OPTIMAL MONETARY POLICY WITH THE STICKY INFORMATION MODEL OF PRICE ADJUSTMENT: INFLATION OR PRICE‐LEVEL TARGETING?

I investigate the optimal monetary policy in a New Keynesian macroeconomic framework with the sticky information model of price adjustment. The model is solved for optimal policy, and welfare implications of three alternative monetary policy regimes under this optimal policy are compared when there is a cost‐push shock to the economy. These monetary policy regimes are the unconstrained policy, price‐level targeting and inflation targeting regimes. The results illustrate that optimal policy depends on the degree of price stickiness and the persistence of the shock. Inflation targeting emerges as the optimal policy if prices are flexible enough or the shock is persistent enough. However, the unconstrained policy or price‐level targeting might be preferable to inflation targeting if prices are not very flexible and the shock is not very persistent. The results also show that as prices become more flexible, the welfare loss usually gets bigger.     

Inflation persistence and exchange rate regime: Implications for dynamic adjustment to shocks in a small open economy

The paper examines implications of inflation persistence for business cycle dynamics following terms of trade shock in a small oil producing economy, under inflation targeting and exchange rate targeting regimes. It is shown that due to the ‘Walters critique’ effect, the country’s adjustment paths are slow and cyclical if there is a significant backward-looking element in the inflation dynamics and the exchange rate is fixed. It is also shown that such cyclical adjustment paths are moderated if there is a high proportion of forward-looking price setters in the economy, so that when the Phillips curve becomes completely forward-looking cyclicality in adjustment paths disappears and the response of the real exchange rate becomes hump-shaped. In contrast, with an independent monetary policy, irrespective of the degree of inflation persistence, flexible exchange rate allows to escape severe cycles, which results in a smooth response of the real exchange rate.     

Impact of foreign prices and interest rates on canadian economy under alternative monetary and exchange rate regimes

The main objective of this paper is to analyze the impact of U.S. short- and long-term monetary policy under both flexible and managed floating systems, using the new CANDIDE Model 2.0. We have also examined the role of domestic monetary policy in the Canadian economy under both fixed and flexible exchange rate systems. The following are some of the important findings of our study:

1. Our results support the traditional view that under the fixed exchange rate regime, monetary authorities cannot successfully pursue an independent monetary policy from its trading partners — an effort to increase money supply will be almost offset by increases in the balance of payments deficit. In contrast, in the flexible exchange rate regime, monetary policy is more effective in producing an increased growth in output and employment. However the increased output growth comes at the cost of higher prices induced by increased wages and a depreciation of the Canadian dollar.
2. Our results suggest that the impact of U.S. interest rates on investment, GNE, employment, productivity, and government debt is less severe in a pure floating exchange rate regime, compared to the managed floating system. However, the impact of U.S. interest rate policy on the Canadian inflation rate is worse in the case of flexible exchange rate regime. Even though real income and inflation are less favourable in both cases, our results indicate a trade-off between output growth and inflation.
3. Our results imply that under a pure floating monetary authorities can determine the long-run rate of inflation in Canada independent of others. However, the United States and Canadian economies are interrelated during the adjustment process, even under the flexible exchange rates, through the terms of trade and the wage-price spiral channels.

     

Monetary policy and asset prices

The purpose of this paper is study the effect of monetary policy on asset prices. We study the properties of a monetary model in which a real asset is valued for its rate of return and for its liquidity. We show that money is essential if and only if real assets are scarce, in the precise sense that their supply is not sufficient to satisfy the demand for liquidity. Our model generates a clear connection between asset prices and monetary policy. When money grows at a higher rate, inflation is higher and the return on money decreases. In equilibrium, no arbitrage amounts to equating the real return of both objects. Therefore, the price of the asset increases in order to lower its real return. This negative relationship between inflation and asset returns is in the spirit of research in finance initiated in the early 1980s.     

Does money have a role in the inflation process? Evidence from Australia

Inflation, defined as a sustained increase in the price level, is considered a monetary phenomenon, as it can be explained within the framework of money‐demand and money‐supply relationships. In the extant literature, money growth is shown to remain causally related to inflation across countries and over time, irrespective of the exchange rate regime and stability of the money‐demand function. Nevertheless, emerging literature suggests a diminishing role of money in the conduct of monetary policy for price stability, especially under inflation targeting. Monetary policy in Australia under inflation targeting since 1993 is an example of policy that denies a relationship between money growth and inflation. The proposition that money does not matter insofar as inflation is concerned seems odd in both theory and the best‐practice monetary policy for price stability. This paper uses annual data for the period 1970–2017 and quarterly data for the period 1970Q1–2015Q1. It deploys both the Johansen cointegration approach and the autoregressive distributed lag (ARDL) cointegration approach to investigate for Australia whether money, real output, prices and the exchange rate (non‐stationary variables) maintain the long‐run price‐level relationship that the classical monetary theory suggests in the presence of such stationary variables as the domestic and foreign interest rates. As expected, the empirical findings for Australia are consistent with the classical long‐run price‐level relationship between money, real output, prices and the exchange rate. The error‐correction model of inflation confirms the presence of a cointegral relationship among these variables; it also provides strong evidence of a short‐run causal relationship between money supply growth and inflation. On the basis of a priori theoretical predictions and empirical findings, the paper draws the conclusion that the monetary aggregate and its growth rate matter insofar as inflation is concerned, irrespective of the strategy of monetary policy for price stability.     

MARKET POWER,PRICE ADJUSTMENT,AND INFLATION*

We study a monetary search economy in which endogenous fluctuations in market power driven by changes in consumers' search intensity determine the extent of price adjustment to movements in productivity and the money growth rate. A calibrated version of the economy exhibits countercyclical fluctuations in markups and is consistent with the observed incomplete response of nominal prices to cost movements associated with productivity fluctuations and to changes in the money growth rate. Furthermore, a higher average rate of inflation results in a lower average markup and increases the sensitivity of prices to fluctuations in either productivity or money growth.     

通货膨胀、汇率波动与货币政策——基于符号约束的贝叶斯VAR模型实证研究

通过构建通货膨胀形成的理论模型,本文运用符号约束的贝叶斯VAR方法探讨通货膨胀和汇率波动对产出增长的影响。结果发现：实际利率对通货膨胀和人民币升值冲击均有较大的响应,且受通货膨胀的影响更大,即稳定价格的货币政策比稳定汇率的政策更加有效;通货膨胀冲击下,实际利率在长期有所上升,但并未达到控制通货膨胀的效果,实际利率偏低阻碍了货币政策效果的发挥;人民币升值对产出增长具有较大的负面影响,对通货膨胀具有负向）中击,但由于油价上涨的原因,人民币升值并没有降低通货膨胀水平。     

INFLATION PERSISTENCE AND FLEXIBLE PRICES*

If the central bank follows an interest rate rule, then inflation is likely to be persistent, even when prices are fully flexible. Any shock, whether persistent or not, may lead to inflation persistence. In equilibrium, the dynamics of inflation are determined by the evolution of the spread between the real interest rate and the central bank's target. Inflation persistence can be characterized by a vector autocorrelation function relating inflation and output. This article shows that a flexible‐price, general‐equilibrium business cycle model with money and a central bank using an interest rate target can account for such inflation persistence.     

Optimal Monetary Policy

Optimal monetary policy maximizes the welfare of a representative agent, given frictions in the economic environment. Constructing a model with two sets of frictions—costly price adjustment by imperfectly competitive firms and costly exchange of wealth for goods—we find optimal monetary policy is governed by two familiar principles. First, the average level of the nominal interest rate should be sufficiently low, as suggested by Milton Friedman, that there should be deflation on average. Yet, the Keynesian frictions imply that the optimal nominal interest rate is positive. Second, as various shocks occur to the real and monetary sectors, the price level should be largely stabilized, as suggested by Irving Fisher, albeit around a deflationary trend path. Since expected inflation is roughly constant through time, the nominal interest rate must therefore vary with the Fisherian determinants of the real interest rate. Although the monetary authority has substantial leverage over real activity in our model economy, it chooses real allocations that closely resemble those which would occur if prices were flexible. In our benchmark model, there is some tendency for the monetary authority to smooth nominal and real interest rates.     

Optimal Monetary Policy with Vertical Production and Trade*

This paper explores the optimal monetary policy response to domestic and foreign technology shocks in an open economy with vertical structure of production and trade. We find that any stage‐specific productivity shock in one country may have a transborder spillover effect on the other country via the vertical trade. So when choosing optimal monetary rules, each monetary authority should respond to both home and foreign productivity shocks. Also, the flexible exchange rate cannot replicate the flexible price equilibrium, even under producer currency pricing, due to price stickiness in multiple stages. We also find that the existence of a transborder spillover effect depends on the currencies of price setting. Finally, vertical trade may affect the value of exchange rate flexibility under PCP and LCP setting.     

Expectations and regime robustness in price formation: evidence from vector autoregressive models and recursive methods

The forward-looking linear quadratic adjustment cost (LQAC) model has received attention when modelling prices. Empirical evidence supporting the model seems, however, ambiguous. We find that the LQAC-model is severely at odds with price data for Norwegian machinery exports also when the pure forward-looking rule is augmented by additional lags of the targeted variable. A conditional equilibrium correction (EqCM) model explains the export price behaviour more accurately. Our findings may rule out a large class of expectations based models and not just the particular LQAC-model in the formation of export prices. We also demonstrate that the EqCM-model performs well post-sample despite that monetary policy in Norway has changed from a fixed to a floating exchange rate regime following a recent introduction of inflation targeting. This regime robustness shows that the Lucas critique lacks force empirically in our case.     

Thai inflation dynamics: A view from disaggregated price data

This paper utilizes disaggregated prices at the micro level to examine the patterns of price adjustment in Thailand. Among the key stylized facts, we found that the frequency of price changes are generally low, prices decreases are common, the size of price changes are large relative to the inflation rate, and there is significant dispersion in price levels as well as in the synchronicity of price changes across regions. To better understand the underlying sources of heterogeneous price dynamics, we conduct dynamic factor analyses and highlight the importance of relative price changes in driving the bulk of overall CPI movements. This suggests an important role of non-monetary factors in driving inflation. A significant Phillips curve relation is detected once idiosyncratic price changes are filtered out, reinforcing the importance of disaggregated analysis of price trends in the conduct of monetary policy.     

Productivity Shocks and Monetary Policy in a Two-Country Model

In this paper, we examine the effects of foreign productivity shocks on monetary policy in a symmetric open economy. Our two-country model incorporates the New Keynesian features of price stickiness and monopolistic competition based on the cost channel of Ravenna and Walsh (2006). In particular, in response to asymmetric productivity shocks, firms in one country achieve a more efficient level of production than those in another economy. Because the terms of trade are directly affected by changes in both economies’ output levels, international trade creates a transmission channel for inflation dynamics in which a deflationary spiral in foreign producer prices reduces domestic output. When there is a decline in economic activity, the monetary authority should react to this adverse situation by lowering the key interest rate. The impulse response function from the model shows that a productivity shock can cause a real depreciation of the exchange rate when economies are closely integrated through international trade.     

Long-Run Links among Money, Prices and Output: Worldwide Evidence

Abstract. Starting from the quantity theory of money we analyse the dynamic relationships between money, real output and prices for an unbalanced panel of 110 economies. Complementary to trivariate analyses we also adopt a P-star model explaining inflation via an equilibrium price level (P-star), which in turn depends on potential output and money. A key issue of the paper is the cross-sectional stability of estimation and inference results. We find cointegration among the considered variables. Particularly for high inflation countries homogeneity between prices and money cannot be rejected. Given homogeneity we find evidence for an error-correction mechanism linking current price changes and the lagged price gap. Parameter estimates indicating the adjustment towards the price equilibrium are larger in absolute value for high inflation countries. The latter results indicate that central banks, even in high inflation countries, can improve price stability by controlling monetary growth.     

食品与非食品价格的长期均衡关系与短期非线性调整——基于两区制门槛协整模型的实证研究

食品通胀率与非食品通胀率之间的测量缺口近期持续扩大,引起了市场广泛关注。文章根据1994年1月至2010年8月的食品价格与非食品价格数据,运用两区制门槛误差修正模型研究两者的长期均衡关系和短期价格调整以及传导机制中的非线性特征。结果发现,食品通胀率与非食品通胀率存在门槛协整关系,而且估计缺口稳定,这表明测量缺口夸大了两者的真实偏离。文章还发现了食品价格传导的新信息内涵,即食品价格对非食品价格具有非线性的价格传导性:短期内偏离主要是食品价格上升造成,尤其是在高通货膨胀区制,偏离速度有加快趋势。两区制的Granger因果关系检验发现,在极端区制,食品价格通胀与非食品价格通胀具有双向的短期Granger原因,即两者相互领先;而在正常区制,食品价格通胀与非食品价格通胀具有双向的长期Granger原因。     

MONEY,CAPITAL, AND EXCHANGE RATE FLUCTUATIONS*

We explore how the informational frictions underlying monetary exchange affect international exchange rate dynamics. Our perfectly flexible price model is capable of producing endogenously rigid international relative prices in response to technology and monetary shocks. The model is capable of accounting for the empirical regularities that the real and nominal exchange rates are more volatile than U.S. output, and that the two are positively and perfectly correlated. The model is also consistent with other standard real business cycle facts for the United States.     

TAYLOR RULE REACTION COEFFICIENTS AND REAL EXCHANGE RATE PERSISTENCE

Recent literature has established a link between the persistence of real exchange rates and the degree of inertia in Taylor rule monetary policy reactions functions. This paper provides a different view on this link by investigating how the size of Taylor rule reaction coefficients impacts the adjustment dynamics of the real exchange rate. Within a stylized sticky‐price open‐economy macro model, it is demonstrated that a stronger interest rate reaction to inflation in the Taylor rule raises the convergence speed of the real exchange rate. Conversely, raising the coefficient on the output gap or attending to the exchange rate in an open‐economy version of the Taylor rule slows down real exchange rate adjustment. In all cases, more rapid convergence comes at the cost of stronger initial real exchange rate misalignments in the wake of monetary policy shocks.     

紧缩性货币政策应对当前通货膨胀的低效性

近期我国出现了居民消费物价指数快速上涨的现象,通货膨胀压力逐步显现,货币当局采取了一系列紧缩性货币政策。然而当前通货膨胀的重要特征是结构性价格调整,其深层次原因是扭曲的要素价格体系的调整和经济增长方式的转变,数据也显示货币供给量的平稳增长和通货膨胀率存在背离的现象。因此,继续采取紧缩性货币政策应对当前通货膨胀是低效的,应当综合采取多种政策手段实现对经济的调控。     

Oil shocks and monetary policy rules in emerging economies

We examine the effects of shocks in the oil market on key macroeconomic variables in small open economies using a dynamic stochastic general equilibrium model with sticky prices and imperfect competition under different monetary policy rules. The numerical solutions show that the types of exchange rate regimes and monetary policies could partly explain the trends in macroeconomic volatilities considering negative shocks to oil supply (Hamilton, 1983) and positive shocks to oil demand (Kilian, 2009). These findings are confirmed in vector autoregressive responses for Chile and Israel with inflation targeting under flexible exchange regimes and Hong Kong with fixed regime.     

Price setting & price stickiness: A developing economy perspective

We study price setting in Pakistan using 1189 structured interviews of managers organized by the State Bank of Pakistan–Pakistan’s Central Bank. We find that on an annual basis the incidence of price adjustment is three times higher than in developed countries. The remaining price rigidity is explained by the existence of firms’ interactions with the informal sector, strategic interactions with other firms and the uncertainty about temporariness of shocks. The exchange rate and cost-push shocks matter more and are incorporated faster into prices than financial cost and demand-pull shocks. The roughly bimodal nature of price reviewing strategies together with a high frequency of price adjustment imply that monetary policy will carry low potency. Time-dependent price reviewing strategies tend to dominate state-dependent strategies, but the ratio of price reviews to actual adjustment is too high and inconsistent with the moderate levels of inflation experienced by Pakistan.