Monetary conservatism and fiscal policy

Does an inflation conservative central bank à la Rogoff (1985) remain desirable in a setting with endogenous fiscal policy? To provide an answer we study monetary and fiscal policy games without commitment in a dynamic, stochastic sticky-price economy with monopolistic distortions. Monetary policy determines nominal interest rates and fiscal policy provides public goods generating private utility. We find that lack of fiscal commitment gives rise to excessive public spending. The optimal inflation rate internalizing this distortion is positive, but lack of monetary commitment generates too much inflation. A conservative monetary authority thus remains desirable. When fiscal policy is determined before monetary policy each period, the monetary authority should focus exclusively on stabilizing inflation. Monetary conservatism then eliminates the steady state biases associated with lack of monetary and fiscal commitment and leads to stabilization policy that is close to optimal.     

Monetary policy surprises and international bond markets

We examine the impact and spillover effects of monetary policy surprises on international bond returns. Within the framework of Campbell and Ammer (1993), we decompose international bond returns into news regarding future returns, real interest rates and future inflation for Germany, the U.K. and the U.S. We examine how excess bond returns in these three countries are affected by surprise changes in monetary policy in each country. Our measure of the unanticipated element of monetary policy is based on futures markets rather than the more traditional vector autoregression. Our results indicate that excess bond returns primarily react to domestic as compared to foreign monetary policy surprises. We also find there is a strong divergence between the effects of domestic monetary policy on excess bond returns in Germany relative to the U.K. A surprise monetary tightening in Germany (U.K.) leads to a rise (fall) in the excess holding period return. We trace this effect to news about lower (higher) inflation expectations and could be potentially rationalized by differences in the credibility of the monetary policy authority in each country.     

Fiscal Sustainability in a New Keynesian Model

Recent work on optimal monetary and fiscal policy in New Keynesian models suggests that it is optimal to allow steady‐state debt to follow a random walk. In this paper we consider the nature of the time inconsistency involved in such a policy and its implication for discretionary policymaking. We show that governments are tempted, given inflationary expectations, to utilize their monetary and fiscal instruments in the initial period to change the ultimate debt burden they need to service. We demonstrate that this temptation is only eliminated if following shocks, the new steady‐state debt is equal to the original (efficient) debt level even though there is no explicit debt target in the government's objective function. Analytically and in a series of numerical simulations we show which instrument is used to stabilize the debt depends crucially on the degree of nominal inertia and the size of the debt stock. We also show that the welfare consequences of introducing debt are negligible for precommitment policies, but can be significant for discretionary policy. Finally, we assess the credibility of commitment policy by considering a quasi‐commitment policy, which allows for different probabilities of reneging on past promises.     

Learnability and monetary policy: A global perspective

The recent literature on monetary policy design has emphasized the importance of equilibrium determinacy and learnability in the choice of policy rules. This paper contains an analysis of the learnability of the equilibrium in a class of simple, micro-founded models in which the policy authority uses a Taylor-type monetary policy rule. Unlike previous analyses, the model economy is not linearized about a steady state—instead, a global perspective is adopted. Globally, the nonlinear model economy can possess rational expectations equilibria other than the steady state consistent with the inflation target of the monetary authorities. These include a second, low inflation ‘liquidity trap’ steady state, periodic equilibria, and sunspot equilibria. The main results in the paper characterize the conditions under which these alternative equilibria maybe stable under adaptive learning, even when the policy rule obeys the Taylor principle. The stability of multiple equilibria is associated with policy rules which are forecast-based. An important finding is that backward-looking Taylor-type policy rules can guarantee that the unique learnable equilibrium is the steady state associated with the inflation target of the monetary authority.     

Survey forecasts in Brazil: A prismatic assessment of epidemiology,performance, and determinants

This paper assesses the behavior of survey forecasts in Brazil during the inflation targeting regime, when managing expectations is one of the cornerstones of the conduct of monetary policy. The distinctive database of the survey conducted by the Central Bank of Brazil (BCB) among professional forecasters allows for a thorough investigation of the epidemiology, determinants, and performance of forecasts. The main results are: i) top performing forecasters are influential to other forecasters; ii) survey forecasts perform better than vector autoregressive model-based forecasts; iii) common forecast errors prevail over idiosyncratic components across respondents; iv) inflation targets play an important role in inflation expectations; and v) agents perceive the BCB as following a Taylor rule consistent with inflation targeting. The last two suggest high credibility of the monetary authority.     

The central banker as prudential supervisor: Does independence matter?

We study whether central bank independence (CBI) and monetary policy arrangements can jointly influence the likelihood of policymakers assigning banking supervision to central banks. Our empirical analysis shows that, assuming a benevolent government, a higher degree of central bank operational (economic) independence is associated with a lower probability of supervisory powers being entrusted to the monetary authority. We interpret this result as deriving from governments’ fear of the risk of excessively discretionary monetary policy. However, there is evidence that – conditional on operational independence – central banks are more involved in supervision when they pursue tighter monetary policy goals (a specific aspect of political independence). Our interpretation is that the latter may represent a commitment to mitigate central banks’ discretion in the monetization of financial distress. Our study suggests that CBI can be relevant, not only for its alleged effects on macroeconomic variables, but also in influencing policymakers’ decisions on the allocation of banking supervisory powers.     

Monetary Policy in a Forward-Looking Input–Output Economy

This paper examines the implications for monetary policy of sticky prices in both final and intermediate goods in a New Keynesian model. Both optimal policy under commitment and discretionary policy under simple loss functions are studied. Household utility losses under alternative loss functions are compared; additionally, the robustness of policy performance to model and shock misperceptions and parameter uncertainty is examined. Targeting inflation in both consumer and intermediate goods performs better than targeting inflation in one sector; targeting price levels of both final and intermediate goods performs significantly better. Moreover, targeting price levels in both sectors yields superior robustness properties.     

Deconstructing credibility: The breaking of monetary policy rules in Brazil

Can political interference deconstruct credibility that was hardly-earned through successful stabilization policy? We analyze the recent switch in the conduct of monetary policy by the Central Bank of Brazil (BCB). Brazil is the largest Emerging Market Economy to formally target inflation, having adopted the Inflation Targeting (IT) regime in 1999. In the early years of IT, the BCB engaged in constructing credibility with price setting agents and succeeded to anchor inflation expectations to its target even under adverse conditions such as exchange rate crises. We argue that this effort to maintain IT rules-based policy ended in 2011, as a new country president and BCB board came to power. We then discuss the consequences of this credibility loss. Our main results can be summarized as follows: (i) we provide strong empirical evidence of the BCB’s shift toward looser, discretionary policy after 2011; (ii) preliminary evidence suggests that this shift has affected agents’ inflation expectations generating social and economic costs.     

The Value of Interest Rate Stabilization Policies When Agents Are Learning

We examine the expectational stability (E-stability) of rational expectations equilibrium in the "New Keynesian" model where monetary policy is optimally derived and interest rate stabilization is added to the central bank's traditional objectives of inflation and output stabilization. We consider both the case where the central bank lacks a commitment technology and the case of full commitment. We show that for both cases, optimal policy rules yield rational expectations equilibria that are E-stable for a wide range of empirically plausible parameter values. These findings stand in contrast to Evans and Honkapohja's findings for optimal monetary policy rules in environments where interest rate stabilization is not a central bank objective.     

Discretionary monetary policy and the zero lower bound on nominal interest rates

Ignoring the existence of the zero lower bound on nominal interest rates one considerably understates the value of monetary commitment in New Keynesian models. A stochastic forward-looking model with an occasionally binding lower bound, calibrated to the U.S. economy, suggests that low values for the natural rate of interest lead to sizeable output losses and deflation under discretionary monetary policy. The fall in output and deflation are much larger than in the case with policy commitment and do not show up at all if the model abstracts from the existence of the lower bound. The welfare losses of discretionary policy increase even further when inflation is partly determined by lagged inflation in the Phillips curve. These results emerge because private sector expectations and the discretionary policy response to these expectations reinforce each other and cause the lower bound to be reached much earlier than under commitment.     

货币政策可信度的理论分析

货币政策可信度是指经济主体相信中央银行采取系统性的行动以最终达到所承诺的政策目标.如果公众相信中央银行将言行一致地进行货币政策操作,那么这样的货币政策就是可信的.市场经济中,货币政策的可信度在很大程度上影响到货币政策的效率.因此,明确货币政策可信度的涵义,分析货币政策可信度的影响因素,致力于提高货币政策可信度的制度建设,对提高货币政策的有效性具有现实意义.     

Inflation targeting,credibility, and non-linear Taylor rules

In this paper we systematically evaluate how central banks respond to deviations from the inflation target. We present a stylized New Keynesian model in which agents' inflation expectations are sensitive to deviations from the inflation target. To (re-) establish credibility, monetary policy under discretion sets higher interest rates today if average inflation exceeded the target in the past. Moreover, the central bank responds non-linearly to past inflation gaps. This is reflected in an additional term in the central bank's instrument rule, which we refer to as the ”credibility loss.” Augmenting a standard Taylor (1993) rule with the latter term, we provide empirical evidence for the interest rate response for a sample of five inflation targeting (IT) economies. We find, first, that past deviations from IT feed back into the reaction function and that this influence is economically meaningful. Deterioration in credibility (ceteris paribus) forces central bankers to undertake larger interest rate steps. Second, we detect an asymmetric reaction to positive and negative credibility losses, with the latter dominating the former.     

Managing Expectations

The idea that monetary policy is principally about “managing expectations” has taken hold in central banks around the world. Discussions of expectations management by central bankers, academics and by financial market participants frequently also include the idea that central bank credibility is imperfect. We adapt a familiar macroeconomic model so as to discuss key concepts in the area of expectations management. Our work also exemplifies a model construction approach to analyzing the dynamics of announcements, actions, and credibility that we think makes feasible a wide range of future investigations concerning the management of expectations.     

Time Inconsistency and Free‐Riding in a Monetary Union

In monetary unions, a time inconsistency problem in monetary policy leads to a novel type of free‐rider problem in the setting of non‐monetary policies. The free‐rider problem leads union members to pursue lax non‐monetary policies that induce the monetary authority to generate high inflation. Free‐riding can be mitigated by imposing constraints on non‐monetary policies. Without a time inconsistency problem, the union has no free‐rider problem; then constraints on non‐monetary policies are unnecessary and possibly harmful. This theory is here detailed and applied to several non‐monetary policies: labor market policy, fiscal policy, and bank regulation.     

Inflation Targeting,Recursive Inattentiveness,and Heterogeneous Beliefs

We consider a monetary authority that provides an explicit inflation target in order to align expectations with the policy objective. However, biased perceptions of the target may arise due to imperfect information flows. We allow agents to revise expectations over time and we model their recursive choice among prediction strategies as an optimization problem under rational inattention. We then investigate whether a simple policy rule can steer the economy toward the targeted equilibrium. Our findings suggest that determinacy under rational expectations may not be sufficient to reach the target. Instead, monetary policy should be fine‐tuned to correct agents' biased beliefs.     

Does Monetary Policy Have Asymmetric Effects on Stock Returns?

This paper investigates whether monetary policy has asymmetric effects on stock returns using Markov-switching models. Different measures of a monetary policy stance are adopted. Empirical evidence from monthly returns on the Standard & Poor's 500 price index suggests that monetary policy has larger effects on stock returns in bear markets. Furthermore, it is shown that a contractionary monetary policy leads to a higher probability of switching to the bear-market regime.     

中国货币政策反应函数检验

本文利用历史数据对中国货币当局的政策反应函数进行了实证检验。结果发现,中国货币当局除了按照泰勒(Taylor)规则对通胀偏倚和产出偏倚作出反应之外,还对美国货币政策变量作出反应。这表明,中国货币当局在制定货币政策时已经在某种程度上考虑了国际博弈因素。     

Discretionary monetary policy and inflation persistence

Rational expectations models of staggered price/wage contracts have failed to replicate the observed persistence in inflation and unemployment during disinflationary periods. The current literature on this persistency puzzle has focused on augmenting the nominal contract model with imperfect credibility and learning. In this paper, I re-examine the persistency puzzle by focusing on the discretionary nature of monetary policy. I show that when the central bank is allowed to re-optimize a quadratic loss function each period, imperfect credibility and learning, even in the absence of staggered contracts, can generate a significant amount of inflation persistence and employment losses during a disinflationary period.