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No. And not only for the reason you think. In a world with multiple inefficiencies the single policy tool the central bank has control over will not undo all inefficiencies; this is well understood. We argue that the world is better characterized by multiple inefficiencies and multiple policy makers with various objectives. Asking the policy question only in terms of optimal monetary policy effectively turns the central bank into the residual claimant of all policy and gives the other policymakers a free hand in pursuing their own goals. This further worsens the tradeoffs faced by the central bank. The optimal monetary policy literature and the optimal simple rules often labeled flexible inflation targeting assign all of the cyclical policymaking duties to central banks. This distorts the policy discussion and narrows the policy choices to a suboptimal set. We highlight this issue and call for a broader thinking of optimal policies.
2003, 40
This paper investigates the role that imperfect knowledge about the structure of the economy plays in the formation of expectations, macroeconomic dynamics, and the efficient formulation of monetary policy. Economic agents rely on an adaptive learning technology to form expectations and to update continuously their beliefs regarding the dynamic structure of the economy based on incoming data. The process of perpetual learning introduces an additional layer of dynamic interaction between monetary policy and economic outcomes. We find that policies that would be efficient under rational expectations can perform poorly when knowledge is imperfect. In particular, policies that fail to maintain tight control over inflation are prone to episodes in which the public's expectations of inflation become uncoupled from the policy objective and stagflation results, in a pattern similar to that experienced in the United States during the 1970s. Our results highlight the value of effective communication of a central bank's inflation objective and of continued vigilance against inflation in anchoring inflation expectations and fostering macroeconomic stability. July 2003.
2003, 37
The development of tractable forward looking models of monetary policy has lead to an explosion of research on the implications of adopting Taylor-type interest rate rules. Indeterminacies have been found to arise for some specifications of the interest rate rule, raising the possibility of inefficient fluctuations due to the dependence of expectations on extraneous "sunspots ". Separately, recent work by a number of authors has shown that sunspot equilibria previously thought to be unstable under private agent learning can in some cases be stable when the observed sunspot has a suitable time series structure. In this paper we generalize the "common factor "technique, used in this analysis, to examine standard monetary models that combine forward looking expectations and predetermined variables. We consider a variety of specifications that incorporate both lagged and expected inflation in the Phillips Curve, and both expected inflation and inertial elements in the policy rule. We find that some policy rules can indeed lead to learnable sunspot solutions and we investigate the conditions under which this phenomenon arises.
2004, 24
We develop an estimated model of the U.S. economy in which agents form expectations by continually updating their beliefs regarding the behavior of the economy and monetary policy. We explore the effects of policymakers' misperceptions of the natural rate of unemployment during the late 1960s and 1970s on the formation of expectations and macroeconomic outcomes. We find that the combination of monetary policy directed at tight stabilization of unemployment near its perceived natural rate and large real-time errors in estimates of the natural rate uprooted heretofore quiescent in inflation expectations and destabilized the economy. Had monetary policy reacted less aggressively to perceived unemployment gaps, in inflation expectations would have remained anchored and the stag inflation of the 1970s would have been avoided. Indeed, we find that less activist policies would have been more effective at stabilizing both in inflation and unemployment. We argue that policymakers, learning from the experience of the 1970s, eschewed activist policies in favor of policies that concentrated on the achievement of price stability, contributing to the subsequent improvements in macroeconomic performance of the U.S. economy.
2004, 22
In a plain-vanilla New Keynesian model with two-period staggered price-setting, discretionary monetary policy leads to multiple equilibria. Complementarity between the pricing decisions of forward-looking firms underlies the multiplicity, which is intrinsically dynamic in nature. At each point in time, the discretionary monetary authority optimally accommodates the level of predetermined prices when setting the money supply because it is concerned solely about real activity. Hence, if other firms set a high price in the current period, an individual firm will optimally choose a high price because it knows that the monetary authority next period will accommodate with a high money supply. Under commitment, the mechanism generating complementarity is absent: the monetary authority commits not to respond to future predetermined prices. Multiple equilibria also arise in other similar contexts where (i) a policymaker cannot commit, and (ii) forward-looking agents determine a state variable to which future policy respond. JEL Klassifikation: E5, E61, D78
2006, 30
The paper constructs a global monetary aggregate, namely the sum of the key monetary aggregates of the G5 economies (US, Euro area, Japan, UK, and Canada), and analyses its indicator properties for global output and inflation. Using a structural VAR approach we find that after a monetary policy shock output declines temporarily, with the downward effect reaching a peak within the second year, and the global monetary aggregate drops significantly. In addition, the price level rises permanently in response to a positive shock to the global liquidity aggregate. The similarity of our results with those found in country studies might supports the use of a global monetary aggregate as a summary measure of worldwide monetary trends. JEL Classification: E52, F01
2007, 14
This paper uses factor-augmented vector autoregressions (FAVAR) estimated using a large data set to disentangle fluctuations in disaggregated consumer and producer prices which are due to macroeconomic factors from those due to sectorial conditions. This allows us to provide consistent estimates of the effects of US monetary policy on disaggregated prices. While sectorial prices respond quickly to sector-specific shocks, we find that for a large number of price series, there is a significant delay in the response of prices to monetary policy shocks. In addition, price responses display little evidence of a “price puzzle,” contrary to existing studies based on traditional VARs. The observed dispersion in the reaction of producer prices is relatively well explained by the degree of market power, as predicted by models with monopolistic competition. JEL Classification: E32, E52
2007, 10
Mortgage markets, collateral constraints, and monetary policy: do institutional factors matter?
(2006)
We study the role of institutional characteristics of mortgage markets in affecting the strength and timing of the effects of monetary policy shocks on house prices and consumption in a sample of OECD countries. We document three facts: (1) there is significant divergence in the structure of mortgage markets across the main industrialised countries; (2) at the business cycle frequency, the correlation between consumption and house prices increases with the degree of flexibility/development of mortgage markets; (3) the transmission of monetary policy shocks on consumption and house prices is stronger in countries with more flexible/developed mortgage markets. We then build a two-sector dynamic general equilibrium model with price stickiness and collateral constraints, where the ability of borrowing is endogenously linked to the nominal value of a durable asset (housing). We study how the response of consumption to monetary policy shocks is affected by alternative values of three key institutional parameters: (i) down-payment rate; (ii) mortgage repayment rate; (iii) interest rate mortgage structure (variable vs. fixed interest rate). In line with our empirical evidence, the sensitivity of consumption to monetary policy shocks increases with lower values of (i) and (ii), and is larger under a variable-rate mortgage structure. JEL Classification: E21, E44, E52
2008, 17
This paper introduces adaptive learning and endogenous indexation in the New-Keynesian Phillips curve and studies disinflation under inflation targeting policies. The analysis is motivated by the disinflation performance of many inflation-targeting countries, in particular the gradual Chilean disinflation with temporary annual targets. At the start of the disinflation episode price-setting firms’ expect inflation to be highly persistent and opt for backward-looking indexation. As the central bank acts to bring inflation under control, price-setting firms revise their estimates of the degree of persistence. Such adaptive learning lowers the cost of disinflation. This reduction can be exploited by a gradual approach to disinflation. Firms that choose the rate for indexation also re-assess the likelihood that announced inflation targets determine steady-state inflation and adjust indexation of contracts accordingly. A strategy of announcing and pursuing short-term targets for inflation is found to influence the likelihood that firms switch from backward-looking indexation to the central bank’s targets. As firms abandon backward-looking indexation the costs of disinflation decline further. We show that an inflation targeting strategy that employs temporary targets can benefit from lower disinflation costs due to the reduction in backward-looking indexation.
2008, 16
Monetary policy analysts often rely on rules-of-thumb, such as the Taylor rule, to describe historical monetary policy decisions and to compare current policy to historical norms. Analysis along these lines also permits evaluation of episodes where policy may have deviated from a simple rule and examination of the reasons behind such deviations. One interesting question is whether such rules-of-thumb should draw on policymakers "forecasts of key variables such as inflation and unemployment or on observed outcomes. Importantly, deviations of the policy from the prescriptions of a Taylor rule that relies on outcomes may be due to systematic responses to information captured in policymakers" own projections. We investigate this proposition in the context of FOMC policy decisions over the past 20 years using publicly available FOMC projections from the biannual monetary policy reports to the Congress (Humphrey-Hawkins reports). Our results indicate that FOMC decisions can indeed be predominantly explained in terms of the FOMC´s own projections rather than observed outcomes. Thus, a forecast-based rule-of-thumb better characterizes FOMC decision-making. We also confirm that many of the apparent deviations of the federal funds rate from an outcome-based Taylor-style rule may be considered systematic responses to information contained in FOMC projections.