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A number of contributions to research on monetary policy have suggested that policy should be asymmetric near the lower bound on nominal interest rates. As inflation and economic activity decline, policy should ease more aggressively than it would in the absence of the lower bound. As activity recovers and inflation picks up, the central bank should act to keep interest rates lower for longer than without the bound. In this note, we investigate to what extent the policy easing implemented by the ECB since summer 2013 mirrors the rate recommendations of a simple policy rule or deviates from it in a way that indicates a “lower for longer” approach to policy near zero interest rates.
Veronika Grimm, Lukas Nöh, and Volker Wieland assess the possible development of government interest expenditures as a share of GDP for Germany, France, Italy and Spain. Until 2021, these and other member states could anticipate a further reduction of interest expenditure in the future. This outlook has changed considerably with the recent surge in inflation and government bond rates. Nevertheless, under reasonable assumptions current yield curves still imply that interest expenditure relative to GDP can be stabilized at the current level. The authors also review the implications of a further upward shift in the yield curves of 1 or 2 percentage points. These implications suggest significant medium-term risks for highly indebted member states with interest expenditure approaching or exceeding levels last observed on the eve of the euro area debt crisis. In light of these risks, governments of euro area member states should take substantive action to achieve a sustained decline in debt-to-GDP ratios towards safer levels. They bear the responsibility for making sure that government finances can weather the higher interest rates which are required to achieve price stability in the euro area.
Since 2014 the ECB has implemented a massive expansion of monetary policy including large-scale asset purchases and negative policy rates. As the euro area economy has improved and inflation has risen, questions concerning the future normalization of monetary policy are starting to dominate the public debate.
The study argues that the ECB should develop a strategy for policy normalization and communicate it very soon to prepare the ground for subsequent steps towards tightening. It provides analysis and makes proposals concerning key aspects of this strategy. The aim is to facilitate the emergence of expectations among market participants that are consistent with a smooth process of policy normalization.
The currrent debate on monetary and fiscal policy is heavily influenced by estimates of the equilibrium real interest rate. Beyer and Wieland re-estimate the U.S. equilibrium rate with the methodology of Laubach and Williams and further modifications. They provide new estimates for the United States, the euro area and Germany and subject them to sensitivity tests. Beyer and Wieland conclude that due to the great uncertainty and sensitivity, the observed decline in the estimates is not a reliable indicator of a need for expansionary monetary and fiscal policy. Yet, if those estimates are employed to determine the appropriate monetary policy stance, such estimates are better used together with the consistent estimate of the level of potential output.
The recent decline in euro area inflation has triggered new calls for additional monetary stimulus by the ECB in order to counter the threat of a self‐reinforcing deflation and recession spiral. This note reviews the available evidence on inflation expectations, output gaps and other factors driving current inflation through the lens of the Phillips curve. It also draws a comparison to the Japanese experience with deflation in the late 1990s and the evidence from Japan concerning the outputinflation nexus at low trend inflation. The note concludes from this evidence that the risk of a selfreinforcing deflation remains very small. Thus, the ECB best await the impact of the long‐term refinancing operations decided in June that have the potential to induce substantial monetary accommodation once implemented for the first time in September.
For some time now, structural macroeconomic models used at central banks have been predominantly New Keynesian DSGE models featuring nominal rigidities and forwardlooking decision-making. While these features are widely deemed crucial for policy evaluation exercises, most central banks have added more detailed characterizations of the financial sector to these models following the Great Recession in order to improve their fit to the data and their forecasting performance. We employ a comparative approach to investigate the characteristics of this new generation of New Keynesian DSGE models and document an elevated degree of model uncertainty relative to earlier model generations. Policy transmission is highly heterogeneous across types of financial frictions and monetary policy causes larger effects, on average. The New Keynesian DSGE models we analyze suggest that a simple policy rule robust to model uncertainty involves a weaker response to inflation and the output gap in the presence of financial frictions as compared to earlier generations of such models. Leaning-against-the-wind policies in models of this class estimated for the Euro Area do not lead to substantial gains. With regard to forecasting performance, the inclusion of financial frictions can generate improvements, if conditioned on appropriate data. Looking forward, we argue that model-averaging and embracing alternative modelling paradigms is likely to yield a more robust framework for the conduct of monetary policy.
In this paper, we provide some reflections on the development of monetary theory and monetary policy over the last 150 years. Rather than presenting an encompassing overview, which would be overambitious, we simply concentrate on a few selected aspects that we view as milestones in the development of this subject. We also try to illustrate some of the interactions with the political and financial system, academic discussion and the views and actions of central banks.
Renewed interest in fiscal policy has increased the use of quantitative models to evaluate policy. Because of modeling uncertainty, it is essential that policy evaluations be robust to alternative assumptions. We find that models currently being used in practice to evaluate fiscal policy stimulus proposals are not robust. Government spending multipliers in an alternative empirically-estimated and widely-cited new Keynesian model are much smaller than in these old Keynesian models; the estimated stimulus is extremely small with GDP and employment effects only one-sixth as large.
The global financial crisis and the ensuing criticism of macroeconomics have inspired researchers to explore new modeling approaches. There are many new models that deliver improved estimates of the transmission of macroeconomic policies and aim to better integrate the financial sector in business cycle analysis. Policy making institutions need to compare available models of policy transmission and evaluate the impact and interaction of policy instruments in order to design effective policy strategies. This paper reviews the literature on model comparison and presents a new approach for comparative analysis. Its computational implementation enables individual researchers to conduct systematic model comparisons and policy evaluations easily and at low cost. This approach also contributes to improving reproducibility of computational research in macroeconomic modeling. Several applications serve to illustrate the usefulness of model comparison and the new tools in the area of monetary and fiscal policy. They include an analysis of the impact of parameter shifts on the effects of fiscal policy, a comparison of monetary policy transmission across model generations and a cross-country comparison of the impact of changes in central bank rates in the United States and the euro area. Furthermore, the paper includes a large-scale comparison of the dynamics and policy implications of different macro-financial models. The models considered account for financial accelerator effects in investment financing, credit and house price booms and a role for bank capital. A final exercise illustrates how these models can be used to assess the benefits of leaning against credit growth in monetary policy.
There is substantial disagreement about the consequences of the Tax Cuts and Jobs Act (TCJA) of 2017, which constitutes the most extensive tax reform in the United States in more than 30 years. Using a large-scale two-country dynamic general equilibrium model with nominal rigidities, we find that the TCJA increases GDP by about 2% in the medium-run and by about 2.5% in the long-run. The shortrun impact depends crucially on the degree and costs of variable capital utilization, with GDP effects ranging from 1 to 3%. At the same time, the TCJA does not pay for itself. In our analysis, the reform decreases tax revenues and raises the debt-to-GDP ratio by about 15 percentage points in the medium-run until 2025. We show that combining the TCJA with spending cuts can dampen the increase in government indebtedness without reducing its expansionary effect.