This paper studies the cost of limited commitment when a central bank commits to a price‐level target path but retains the discretion to re‐optimize it whenever the cost of honouring its commitment ...exceeds a tolerance threshold. Such discretion undermines the credibility of the price‐level target path and weakens its effectiveness to stabilize the economy. Endogenous target resets are more costly than exogenous target re‐optimizations and can give rise to multiple equilibria, including a low credibility equilibrium with frequent target resets and high volatility. Canadian data suggest that price‐level target resets could be quite frequent in practice.
Résumé
Engagement limité, crédibilité endogène et difficultés sur le plan de la cible de niveau de prix. L'article étudie le coût de l'engagement limité lorsqu'une banque centrale s'engage sur une certaine trajectoire à l'égard d'une cible de niveau de prix, mais qu'elle conserve un pouvoir discrétionnaire afin de l'optimiser de nouveau si le coût lié au respect de son engagement dépasse un seuil de tolérance. Un tel pouvoir discrétionnaire mine la crédibilité de la trajectoire à l'égard de la cible de niveau de prix et affaiblit son efficacité à stabiliser l'économie. La redéfinition de la cible endogéne est plus coûteuse qu'une nouvelle optimisation exogène de la cible et peut donner lieu à des équilibres multiples, notamment à un équilibre peu crédible accompagné de fréquentes redéfinitions de la cible et d'une volatilité élevée. Les données canadiennes donnent à penser que les redéfinitions de la cible de niveau de prix pourraient âtre assez fréquentes en pratique.
We analyze the impact of interest rate policy on financial stability in an environment where banks can experience runs on their short-term liabilities forcing them to sell assets at fire-sale prices. ...Price adjustment frictions and a state-dependent risk of financial crisis create the possibility of a policy tradeoff between price stability and financial stability. Focusing on Taylor rules with monetary policy possibly reacting to banks' short-term liabilities, we find that the optimized policy uses the extra tool to support investment at the expense of higher inflation and output volatility. Les auteurs analysent l'impact de la politique des taux d'intérêt sur la stabilité financière dans un environnement où les banques font l'expérience de ruées sur leur passif à court terme les forçant à vendre des actifs au prix de ventes de feu. Des frictions dans l'ajustement des prix et le risque d'une crise financière qui dépend de l'État créent la possibilité d'une relation d'équivalence entre stabilité des prix et stabilité financière. Se focalisant sur les règles de Taylor et la politique monétaire réagissant possiblement au passif à court terme des banques, les auteurs découvrent que la politique d'optimisation utilise l'instrument additionnel pour supporter l'investissement au prix d'une inflation plus forte et d'une volatilité de la production.
We develop a model in which a financial intermediary's investment in risky assets—risk taking—is excessive due to limited liability and deposit insurance, and characterize the policies that implement ...efficient risk taking. In the calibrated model, combining interest rate policy with state‐contingent macroprudential regulations—either capital or leverage regulation, and a tax on profits—achieves efficiency. Interest rate policy mitigates excessive risk taking by altering the return and the supply of collateralizable safe assets. In contrast to commonly used capital regulation, leverage regulation has stronger effects on risk taking and calls for higher interest rates. (JEL E44, E52, G11, G18)
This article proposes a simulation-based approach to find the optimal values of discretionary parameters in portfolio optimization problems. An algorithm is developed for finding jointly optimal ...values of required expected returns and of diversification restrictions.
There is a growing literature that studies the properties of models that combine international trade and neoclassical growth theory, but mostly in a deterministic setting. In this paper we introduce ...uncertainty in a dynamic Heckscher–Ohlin model and characterize the equilibrium of a small open economy in such an environment. We show that, when trade is balanced period-by-period, the per capita output and consumption of a small open economy converge to an invariant distribution that is independent of the initial wealth. Further, at the invariant distribution, there are periods in which the small economy diversifies. Numerical simulations show that the speed of convergence increases with the size of the shocks. In the limit, when there is no uncertainty, there is no convergence and countries may specialize permanently. The paper highlights the role of market incompleteness, as a result of the period-by-period trade balance, in this setup. Through an analytical example we also illustrate the importance of country specific risk in delivering our results.
This paper studies the effects of monetary policy shocks on firms’ participation in exporting. The VAR analysis shows that the extensive margin of exports declines in response to domestic ...expansionary monetary shocks. We develop a two-country dynamic stochastic general equilibrium model in which heterogeneous firms make forward-looking decisions on whether to participate in the export market and prices are staggered across firms and time. We show that while lower interest rates and a currency depreciation associated with an expansionary monetary policy help to increase the value of exporting, the inflationary effects of the policy stimulus weaken the competitiveness of some firms, resulting in a contraction in firms’ export participation. In contrast, positive productivity shocks lead to a currency depreciation and an expansion in export participation at the same time. We show that, overall, the extensive margin is more sensitive to firms’ price competitiveness with other firms in the export market than to exchange rate movements or interest rates.
Like the gold standard, price-level targeting (PT) involves not letting past deviations of inflation be bygones; both regimes return the price level (or price of gold) to its target. The experience ...of suspension of the gold standard in World War I and resumption in the 1920s (for some countries at a different parity) is reviewed. It suggests that, in practice, PT might operate with an escape clause that would allow rebasing of the price target in the face of large shocks. Using a calibrated general equilibrium model, we show that such an escape clause can produce multiple equilibria. For some parameterizations, there is a low credibility equilibrium (with high expectation of a reset) associated with high output volatility and frequent resets. These problems reduce, or reverse, the expectational advantage PT has over inflation targeting.
Empirical evidence suggests financial intermediaries increase risky investments when interest rates are low. We develop a model consistent with this observation and ask whether the risks undertaken ...exceed the social optimum. Interest rate policy affects risk taking in the model through two opposing channels. First, low policy rates make riskier assets more attractive than safe bonds. Second, low policy rates reduce the amount of safe bonds available for collateralized borrowing in interbank markets. The calibrated model features excessive risk taking at the optimal policy. However, at low policy rates, collateral constraints tighten and risk taking does not exceed the social optimum.
Quantitative dynamic stochastic general equilibrium (DSGE) models often admit that the zero bound on nominal interest rates does not constrain (optimal) monetary policy. Recent economic events, ...however, have reinforced the relevance of the zero bound. This paper sheds some light on this disconnect by studying a broad range of shocks within a standard DSGE model. In contrast to earlier studies, we find that risk premium shocks are key to building quantitative models where the zero bound is relevant for monetary policy design. Other commonly included shocks, such as productivity, government spending, and money demand shocks, are unable to push nominal rates close to zero.
This paper examines the role of monetary policy in an environment with aggregate risk and incomplete markets. In a two-period overlapping-generations model with aggregate uncertainty, optimal ...monetary policy attains the ex-ante Pareto optimal allocation. This policy aims to stabilize the savings rate in the economy by changing real returns of nominal bonds via variation in expected inflation. Optimal expected inflation is procylical and on average higher than without uncertainty. Simple inflation targeting rules closely approximate the optimal monetary policy. PUBLICATION ABSTRACT
PDF
