Nominal debt as a burden on monetary policy

We characterize the optimal sequential choice of monetary policy in economies with either nominal or indexed debt. In a model where nominal debt is the only source of time inconsistency, the Markov-perfect equilibrium policy implies the progressive depletion of the outstanding stock of debt, until the time inconsistency disappears. There is a resulting welfare loss if debt is nominal rather than indexed. We also analyze the case where monetary policy is time inconsistent even when debt is indexed. In this case, with nominal debt, the sequential optimal policy converges to a time-consistent steady state with positive—or negative—debt, depending on the value of the intertemporal elasticity of substitution. Welfare can be higher if debt is nominal rather than indexed and the level of debt is not too high.     

Labor immobility and the transmission mechanism of monetary policy in a monetary union

It is believed that a common monetary policy in a monetary union will have identical effects on different countries as long as these countries have identical fundamentals. We show that, when there is specialization in production, the terms of trade react to the shock. The transmission mechanism of a monetary shock has in this case an additional channel, the terms of trade. This is the case even if state contingent assets can be traded across countries. For a reasonable parametrization, the differential on the transmission across countries is quantitatively significant when compared with the effect on the union's aggregates. Monetary shocks create cycles with higher volatility in “poor” countries than in “richer” ones.     

On the benefits of fiscal policy coordination in a currency union: a note

It is quite often claimed by politicians that a common currency makes it beneficial to be also endowed with a common fiscal policy. However, if fiscal policy can reasonably be considered to be a source of shocks, national fiscal policies which are steered independently from each other are generally preferable because they allow the possibility to diversify macroeconomic risks. Abstracting from automatic stabilizers, this view is valid independent on whether the ECB targets money growth or interest rates.

Government debt and optimal monetary and fiscal policy

How do different levels of government debt affect the optimal conduct of monetary and fiscal policies? And what do these optimal policies imply for the evolution of government debt over time? To provide an answer, this paper studies a standard monetary policy model with nominal rigidities and monopolistic competition and adds to it a fiscal authority that issues nominal non-state contingent debt, levies distortionary labor income taxes and determines the level of public goods provision. Higher government debt levels make it optimal to reduce public spending, so as to dampen the adverse incentive effects of distortionary taxes, but also strongly influence the optimal stabilization response following technology shocks. In particular, higher debt levels give rise to larger risks to the fiscal budget and to tax rates. This makes it optimal to reduce government debt over time. The optimal speed of debt reduction is missed when using first-order approximations to optimal policies, but is shown to be quantitatively significant in a second-order approximation, especially when technology movements are largely unpredictable in nature.     

货币政策与财政政策的区域产业结构调整效应比较

本文运用1978—2007年东、中、西部的面板数据分析。货币政策和财政政策是否具有区域产业结构调整效应结果显示:第一,财政政策具有产业结构调整效应,而货币政策的产业结构调整效应并不明显。第二,货币政策在对第一和第三产业的效应方面强于财政政策,而财政政策则在对第二产业的效应方面具有优势。第三,货币政策和财政政策对三次产业的效应都存在比较明显的区域效应。第四,在东部地区货币政策和财政政策对第一产业和第二产业的效应相差非常悬殊,而对第三产业的效应则集中在高位;在中部地区货币政策和财政政策对第二产业的效应集中在高位;在西部地区货币政策对第一产业的效应集中在高位,而财政政策对第一产业的效应则集中在低位。     

The identification of fiscal and monetary policy in a structural VAR

Good economic management depends on understanding shocks from monetary policy, fiscal policy and other sources affecting the economy and their subsequent interactions. This paper presents a new methodology to disentangle such shocks in a structural VAR framework. The method combines identification via sign restrictions, cointegration and traditional exclusion restrictions within a system which explicitly models stationary and non-stationary variables and accounts for both permanent and temporary shocks. The usefulness of the approach is demonstrated on a small open economy where policy makers are actively considering the interaction between monetary and fiscal policies.     

Monetary and fiscal policy interactions in a New Keynesian model with capital accumulation and non-Ricardian consumers

The paper examines simple monetary and fiscal policy rules consistent with determinate equilibrium dynamics in the absence of Ricardian equivalence. Under this assumption, government debt turns into a relevant state variable which needs to be accounted for in the analysis of equilibrium dynamics. The key analytical finding is that without explicit reference to the level of government debt it is not possible to infer how strongly the monetary and fiscal instruments should be used to ensure determinate equilibrium dynamics. Specifically, we identify bifurcations associated with threshold values of steady-state debt, leading to qualitative changes in the local determinacy requirements.     

Optimal simple rules for the conduct of monetary and fiscal policy

Stabilization policy involves joint monetary and fiscal rules. We develop a model enabling us to characterize systematic simple monetary and fiscal policy over the business cycle. We principally focus on the following question. What are the key properties of the joint simple rule governing the conduct of systematic stabilization policy? We find that conducting stabilization policy incorporates not only a set of monetary policy choices governed by the so-called ‘Taylor principle’ but also fiscal policy that gives considerable force to automatic stabilizers. Recent US and UK monetary and fiscal choices seem broadly consistent with this model. This result is found to be robust to a number of alternate modeling strategies.     

Optimal information acquisition and monetary policy

I study optimal monetary policy with an expectational AS curve and private agents who optimally choose their amount of information pertinent to predicting policy. Shocks with time-varying variance (ARCH) induce interesting information acquisition (IA) dynamics; optimal IA affects optimal policy and vice versa. Under discretion, IA dynamics cause time-varying effectiveness of policy because of the expectational AS curve; policy may be rendered completely ineffective. In policy game equilibrium, a fall in the shock’s variance typically induces less IA and raises welfare. In one exceptional case the opposite occurs, a result which does not require implausible unstable equilibria. An agent becoming informed increases the endogenous component of economic volatility; IA therefore has a negative externality. Under commitment policy’s effectiveness is again time-varying, but policy is never completely ineffective: commitment enables the central bank to credibly limit policy’s volatility; this limits private agents’ incentive to become informed, so limits expectation-induced policy neutrality.     

Optimal fiscal policy in a world liquidity trap

We construct a model of the international transmission of ‘liquidity trap’ shocks, and examine the case for international coordination of fiscal policy to respond to the liquidity trap. Integrated financial markets tend to propagate liquidity traps. In a global environment, fiscal policy may be effective in raising GDP when the economy is stuck in a liquidity trap, but it does so in a ‘beggar thy neighbor’ fashion; when one economy is in a liquidity trap, the cross country spillover effect of fiscal policy is negative. We examine the welfare optimizing policy response to a liquidity trap when countries coordinate on fiscal policy. Fiscal policy may be an effective tool in responding to a liquidity trap, although it is never optimal to use fiscal expansion sufficiently to fully eliminate a downturn. Moreover, there is little case for coordinated global fiscal expansion. For the most part, the country worst hit by a liquidity trap shock should use its own policies to respond, without much help from foreign policies.     

Optimal choice of monetary policy instruments under velocity and fiscal shocks

This paper, in the spirit of Poole [Poole, William, 1970. The Optimal Choice of Monetary Policy Instruments in a Simple Macro Model. Quarterly Journal of Economics, 84, 192–216.], studies how differently monetary and fiscal shocks influence the appropriate choice of the monetary policy regime. Velocity shocks are introduced by embedding a stochastic cash-in-advance constraint within the New Keynesian framework. In addition to optimal policy under discretion, three classic rules, interest rate targeting, monetary targeting, and the Taylor rule are ranked under both fiscal and velocity shocks. The non-stationarity of prices under the Taylor rule makes it inferior to the other rules under which prices are stationary. Monetary targeting, by stabilizing aggregate demand under fiscal shocks, outperforms interest rate targeting, while the latter provides a better insulation against velocity shocks. Monetary targeting (under fiscal shocks) and interest rate targeting (under velocity shocks) even outperform the optimal policy under discretion for sufficiently high intertemporal elasticities of consumption substitution.     

Tax multipliers and monetary policy: Evidence from a threshold model

Romer and Romer (2010) use the narrative record to generate a time series of exogenous shocks to fiscal policy. They report a tax multiplier of 3.0. We extend their analysis and allow for nonlinearities between their shocks and the effects on output by estimating a threshold regression model. Using Hansen’s (1997) procedure, we find the best fitting threshold is changes in the federal fund rate with a delay of two quarters. Moreover, we find that the tax multiplier is approximately 4.3 if accompanied by an accommodative monetary policy and approximately 1.2 under tight monetary policy.     

Even more on monetary policy in a small open economy

It is well known that in a small open economy with full capital mobility and a fixed exchange rate, monetary policy is ineffective in influencing real output (e.g. the works of Fleming [Int. Monetary Fund Staff Pap. 9 (1962) 369.] and Mundell [Can. J. Econ. Polit. Sci. 29 (1963) 475.]). However, Wu [Int. Rev. Econ. Finance 8 (1999) 223.] finds that when the credit channel is added to this model, monetary policy can have real effects under a fixed exchange rate system. This conclusion hinges on the assumption that open market operations have no effect on foreign exchange reserves of the central bank when evaluating how a change in monetary policy affects the loan market. This assumption is incorrect because under a fixed exchange rate regime, the quantity of foreign reserves becomes endogenous in the model. It is shown that when this assumption is relaxed, monetary policy is still ineffective in influencing output under a fixed exchange regime, even with an operative credit channel.     

Using pre-EMU money market rates to assess monetary policy in the euro area

This note addresses the problems arising when using national pre-EMU interest rate data in the estimation of monetary policy reaction functions for the euro area. We provide evidence that failing to adjust for interest rate risk premia leads to an overestimation of the response of monetary policy both to inflationary pressures and to the output gap. A method for adjusting pre-EMU interest rate data for risk premia is proposed.     

Determinacy, stock market dynamics and monetary policy inertia

We study equilibrium determinacy in a New-Keynesian model where the Central Bank responds to asset prices growth. Unlike Taylor-type rules that react to asset prices, the proposed alternative does not harm dynamic stability and in certain cases promotes determinacy by inducing interest-rate inertia.     

Monetary and fiscal policy interactions in the EMU when cyclical conditions are uncertain

This paper examines economic policy interactions in the Economic and Monetary Union when the assessment of cyclical conditions in real time is surrounded by uncertainty. On the basis of a simple stylised model it shows that with a Nash-type of interaction different views about the output gap on the side of the policy players—the Council of the European Union, the European Commission and the European Central Bank—can give rise to excessive activism with policy players pushing economic variables into opposite directions. It argues that the costs of such policy conflicts can be reduced by agreeing on a common assessment of the cycle, by constraining policy variables, and/or by increasing the weight of fiscally conservative institutions. An alternative option to sidestep policy conflicts ensuing from diverging views of the cycle is to take policy decisions sequentially, as is the case in a Stackelberg-type of interaction. The paper shows that for a given misperception of the cycle, the impact on the policy instruments and on output and inflation are generally smaller in the Stackelberg equilibrium as compared to a Nash outcome. Alternative allocations of roles—that is leader versus follower—are discussed and assessed.

Monetary policy, oil shocks, and TFP: Accounting for the decline in US volatility

An equilibrium model is used to assess the quantitative importance of monetary policy for the post-1984 decline in US inflation and output volatility. The principal finding is that monetary policy played a substantial role in reducing inflation volatility, but a small role in reducing real output volatility. The model attributes much of the decline in real output volatility to smaller TFP shocks. We also investigate the pattern of output and inflation volatility under an optimal monetary policy counterfactual. We find that real output volatility would have been somewhat lower, and inflation volatility substantially lower, had monetary policy been set optimally.     

Comparing monetary policy reaction functions: ECB versus Bundesbank

This paper compares the European Central Bank’s (ECB) conduct of monetary policy with that of the Bundesbank. Estimated monetary policy reaction functions show that the ECB reacts similarly to expected inflation but significantly stronger to the output gap than the Bundesbank did. Theoretical considerations suggest that this stronger response to the output gap may rather be due to a higher interest rate sensitivity of the German output gap than to a higher weight given to output stabilisation in the objective function of the ECB. Counterfactual simulations based on the estimated interest rate reaction functions reveal that German interest rates would not have been lower under a hypothetical Bundesbank regime after 1999. However, this conclusion crucially depends on the assumption of an unchanged long-run real interest rate for the EMU period and is reversed when the Bundesbank reaction function is adjusted for the lower long-run real interest rate estimated for the ECB regime.