the conduct of monetary policy over the last two decades can be characterized by two regimes, which we term ‘Hawk’ and ‘Dove.’ In the first of these two regimes, the central bank reveals a greater relative (though not absolute) weight on controlling inflation vis-à-vis narrowing the output gap. The central bank however was found to be in the “Dove” regime about half of our sample period, focusing more on the output gap and exchange rate targets to stimulate exports, rather than moderating inflation. India thus seems to be following its own direction in the conduct of monetary policy, seemingly not overly influenced by the emphasis on quasi-inflation targeting seen in many emerging markets.     

Inflation,uncertainty, and monetary policy

Low inflation likely reflects factors whose influence should fade over time. But many uncertainties attend this assessment, and downward pressures on inflation could prove to be unexpectedly persistent. My colleagues and I may have misjudged the strength of the labor market, the degree to which longer-run inflation expectations are consistent with our inflation objective, or even the fundamental forces driving inflation. In interpreting incoming data, we will need to stay alert to these possibilities and, in light of incoming information, adjust our views about inflation, the overall economy, and the stance of monetary policy best suited to promoting maximum employment and price stability. How should policy be formulated in the face of such significant uncertainties? In my view, it strengthens the case for a gradual pace of adjustment. But we should also be wary of moving too gradually. It would be imprudent to keep monetary policy on hold until inflation is back to 2%.     

Price stability through price-level targeting or inflation targeting? A tale of two experiments

Price stability can be attained through price-level or inflation targeting. This paper compares the two monetary policy strategies from both a historical and a theoretical perspective. The Swedish experiment with price-level targeting in the 1930 occurred within a framework that lacked the accountability characteristic of New Zealand's current policy framework for inflation-targeting. Using a simple forward-looking rational expectations framework, we show that price-level targeting offers a better output-inflation variability tradeoff than inflation targeting in the forward-looking New Keynesian framework.     

适度宽松货币政策下的价格总水平运行分析

近年来,我国经济环境发生了显著变化,中央银行调控货币政策的手段、能力日渐成熟。适度宽松的货币政策对于抑制通缩预期,提振市场信心,防止陷入通货紧缩与经济下行相互加强的恶性循环,促使经济回暖发挥了至关重要的作用。但是,在全球经济总体回暖、货币条件较为宽松的大背景下,国内外通胀预期也有所增强。因此,正确把握新形势下我国货币供应量与价格总水平波动之间的关系,对于未来货币政策的实施具有重要实践意义。     

The “Output Gap” and Excess Labor Employment

The debate surrounding the current status of monetary policy and inflation has appealed to the existence of an output gap that will prevent the resurgence of substantial inflation. This paper presents evidence that the expansion in the late 1990s was unusual and should not be used as a basis for benchmarking the output gap at zero. In particular, there was an unusual psychology that prevailed in the late 1990s and 2000 that led to excessive capital spending and hiring. If policymakers overestimate the magnitude of the output gap by overestimating excess labor supply, they run the risk of making timing errors in the implementation of economic policy.JEL Classification E240, J210     

论当前通货膨胀及其治理

多年来,我国经济始终保持着高增长、低通胀率的良好状态,这种现象甚至被外国学者称为"中国之谜"、"中国奇迹"。而自2007年开始,我国经济却接连遇到各种问题,经济增加放缓,连续两轮高通货膨胀,股市崩盘,何时经济回暖始终未知。本文主要从货币角度分析通货膨胀的成因,以及目前高通胀预期对经济增速放缓的影响,并对政策提出意见。     

The Economy Today and a Policy Framework for Today and Tomorrow

The U.S. economy appears to be on track for a sustainable recovery, dominated by private demand, with major components of growth other than residential construction likely to grow at a healthy rate through 2011. Inflation is likely to remain in an acceptable zone, but policymakers must be vigilant concerning inflation expectations. Employment is expected to recover slowly. Within this broad outlook, uncertainty appears to be growing, particularly with the unrest in the Middle East and North Africa. This uncertainty implies that flexibility is essential in either extending Federal Reserve asset purchases or in exiting from its current position. Given that passive unwinding of this position will probably not be feasible and that monetary policy acts with lags, it is important to employ a forward-looking rule to guide action.     

Central Banking After the Crisis: No Return to Past Certainties

Before the 2008 crisis, macroeconomic theory and central bank practice regarded low and stable inflation to be a policy objective that was sufficient to ensure macroeconomic and financial stability. There was little concern with the details of the financial system or balance sheet aggregates. This article makes the case that these details are important and that monetary and macroprudential policy must control both the quantity and allocation of credit. This entails a revision of conventional monetary theory as well as policy, particularly to explain the paradox of the precrisis situation of so much credit and so little inflation. The particular role of real estate investment is described as a source of financial instability that can only be addressed by nuanced monetary and macroprudential policy.     

Monetary policy and risk management at a time of low inflation and low unemployment

I do not see it as likely that the Phillips curve is dead, or that it will soon exact revenge. It is more likely that many factors, including better conduct of monetary policy over the past few decades, have greatly reduced, but not eliminated, the effects that tight labor markets have on inflation. However, no one fully understands the nature of these changes or the role they play in the current context. Common sense suggests we should beware when forecasts predict events seldom before observed in the economy.     

An Ordered Probit Approach to Predicting the Probability of Inflation/Deflation

This paper provides an ordered probit approach that estimates the probability six months in the future of three distinct scenarios for prices: inflation, deflation, or price stability. The traditional way of forecasting inflation is to predict a single level and/or growth rate of the PCE deflator. However, this approach is not useful for identifying options or risks facing decision-makers, especially in financial markets. Also, point estimates of inflation convey a sense of overconfidence. Our approach is more practical for decision-makers who must hedge their portfolios, but it is also useful for policymakers, investors, and consumers who must attach a probability with each possible scenario of future price trends. Our results indicate that since June 2011 the probability of deflation has been persistently higher than of the other two scenarios. Thus, the recent years’ higher deflation probabilities may offer a justification for the persistence of the Federal Reserve’s highly accommodative monetary policy during 2012–14.     

Enhancing Fed Credibility

The Fed's credibility regarding control of inflation helps to anchor public expectations of price stability. This makes the Fed's actions more predictable in any given set of circumstances and thus strengthens the monetary policy transmission mechanism and shortens policy lags. The importance of the Fed's credibility can be illustrated by the consequences of its absence in the 1970s. This paper discusses the roots of the Fed's current credibility: a systematic approach to controlling inflation, transparency of its policy decisions, and timely communication of the decisions and the considerations upon which they are based. The paper also discusses areas in which there is room for further improvement. It argues that the most important future step would be to adopt specific inflation targets. Such a step would not only enhance credibility, it would help to focus policy-making itself. While there are some risks to establishing specific numerical targets, these risks can be managed and are outweighed by the benefits of explicit targets. JEL Classification E58     

Risks of deflation versus risks of excessive inflation in Europe

Economists are currently divided over the question of what represents a more immediate threat to the global economy — deflation or excessive inflation. Using stochastic simulations, this article extrapolates the likely inflation rates in individual European countries and the euro area as a whole. The results indicate that as the financial crisis continues to subside, policymakers should be vigilant about expeditiously rolling back the unconventional monetary policy measures implemented during the crisis.     

One fits all in the EMU? One monetary policy for eleven countries

Euro-skeptics continue to argue that the discrepancies between national business cycles are too wide, and that a common European monetary policy cannot work in the long run. The laboriously accomplished monetary stability will therefore not be able to last, high rates of inflation and a “soft” euro will, in the long run, be the inevitable consequences. The empirical evidence given in the following article supports a different view: not only has there been a strong correlation of business cycles in Euroland over the past decade, but there are also a multitude of forces that are working towards further convergence.     

Symbiosis of monetary and fiscal policies in a monetary union

We consider the interaction between the monetary policy in a monetary union, and the separate fiscal policies of the member countries. We use a Barro–Gordon-type model extended to many countries and fiscal policies. Each country’s fiscal policies inflict externalities on other countries, and the common monetary policy has its time-consistency problem. But if the two types of policymakers agree about the ideal levels of output and inflation, then this ideal is attained despite disagreements about the weights of the objectives, despite ex post monetary accommodation to fiscal profligacy, without fiscal coordination, without monetary commitment, and for any order of moves.     

The ECB’s New Monetary Policy Strategy

The ECB updated its monetary policy strategy for the first time in 18 years in July 2021. Therein, the ECB announced that it is willing to accept a transitory period of moderate inflation overshoot in its efforts to push inflation upwards after a long period of undershooting its target. This study explores whether such an overshoot can be economically justified employing a simple Phillips curve model. The results point to the conclusion that the average inflation rate over the business cycle consolidated about one percentage point below the ECB’s target rate. A temporary asymmetry of the ECB’s monetary strategy seems therefore justified to realign inflation and inflation expectations with the target rate.

     

Fiscal and monetary rules for a currency union

This paper addresses the optimal joint conduct of fiscal and monetary policy in a two-country model of a currency union with staggered price setting and distortionary taxes. A tractable linear-quadratic approximation permits a representation of the optimal policy plan in terms of targeting rules. In the optimal equilibrium, monetary policy should achieve aggregate price stability following a flexible inflation targeting rule. Fiscal policy should stabilize idiosyncratic shocks allowing for permanent variations of government debt but should abstain from creating inflationary expectations at the union level. Simple policy rules can approximate the optimal commitment benchmark through a mix of strict inflation targeting and flexible budget rules. Conversely, the welfare costs of balanced budget rules are at least one order of magnitude higher than conventional estimates of the costs of business cycle fluctuactions.     

A new twist on an old framework: bounded price-level targeting

One of the notable macroeconomic developments of the last two decades has been the apparent decline in the so-called neutral real rate of interest (or r-star). The declining level of r-star has significantly reduced forecasts of the steady-state federal funds rate associated with “normalized” monetary policy. Because a lower steady-state policy rate implies a heightened probability of reaching the effective lower bound on the federal funds rate in the event of an economic downturn, a debate has opened among academics and policymakers about potential changes in Fed’s monetary policy framework that might ameliorate the lower bound problem. This paper introduces a variation of price-level targeting that satisfies a definition of price stability that requires the central bank to keep the price level within a pre-specified percentage of a pre-specified target path for all time horizons into the future. The framework, referred to as bounded price-level targeting, is compared to other proposed frameworks. The paper discusses the conditions under which bounded price-level targeting is consistent with other proposals.     

Thoughts about Monetary and Fiscal Policy in a Postinflation World

There is a cultural lag in economic policy, particularly when it comes to inflation. Should inflation continue to be a concern, or is the new “normal” one in which inflation is low on the list of threats? In particular, central banks should focus on their original mission of ensuring financial stability and recognize that monetary accommodation is likely to continue to be appropriate. Budget policy, too, must play a role in promoting economic health—but expenditures should be shifted toward investment that increases productivity rather than consumption. Also, the federal tax codes and entitlements should be restructured so that they promote rather than impede growth. Finally, it is important to guard against institutions and individuals that have enormous financial power using that power to gain short-run advantage for themselves at the expense of long-term stability and prosperity for all.     

Monetary policy surprises and interest rates under China's evolving monetary policy framework

China's monetary policy framework has evolved considerably in the past two decades, increasingly moving from using quantity-based instruments and targets to using price-based instruments and targets. This paper assesses the effectiveness of monetary policy in China by examining the influence of monetary policy on market interest rates using an event-study approach. We find that the effectiveness of price-based instruments in impacting market interest rates increases over time, and that price-based instruments are as effective as quantity instruments during the period since the completion of interest rates liberalization. Furthermore, central bank communications, an increasingly important aspect of monetary policy, affect medium- and long-term market interest rates. Our findings are robust to the use of an alternative measure of monetary policy surprise and an alternative estimation method.     

Comments at the Panel “Responders of First or Last Resort: Central Bank Strategies in an Era of Ultra-Low Interest Rates”

There is an emerging consensus among economists that the trend rate of economic growth in the U.S. is much lower now than in the past. In a lower-trend-growth regime, short-term equilibrium real interest rates are lower, all else being equal. In these circumstances monetary policymakers have less room to cut policy rates before hitting the zero lower bound and relying on unconventional policy tools to provide additional accommodation. Moreover, preserving the Fed’s credibility for providing sufficient accommodation to achieve our symmetric inflation objective and maximum employment remains an important consideration. Therefore, risk-management policies favor skewing policy today to lower the chances of facing more difficult zero-lower-bound outcomes in the future.