The design of monetary and fiscal policy: A global perspective

We study the emergence of multiple equilibria in models with capital and bonds under various monetary and fiscal policies. We show that the presence of capital is indeed another independent source of local and global multiplicities, even under active policies that yield local determinacy. We also show how a very similar mechanism generates multiplicities in models with bonds and distortionary taxation. We then explore the design of monetary policies that avoid multiple equilibria. We show that interest rate policies that respond to the output gap, while potentially a source of significant inefficiencies, may be effective in preventing multiple equilibria and costly oscillatory equilibrium dynamics.     

The effect of GNP announcements on fluctuations of GNP growth

This paper is an empirical study of the degree in which perceptions affect the evolution of the economy. We study the effects of the announcements that the government makes on GNP growth. These announcements are subject to a substantial degree of noise and its accuracy improves with time. A revised number is published several years after the first announcement was made public. We consider that the final revision is the “true” value of GNP growth. We show that once announcements are taken into account, the true value of GNP growth at time t has no predictive power in determining growth at any future time. All the predictive power lies in the announcements, and not in the true level of growth. Actually, we show that the variable that determines future growth is the unexpected part of the announcements. We also show that announcements affect growth via aggregate investment.     

Optimal monetary policy regime for oil producing developing economies: Implications for post-war Iraq

This paper theoretically investigates optimal monetary policy regime for oil producing developing countries. We analyze credibility and reputation of the Central Bank and macroeconomic dynamics under alternative monetary policy regimes. We construct a detailed and realistic model that can be used to analyze macroecomic structure and expectation dynamics of an oil producing open economy. We take into account the asymmetric information between the public and the central bank and theoretically investigate how this asymmetric information impacts the real economy and the credibility of the central bank. The simulation results indicate that central bank achieves higher credibility and lower inflation under dollarization and higher output levels under currency board regime. The model constructed in this paper has many policy implications for oil producing open economies. Using the implications of the model, we make monetary policy regime recommendations for post-war Iraq.     

Intermediaries and payments instruments

We study an economy in which intermediaries have incentives to issue circulating liabilities as part of an equilibrium. We show that, with arbitrarily small transactions costs, only the liabilities of intermediaries will circulate, and not those of other private sector agents. Therefore, our model connects intermediation activity with the issuance of payments media, a connection that has not been made in earlier literature. We use our model to suggest a resolution of the “ banknote underissue puzzle” of Cagan (in: D. Carson (Ed.), Banking and Monetary Studies, Richard D. Irwin Publishing, Homewood, IL, 1963).     

Data uncertainty and the role of money as an information variable for monetary policy

In this study, we perform a quantitative assessment of the role of money as an indicator variable for monetary policy in the euro area. We document the magnitude of revisions to euro area-wide data on output, prices, and money, and find that monetary aggregates have a potentially significant role in providing information about current real output. We then proceed to analyze the information content of money in a forward-looking model in which monetary policy is optimally determined subject to incomplete information about the true state of the economy. We show that monetary aggregates may have substantial information content in an environment with high variability of output measurement errors, low variability of money demand shocks, and a strong contemporaneous linkage between money demand and real output. As a practical matter, however, we conclude that money has fairly limited information content as an indicator of contemporaneous aggregate demand in the euro area.     

Solving the price puzzle with an alternative indicator of monetary policy

We identify the effects of monetary policy shocks on macroeconomic variables in VARs using the Divisia M4 measure of money as the policy indicator variable. We obtain theoretically sensible responses—whether or not a commodity price index is included. Thus, we eliminate the well-known empirical puzzles from the VAR by a novel choice in a policy variable, rather than the usual attachment of an ad hoc variable.     

The impact of ECB and FED announcements on the Euro interest rates

We investigate the impact of news in the ECB and FED monetary policy announcements on daily changes in Euro interest rates. We document significant impacts of ECB announcements throughout the period but only until mid 2004 of FED announcements.     

A simple and flexible alternative to Stability and Growth Pact deficit ceilings. Is it at hand?

We model a monetary union where fiscal discretion generates excessive debt accumulation in steady state and inefficiently delayed debt adjustment following shocks. By setting a debt target and raising the political cost of deviating from the optimal pace of debt reversal¸ institutional design induces fiscal policymakers to implement unbiased responses to shocks. This is partly achieved by increasing the transparency of the decision-making process. We therefore call for more focused supervision tasks for the European Commission and for parliamentary discussion whenever a disagreement arises between the Commission and a national government.     

Rule-of-thumb behaviour and monetary policy

We investigate the implications of rule-of-thumb behaviour by consumers or price setters for optimal monetary policy and simple interest rate rules. This behaviour leads to endogenous persistence in output and inflation and alters the policymaker's welfare objective. Our main finding is that highly inertial policy is optimal regardless of what fraction of agents occasionally follow a rule of thumb. We also find that a first-difference version of Taylor's (Carnegie-Rochester Conf. Ser. Public Policy 39 (1993) 195-214) rule generally has desirable properties. By contrast, the coefficients in other optimised simple rules tend to be extremely sensitive with respect to the fraction of rule-of-thumb behaviour.     

Open-Economy Inflation-Forecast Targeting

Abstract. We study simple inflation-forecast targeting in an open-economy setting. Simple inflation-forecast targeting implies setting an interest rate which, if kept unchanged throughout the forecast-targeting horizon, produces a conditional inflation forecast equal to the inflation target at the end of the horizon. We find that the optimal forecast-targeting horizon is relatively short (one year). A longer horizon does not consistently contribute to improved output stability, indeed it increases exchange rate variability and traded sector variability. The targeting procedure is substantially inferior to the optimal pre-commitment policy. Moreover, the targeting procedure does not necessarily determine the rational-expectations equilibrium and is subject to time inconsistency.     

Supply side inflation persistence

We explore the role of the cost channel in accounting for inflation persistence in the New Keynesian model with Calvo pricing. Hump-shaped responses of inflation to monetary shocks are obtained under purely nominal rigidities.     

The NIRCU and the Phillips curve: an approach based on micro data

Abstract In this paper we propose a straightforward method to derive a non‐inflationary rate of capacity utilization (NIRCU) based on micro data. We condition the current capacity utilization of firms on their current and planned price adjustments. The non‐inflationary capacity utilization rate is then defined as the rate where a firm feels no price adjustment pressure. One of the main advantages is that this methodology uses structural aspects and does not make it necessary to operate with – often rather arbitrary – statistical filters. We show that our aggregate NIRCU performs remarkably well as an indicator of inflationary pressure in a Phillips curve estimation.     

How do central banks react to wealth composition and asset prices?

We assess the response of monetary policy to developments in asset markets in the euro area, the US and the UK. We estimate the reaction of monetary policy to wealth composition and asset prices using: (i) a linear framework based on a fully simultaneous system approach in a Bayesian environment; and (ii) a nonlinear specification that relies on a smooth transition regression model.     

The composition of government spending and the multiplier at the zero lower bound

We investigate the size of the multiplier at the ZLB in a New Keynesian model. It ranges from around −0.25 to +1.5, depending on the extent to which the government spending is productive, substitutable or not for private consumption.     

Bubble-free policy feedback rules

We consider a broad class of linear dynamic stochastic rational-expectations models made of a finite number N of structural equations for N+1 endogenous variables and to be closed by one policy feedback rule. We design, for any model of this class and any stationary VARMA solution of that model, a “bubble-free” policy feedback rule ensuring that this solution is not only the unique stationary solution of the closed model, but also its unique solution. We apply these results to locally linearisable models of the monetary transmission mechanism and obtain interest-rate rules that not only ensure the local determinacy of the targeted equilibrium in the neighbourhood of the steady state considered, but also prevent the economy from gradually leaving this neighbourhood.     

Two-period cycles in a three-period overlapping generations model

We study the properties of two-period monetary cycles in simple pure exchange overlapping generations economies in which the households live for three periods. We demonstrate that these economies can support cycles under a much broader—and, arguably, more plausible—range of assumptions than the analogous two-period economies. We show that economies that fail the well-known Grandmont (Econometrica 53 (1985) 995) condition can have cycles, and that economies that satisfy the condition can fail to have cycles. In addition, we show that economies can have monetary cycles when they do not have conventional monetary steady states, and when aggregate demand for assets is not decreasing in the real return rate at a gross real rate of unity.     

Flexible inflation forecast targeting: Evidence from Canada

We test whether the Bank of Canada pursues a flexible inflation forecast target, one that weights output growth as well as inflation. For the period 1996–2007, we find evidence that the Bank did effectively pursue such a target over the forecast horizon of 12 to 18 months. We find the relative weight that the Bank gives to output growth in its target to be positive and statistically significant within the range of 0.2 to 0.4.     

Financial systems and the cost channel transmission of monetary policy shocks

We study the role of financial systems for the cost channel transmission of monetary policy in a calibrated business cycle model. We characterize financial systems by the share of bank-dependent firms and by the degree of the pass-through from policy to bank lending rates, for which we provide empirical estimates for the euro area and the US. For plausible calibrations of the dynamics of the lending rate we find that the cost effects directly related to interest rate movements have only a limited effect on the transmission mechanism.     

Expectation driven business cycles with limited enforcement

We explore shocks to expected future productivity in a model with limited enforcement of financial contracts. A microfounded collateral constraint implies that good news about future productivity yield an increase in stock prices, available credit and a general economic expansion.     

Forecasting Canadian time series with the New Keynesian model

Abstract.  This paper assesses the out-of-sample forecasting accuracy of the New Keynesian Model for Canada. We estimate a variant of the model on a series of rolling subsamples, computing out-of-sample forecasts one to eight quarters ahead at each step. We compare these forecasts with those arising from vector autoregression (VAR) models, using econometric tests of forecasting accuracy. We show that the forecasting accuracy of the New Keynesian Model compares favourably with that of the benchmarks, particularly as the forecasting horizon increases. These results suggest that the model could become a useful forecasting tool for Canadian time series.