Deviations from long-run price stability are optimal in the presence of endogenous entry and product variety in a sticky-price model in which price stability would be optimal otherwise Long-run ...inflation (deflation) is optimal when the benefit of variety to consumers falls short of (exceeds) the market incentive for creating that variety—the desired markup; Price indexation exacerbates this mechanism. Plausible preference specifications and parameter values justify positive long-run inflation rates. However, short-run price stability (around this non-zero trend) is close to optimal, even in the presence of endogenously time-varying desired markups that distort the intertemporal allocation of resources.
•Long-run inflation is optimal when variety benefit to consumer is lower than markup.•Plausible preferences imply optimal long-run inflation of at least 1 percent yearly.•Short-run price stability is nearly optimal even for large dynamic entry distortion.•Welfare loss from fully stabilizing prices can be large.•Policymaker has an extra incentive to renege on (timeless-)optimal policy.
After the global financial crisis, the ECB, as other major central banks, has introduced new monetary instruments to effectively respond to economic and financial shocks. This paper aims to analyse ...the role of monetary policy in the Eurozone's economic activity and studies responses of industrial production and inflation to standard and non-standard monetary tools. First, we perform a VAR model to estimate the effects of exogenous innovations in conventional and unconventional tools on industrial production and inflation. Then, to summarize the external economic developments, we condense the information contained in a large set of time series into a few factors, and then put these factors in a new VAR model (FAVAR). The results show that the unconventional policy has played an important role on economic and financial stabilization. The empirical model suggests also how the contemporaneous implementation of the two different policies is “big guns” on hand to ECB.
Fifty years ago, Milton Friedman articulated the natural rate hypothesis. It was composed of two sub-hypotheses: First, the natural rate of unemployment is independent of monetary policy. Second, ...there is no long-run trade-off between the deviation of unemployment from the natural rate and inflation. Both propositions have been challenged. The paper reviews the arguments and the macro and micro evidence against each. It concludes that, in each case, the evidence is suggestive, but not conclusive. Policymakers should keep the natural rate hypothesis as their null hypothesis, but keep an open mind and put some weight on the alternatives.
Modeling nominal interest rates requires to take into account the effective lower bound (ELB). We propose a flexible time‐series approach that includes a “shadow rate”—a notional rate identical to ...the actual nominal rate except when the ELB binds . We apply this approach to a trend‐cycle decomposition of interest rates and macro‐economic variables that generates competitive interest‐rate forecasts. Our estimates of the real‐rate trend have edged down somewhat in recent decades, but not significantly so. We identify monetary policy shocks from shadow‐rate surprises and find that they were particularly effective at stimulating economic activity during the ELB period.
How do nominal exchange rates adjust after surprise contractions in monetary policy? While the seminal contribution by Dornbusch provides concise predictions—exchange rates appreciate, i.e., ...overshoot on impact before depreciating gradually—empirical support for his hypothesis is at best mixed. I argue that the failure to discover overshooting may result from assumptions researchers have imposed to recover structural VARs. Specifically, simultaneous feedback effects between interest rates and exchange rates, which are inherently forward-looking variables, are often excluded or modeled alongside with strong restrictions. In this paper, I identify U.S. monetary policy shocks using surprises in Federal funds futures around policy announcements as external instruments, which recent literature has established to represent the appropriate laboratory in settings encompassing macroeconomic and financial variables. Resulting adjustments of the dollar, conditional on shifts in policy, generally align with Dornbusch's predictions during the post-Bretton-Woods era, including Volcker's tenure as Fed Chair.
This paper structurally investigates the changes in the Fed's communication strategy since the mid-1990s through the lens of anticipated and unanticipated disturbances to a Taylor rule. The ...anticipated disturbances are identified using Treasury bond yield data in estimating a dynamic stochastic general equilibrium (DSGE) model with a term structure of interest rates. Our estimation results show that the Fed's decisions were unanticipated for market participants until 1999, but thereafter a larger portion of its future policy actions tended to be communicated in advance. We also find that the relative contribution of the anticipated monetary policy disturbances to macroeconomic fluctuations became larger after 1999. The bond yield data is indispensable to these results, since it contains crucial information on an expected future path of the federal funds rate.
The paper formulates the modeling of unconventional monetary policy and critically evaluates its effectiveness to address the Global Financial Crisis. We begin with certain principles guiding general ...scientific modeling and focus on Milton Friedman's 1968 Presidential Address that delineates the strengths and limitations of monetary policy to pursue certain goals. The modeling of monetary policy with its novelty of quantitative easing to target unusually high unemployment is evaluated by a Markov switching econometric model using monthly data for the period 2002–2015. We conclude by relating the lessons learned from unconventional monetary policy during the Global Financial Crisis to the recent bold initiatives of the Fed to mitigate the economic and financial impact of the Covid-19 pandemic on U.S. households and businesses.
Applying a smooth transition vector autoregression model with survey expectation data, we investigate the nonlinear effects of exchange rate shocks on inflation across monetary policy credibility ...states in Korea. We find that the impact of the exchange rate shocks is statistically larger in the low credibility regime, particularly in the short run. Our findings suggest that monetary policy credibility plays a significant role in maintaining for price stability in Korea.
•We investigate the nonlinear exchange rate pass-through (ERPT) across the monetary policy (MP) credibility states for Korea.•We use MP credibility, measured as the disagreement among professional forecasters, as a transition variable.•We find that the impact of the exchange rate shocks is statistically larger in the low credibility regime.•The results suggest MP credibility plays a significant role in maintaining for price stability in Korea.
How do global oil price fluctuations affect macroeconomic activity and monetary policy in resource-rich emerging economies? This paper tackles this question by developing a unified emerging ...market/rest-of-the-world DSGE framework featuring Ricardian and Non-Ricardian households, an oil-producing sector, a fuel subsidy programme, and a regime-switching process. The model is estimated using Bayesian methods, allowing us to be agnostic regarding regime shifts in the monetary policy rule and oil price volatility. Using data for Nigeria, we find substantial empirical support for the regime-switching behaviour and discuss how macroeconomic implications of oil price shocks may vary depending on the nature of the shock, monetary policy responses, and the fuel subsidy policy in place. Apart from providing important insights into the monetary policy transmission mechanism, the paper offers a novel, flexible, and functional model for future policy analysis, especially in resource-rich emerging countries.
•Recurrent regime shifts are driven by persistence and volatility of oil price shock.•Monetary policy regime shifts reinforce the propagation of oil price shocks.•High uncertainty about oil prices generates significant macroeconomic implications.•The fuel subsidy regime affects the monetary policy response to oil price shocks.•Modelling sources of time variations generates substantial improvement in data fit.
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