Forward-looking monetary policy and anticipated shocks to inflation

This paper extends a standard New Keynesian model to describe the effects of anticipated shocks to inflation and forward-looking monetary policy. Using the data generated from this modified model suggests that overlooking these two factors in the standard Cholesky structural vector autoregressive identification scheme will generate a price puzzle. Furthermore, this paper demonstrates that failing to account for these two factors may result in significant estimates of two other explanations of the price puzzle—the cost channel of transmission of monetary policy and indeterminacy due to violation of the Taylor principle—even though neither features in the data generating process.     

Timeless perspective versus discretionary policymaking when the degree of inflation persistence is unknown

One major strand in optimal monetary policy analysis considers the robustness of alternative policies under model uncertainty. Another has focused on the appropriate perspective for optimal monetary policy, namely discretion or the timeless perspective (TP). The paper bridges these two parallel lines of research by assessing the welfare consequences of both policy perspectives in the presence of misperceptions about the degree of intrinsic inflation persistence. Contrary to most standard results, discretion can be the more robust perspective, the reason being that the TP exploits the expectations channel. With misperceptions this leads to large deteriorations in welfare.     

The empirical validity of the New Keynesian Phillips curve using survey forecasts of inflation

This paper investigates the performance of the New Keynesian Phillips curve when survey forecasts of inflation are used to proxy for inflation expectations. Previous authors such as Brissimis and Magginas (2008) have applied survey measures of inflation expectations to the NKPC, and have concluded that these estimates are superior to those estimated using actual data on future inflation. However this approach employs the use of the labor income share as the proxy for real marginal cost, something which is highly problematic once we consider the countercyclicality of this variable. This paper develops and tests a procyclical marginal cost variable alongside various survey measures of inflation forecasts in the NKPC, while recognizing the problem of weak instruments that occurs when estimating the model using conventional GMM. We find that the NKPC produces a counter-intuitive negative and significant coefficient on procyclical marginal cost when surveys of inflation forecasts are used, which casts serious doubt on the empirical viability of the NKPC model, even when estimated with survey inflation forecasts.     

Noisy information, interest rate shocks and the Great Moderation

In this paper we evaluate the hypothesis that the Great Moderation is partly the result of a less activist monetary policy. We simulate a New Keynesian model in which the central bank can only observe a noisy estimate of the output gap and find that the less pronounced reaction of the Federal Reserve to output gap fluctuations since 1979 can account for a substantial part of the reduction in the standard deviation of GDP associated with the Great Moderation. Our simulations are consistent with the empirically documented smaller magnitude and impact of interest rate shocks since the early 1980s.     

Announcements and credibility under inflation targeting

We inspect how inflation target announcements are instrumental in building central bank credibility and shaping inflation expectations. Investigating the role of announcements by using a time varying credibility measure, we find that both the accuracy and the frequency of inflation announcements have a positive impact on how much attention the public pays to target announcements.     

Cost-based Phillips Curve forecasts of inflation

It is a well-established idea that prices are a function of marginal cost, yet estimating a reliable measure of marginal cost is difficult to do. Stock and Watson (1999) use the Phillips Curve to forecast inflation for a variety of existing activity variables that researchers commonly use to proxy for marginal cost. This paper uses a similar type of approach to examine the performance of a new candidate for the activity variable, which is marginal cost measured following the theoretical methodology of Bils (1987), which we find to be simple yet powerful when implemented empirically. We then use the Phillips Curve to conduct pseudo out-of-sample inflation forecasts for the US using: output, unemployment, hours, the labor share, the capacity utilization rate, and the new measure of marginal cost. For almost all cases, forecast errors are lowest in the regressions with the new marginal cost variable, indicating that this new measure is an improvement over previous attempts to proxy for marginal cost.     

Implementing and interpreting indicators of core inflation: the case of France

This paper presents a comparison of alternative indicators of underlying or “core” inflation in the French case. Four broad measures are considered and implemented. The first two are inflation excluding food and energy, and the trimmed inflation indicator. We then implement two methods relying on time-series models: the Dynamic Factor Index and the structural VAR approach.  Each indicator stresses on a particular type of shock on the inflation rate, so that no simple ranking of the measures emerges. Combining the various indicators conveys valuable information for appraising short term inflation developments. As regards theoretical interpretation, no indicator is fully satisfactory, lacking an explicit representation of monetary policy. However, comparing forecast performance with respect to inflation provides some specific support in favor of trimmed mean indicators. First version received: January 2000/Final version received: March 2001     

The emerging global financial architecture and exchange rate regimes in a volatile world

Previous work has documented inflation effects on Tobin's q in the long run. This paper examines whether the FED's different policies and chairmen tenure have an impact on Tobin's q, after a modified stylized AD-AS model shows that central banks affect q. We do find changing responses of q depending on the pre-Volcker and post-Volcker periods.     

Financial market imperfections and monetary policy strategy

In a model with imperfect money, credit and reserve markets, we examine if an inflation-targeting central bank applying the funds rate operating procedure to indirectly control market interest rates also needs a monetary aggregate as policy instrument. We show that if private agents use information extracted from money and financial markets to form inflation expectations and if interest rate pass-through is incomplete, the central bank can use a narrow monetary aggregate and the discount interest rate as independent and complementary policy instruments to reinforce the credibility of its announcements and the role of inflation target as a nominal anchor for inflation expectations. This study shows how a monetary policy strategy combining inflation targeting and monetary targeting can be conceived to guarantee macroeconomic stability and the credibility of monetary policy. Friedman's k-percent money growth rule, which can generate dynamic instability, and two alternative stabilizing feedback monetary targeting rules are examined.     

Optimal versus realized policy rules in a regime-switching framework

In this paper we compare a deterministic model and a Markov switching model to analyze the behavior of the US economy and the Federal Reserve. We examine both optimal and empirical monetary policies for the US Federal Reserve between 1960 and 2008. We compare the optimal monetary policy to the actual interest rates and to the empirical reaction function. We also evaluate the sensitivity of the results to the preferences assigned to each objective. We find that there is no unique optimal solution that fits the Federal Reserve behavior over the entire period. The best fit to the actual interest rates is obtained by an optimal policy with preference switches following the rule: a high-volatility regime coincides with a priority on inflation alone while in a low-volatility regime there is equal policy priority on output stabilization and inflation.     

Understanding the effects of technology shocks

The research led by Gali (AER 1999) and Basu et al. (AER 2006) raises two important questions regarding the validity of the RBC theory: (i) How important are technology shocks in explaining the business cycle? (ii) Do impulse responses to technology shocks found in the data reject the assumption of flexible prices? Using an RBC model, this paper argues that the conditional impulse responses of the U.S. economy to technology shocks are not grounds to reject the notion that technology shocks are the main driving force of the business cycle and the assumption of flexible prices, in contrast with the conclusions reached by the literature.     

Geography, skills or both: What explains Fed watchers’ forecast accuracy of US monetary policy?

The paper shows that there is a substantial degree of heterogeneity in the ability of Fed watchers to forecast US monetary policy decisions. Based on a novel database for 268 individual professional forecasters since 1999, the average absolute forecast error of FOMC decisions varies 5–10 basis points between the best and worst-performers across the sample. This heterogeneity is found to be related to both the skills of analysts – such as their educational and employment backgrounds – and to geography. In particular, forecasters located in regions which experience more idiosyncratic economic conditions perform worse in anticipating monetary policy. This evidence is indicative that limited attention and heterogeneous priors are present even for anticipating important events such as monetary policy decisions.     

Monetary policy rules in Central and Eastern European Countries: Does the exchange rate matter?

We estimate monetary policy rules for six Central and Eastern European Countries (CEEC) during the period when they prepared for membership to the EU and monetary union. By taking changes in the policy settings explicitly into account and by splitting up the exchange rate impact into two different components we significantly improve estimation results for monetary policy rules in CEEC. We uncover that the focus of the interest rate setting behaviour in the Czech Republic, Hungary and Poland explicitly switched from defending the peg to targeting inflation. For Slovakia, however, there still seemed to be on ongoing focus on the exchange rate. Finally, Slovenia and, after a policy switch, Romania exhibit a solid relation with inflation as well.     

Assessing the effects of financial heterogeneity in a monetary union a DSGE approach

The aim of this article is to analyze how financial heterogeneity can accentuate the cyclical divergences inside a monetary union that faces technological, monetary, budgetary and financial shocks. To this purpose, this study relies on a two-country Dynamic Stochastic General Equilibrium model, where the two countries are supposed to be differently sensitive to the bank capital channel. The model allows us to demonstrate how a given symmetric shock causes cyclical divergences inside a heterogeneous monetary union. On this point, it allows reproducing some stylized facts recently observed in the Euro Area. Moreover, it appears that the more heterogeneous the union, the larger the effects of financial asymmetries on the transmission of shocks. Finally, we show that a common monetary policy contributes to worsen cyclical divergences, in comparison with monetary policies that would be nationally conducted.     

The inflation bias when the central bank targets the natural rate of unemployment

This paper studies the proposition that an inflation bias can arise in a setup where a central banker with asymmetric preferences targets the natural unemployment rate. Preferences are asymmetric in the sense that positive unemployment deviations from the natural rate are weighted more (or less) severely than negative deviations in the central banker's loss function. The bias is proportional to the conditional variance of unemployment. The time-series predictions of the model are evaluated using data from G7 countries. Econometric estimates support the prediction that the conditional variance of unemployment and the rate of inflation are positively related.     

Corruption, inflation and growth

We present a model in which the embezzlement of tax revenues by public officials leads the government to rely more on seigniorage to finance its expenditures. This raises inflation which depresses investment and growth via a cash-in-advance constraint.     

On the dynamics of international inflation

We investigate the dynamic properties of inflation in 20 OECD countries with a novel approach based on the autocorrelation function. We find evidence in favor of long memory and nonlinearity. Linear autoregressive models are shown to be misspecified.     

Inflation and real sectoral output shares: Dynamic panel model evidence from seven OECD countries

Models of the cost of inflation often conclude that inflation misallocates resources. For example, inflation may lead to an increase in the variability of relative prices and it is often claimed that this increase in variability leads to a misallocation of resources. This claim raises the following empirical question, does inflation alter the composition of real output; that is, does it change real output shares? We examine this question using dynamic panel data methods for nine sector panels each with seven OECD countries from 1970 to 2005. We find evidence that inflation changes the real shares of some sectors even when inflation is treated as endogenous.