MACROECONOMIC STABILIZATION POLICIES IN THE EMU: SPILLOVERS, ASYMMETRIES AND INSTITUTIONS

This paper studies the institutional design of the coordination of macroeconomic stabilization policies within a monetary union in the framework of linear quadratic differential games. A central role in the analysis plays the partitioned game approach of the endogenous coalition formation literature. The specific policy recommendations in the European Economic and Monetary Union (EMU) context depend on the particular characteristics of the shocks and the economic structure. In the case of a common shock, fiscal coordination or full policy coordination is desirable. When anti‐symmetric shocks are considered, fiscal coordination improves the performance but full policy coordination does not produce further gains in policymakers' welfare.     

The Hidden Structural Features of the Fiscal Rule: A European Saga

This paper addresses the question of the reform of the Stability and Growth Pact (SGP). More and more authors and policymakers are bringing to light the negative impacts of the European deficit rule on the countries and their ability to respond asymmetric economic shocks, and some are asking for a redefinition of the pact. If the focus of the SGP is only fiscal, and two of the biggest countries in Europe have failed to abide by the pact since its implementation, it seems clear that the SGP needs at least a re-examination. Yet, on the contrary, if we introduce into the analytical framework the SGPs impacts on the European Unions structural policies, the conclusions are far different. Abolishing the SGP could hinder the presently up-to-date convergence prospective. This paper proposes a theoretical analysis of the SGP that emphasizes a new feature of the SGP: a strong incentive to structural reforms.The author would like to thank the participants of the International Atlantic Economic Conference in Quebec City (Oct. 16–19, 2003) for their helpful comments, Kenneth Donahue, and two anonymous referees. The usual caveat applies.     

The Limits of Transparency

This paper probes the limits of transparency in monetary policymaking along two dimensions: feasibility and desirability. It argues that, due to limited knowledge about the economy, even central banks (CBs) that are considered champions of openness are not very clear about their measurement of the output gap and about their beliefs regarding the effect of policy on inflationary expectations. Consequently, feasibility constraints on transparency are more serious than stylized models of the transmission mechanism would imply. In addition, no CB has made clear statements about its objective function, including in particular the relative weight on output versus inflation stabilization, the policy discount factor and the shape of losses from the inflation and the output gaps over the possible ranges of realizations of those variables.
The paper also argues that there is a trade-off between full transparency and full utilization of information in setting policy and that excessive transparency may facilitate the exertion of political pressures on the CB.
The last section of the paper abstracts from feasibility constraints and discusses the desirable levels of openness in various areas of the policymaking process. It is argued that the strongest case against immediate transparency arises when the CB has private information about problems within segments of the financial system. Premature release of information may, in such a case, destroy efficient risk-sharing arrangements and long-term investments by triggering a run on the financial system. This is illustrated within the context of the classic Diamond–Dybvig model of bank runs. The paper also probes the desirable levels of transparency in other areas of the policymaking process like the bank's objective function, the bank's output target, forecasts of economic shocks, disagreements within the CB board and the publication of CB interest-rate forecasts.     

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.     

An empirical analysis of euro cash payments

If the denominational structure of the euro is used in an optimal way, there should be no preferences for certain coins and notes when making cash payments. In Kippers et al. [2003. An empirical study of cash payments. Statistica Neerlandica 57, 484-508] it is documented that the Dutch public did have certain preferences concerning the Dutch guilder in the sense that a few notes and coins were used less often than they should have been. With the advent of the euro, which changed the denominational structure from 1--5 (guilder) to 1-2-5 (euro), it is of interest to examine whether there are any preferences for euro coins and notes. In this paper we use a unique dataset for the Netherlands to empirically examine if the euro range is used in an optimal way. We find that there are no preferences for certain euro denominations.     

The interaction between monetary and fiscal policies in Turkey: An estimated New Keynesian DSGE model

This paper estimates a New Keynesian open economy DSGE model for Turkey by using Bayesian estimation technique for the period of 2002:q1–2009:q3. It studies fiscal and monetary policy interactions and their role in stabilisation of the economy using a small-scale model following the methodology outlined in Lubik and Schorfheide (2007). The general features of the model can be summarised as follows: Calvo style nominal price rigidities, perfect exchange rate pass-through, complete international asset markets, rule of thumb price setters and distortionary taxation.     

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.     

Fiscal policy under loose commitment

Due to time-inconsistency or political turnover, policymakers' promises are not always fulfilled. We analyze an optimal fiscal policy problem where the plans made by the benevolent government are periodically revised. In this loose commitment setting, the properties of labor and capital income taxes are significantly different than under the full-commitment and no-commitment assumptions. Because of the occasional reoptimizations, the average capital income tax is positive even in the long-run. Also, the autocorrelation of taxes is lower, their volatility with respect to output increases and the correlation between capital income taxes and output changes sign. Our method can be used to analyze the plausibility and the importance of commitment in a wide-class of dynamic problems.     

Evaluating inflation targeting as a monetary policy objective for India

This study formulates a small open economy model for India with exchange rate as a prominent channel of monetary policy. The model is estimated using the Instrumental Variable-Generalized Methods of Moments (IV-GMM) estimator and evaluated through simulations. This study compares different cases of domestic and CPI inflation targeting, strict and flexible inflation targeting, and simple Taylor type rules. The analysis highlights the unsuitability of simple Taylor-type monetary rules in stabilizing the Indian economy and suggests that discretionary optimization works better in stabilizing this economy. There seems to be a trade-off between output gap stabilization and exchange rate stabilization in flexible domestic inflation targeting and CPI inflation targeting respectively. However, flexible domestic inflation targeting seems a better alternative from an overall macro stabilization perspective in India where financial markets are still not sufficiently integrated to ensure quick transmission of interest rate impulses and existence of rigidities in the economy.     

Liquidity traps, learning and stagnation

We examine global economic dynamics under learning in a New Keynesian model in which the interest-rate rule is subject to the zero lower bound. Under normal monetary and fiscal policy, the intended steady state is locally but not globally stable. Large pessimistic shocks to expectations can lead to deflationary spirals with falling prices and falling output. To avoid this outcome we recommend augmenting normal policies with aggressive monetary and fiscal policy that guarantee a lower bound on inflation. In contrast, policies geared toward ensuring an output lower bound are insufficient for avoiding deflationary spirals.     

On policymakers’ loss functions and the evaluation of early warning systems: Comment

Sarlin (2013) suggests that if a loss function approach is chosen to derive the optimal threshold for financial crisis early warning indicators, the loss function specification should explicitly take into account the unconditional sample crisis probability. In this comment we argue that this approach is not robust to small perturbations of the preference parameter and is not easy to use for policy purposes. We suggest therefore to continue using a simpler loss function specification.     

Are Central Bank Preferences Asymmetric? A Comment

A recent paper by Ruge-Murcia (2004) on asymmetric central bank objectives provides a new perspective on the policy roots of inflation in developed economies. More precisely, the paper demonstrates that if the distribution of the supply shocks is normal, then the reduced-form solution for inflation implies a positive (or negative) relation between average inflation and the variance of shocks. We argue that the evidence offered in support of this hypothesis suffers from lack of identification because Phillips curve nonlinearity combined with quadratic central bank preferences yield the same reduced-form solution for inflation. If so, estimating reduced form for inflation will not be able to discriminate between these models. Yet they have quite different implications for policy. Other, structural, evidence is needed.     

Fiscal leadership and central bank design

Abstract.  This article investigates the impact, on economic performance, of the timing of moves in a policy game between the government and the central bank for a government that has both redistributional and stabilization objectives. It is shown that both inflation and income inequality are reduced without sacrificing output growth if the government assumes a leadership role compared with a regime in which monetary and fiscal policy are determined simultaneously. Further, it is shown that government leadership benefits both the fiscal and monetary authorities through the enhanced coordination that this arrangement implies.