optimal monetary policy in an economy with inflation persistence abstract this paper studies optimal monetary policy in a model where inflation is persistent two types of price setters are assumed to exist one acts rationally given calvo type constraints on price setting the other type sets prices according to a rule of thumb this results in a phillips curve with both a forward looking term and a backward looking term the phillips curve nests a standard purely forward looking phillips curve as well as a standard purely backward looking phillips curve as special cases a cost push supply shock is derived from microfoundations by adding a time varying income tax and by making the elasticity of substitution between goods stochastic a central bank loss function for this model is derived from a second order taylor approximation of the household s welfare function optimal monetary policy for different relative values of the forward and backward looking terms is then analyzed for both the commitment case and the case of discretion

monetary fiscal policy interactions and indeterminacy in postwar us data using a micro founded model and a likelihood based inference method we address three questions in this article first what monetary and fiscal policy regimes characterized postwar us data second was equilibrium indeterminacy a feature of the economy before paul volcker s chairmanship at the federal reserve third what were the effects of shifts in monetary and fiscal policy on the aggregate economy we find that pre volcker a passive monetary and fiscal policy regime prevailed while postvolcker an active monetary and passive fiscal policy regime characterized the economy 1 since both monetary and fiscal policies were passive pre volcker there was equilibrium indeterminacy moreover the effects of monetary and fiscal policy shifts on the aggregate economy were substantially different in the two time periods for example while pre volcker an unanticipated increase in interest rates led to an increase in output and inflation post volcker it led to a decrease in output and inflation moreover while pre volcker an unanticipated increase in the lump sum tax revenues to output ratio led to a decline in output and inflation post volcker it had no effects on output or inflation the response of the economy pre volcker was thus similar to that predicted by the fiscal

does competition for capital discipline governments decentralization globalization and public policy competition among countries or regions within them to attract mobile capital is often thought to discipline their governments motivating them to invest more in infrastructure reduce waste and corruption and spend less on non productive public goods the result should be convergence on business friendly policies we argue that this requires an assumption units start out very similar that is often unrealistic if units are heterogeneous in natural resources geographical location inherited human capital or infrastructure capital mobility often weakens discipline on the poorlyendowed units this may help explain disappointing results of liberalizing capital flows within russia and sub saharan africa jel f36 h73 h87

surplus debt regressions abstract single equation estimates of fiscal reaction functions which relate primary surpluses to past debt gdp ratios and control variables are subject to potentially serious simultaneity bias that can produce misleading inferences about fiscal behavior biases arise from failure to model the general equilibrium relationships between government debt and surpluses relationships that bring in the forward looking nature of nominal debt valuation and the role of monetary policy in that valuation

when does it take a nixon to go to china substantial policy changes like market oriented reforms by populist parties and steps towards peace by hawks are sometimes implemented by unlikely parties to account for such episodes this paper develops a framework in which incumbent politicians have better information about the state of the world than voters the incumbent is unable to credibly transmit all this information since voters are also imperfectly informed about his ideology the paper identifies conditions under which an incumbent party s electoral prospects increase the more atypical the policy it proposes popular support for a policy or its credibility depends on the policymaker policy pair copyright 1998 by american economic association

monetary policy when interest rates are bounded at zero this paper assesses the importance of the zero lower bound on nominal interest rates for the interest rate channel of monetary policy we simulate several interest rate setting policy rules with ei

interpreting the macroeconomic time series facts the effects of monetary policy existing theory and evidence on the effects of monetary policy are reviewed substantial room for disagreement among economists remains new evidence based on multivariate time series studies of several countries is presented while certain patterns in the data consistent with effective monetary policy are strikingly similar across countries others particularly the tendency of interest rate increases to predict high inflation are harder to reconcile with effective monetary policy

the role of inflation target adjustment in stabilization policy we study optimal monetary policy in a new keynesian model in which the monetary authority faces a trade off between inflation and output gap stabilization due to cost push shocks in particular we highlight the role of the inflation target adjustment in stabilization policy by showing that it can mitigate this policy trade off and considerably improve welfare the main findings can be summarized as follows first we find that the welfare cost of a standard taylor rule is non trivial even with optimized policy coefficients second we propose an additional policy tool of a medium run inflation target mrit rule when combined with the standard taylor rule the optimal mrit significantly reduces fluctuations in inflation originating from the cost push shocks and results in a similar level of welfare to that associated with the ramsey optimal policy third the optimal mrit needs to be adjusted in a persistent manner and in the opposite direction to the realization of a cost push shock fourth the welfare implication of the mrit is more pronounced under a flatter phillips curve finally the main findings are relevant to the current economic environment of low inflation rates under a flat phillips curve implying that the monetary authority should increase the inflation target in such an environment

testing for indeterminacy an application to u s monetary policy reply this paper considers a prototypical new keynesian model in which the equilibrium is undetermined if monetary policy is passive the likelihood based estimation of dynamic equilibrium models is extended to allow for indeterminacies and sunspot fluctuations we construct posterior weights for the determinacy and indeterminacy region of the parameter space and estimates for the propagation of fundamental and sunspot shocks according to the estimated model u s monetary policy post 1982 is consistent with determinacy whereas the pre volcker policy is not we find that before 1979 indeterminacy substantially altered the propagation of shocks

monetary fiscal policy interaction and fiscal inflation a tale of three countries abstract we study the impact of the interaction between fiscal and monetary policy on the low frequency relationship between the fiscal stance and inflation using cross country data from 1965 to 1999 in a first step we contrast the monetary fiscal narrative for germany the u s and italy with evidence obtained from simple regression models and a time varying var we find that the low frequency relationship between the fiscal stance and inflation is low during periods of an independent central bank and responsible fiscal policy and more pronounced in times of non responsible fiscal policy and accommodative monetary authorities in a second step we use an estimated dsge model to interpret the low frequency measure structurally and to illustrate the mechanisms through which fiscal actions affect inflation in the long run the findings from the dsge model suggest that switches in the monetary fiscal policy interaction and accompanying variations in the propagation of structural shocks can well account for changes in the low frequency relationship between the fiscal stance and inflation

monetary and fiscal policy interactions in the post war u s abstract a new keynesian model allowing for an active monetary and passive fiscal policy ampf regime and a passive monetary and active fiscal policy pmaf regime is estimated to fit various u s samples from 1955 to 2007 the results show that data in the pre volcker periods strongly prefer an ampf regime even with a prior centered in the pmaf region the estimation however is not very informative about whether the federal reserve s reaction to inflation is greater than one in the pre volcker period because much lower values can still preserve determinacy under passive fiscal policy in addition whether a pmaf regime can generate consumption growth following a government spending increase depends on the degree of price stickiness an income tax cut can yield an unusual negative labor response if monetary policy aggressively stabilizes output growth

monetary policy trend inflation and the great moderation an alternative interpretation with positive trend inflation the taylor principle does not guarantee a determinate equilibrium we provide new theoretical results on determinacy in new keynesian models with positive trend inflation and new empirical findings on the federal reserve s reaction function before and after the volcker disinflation to find that i while the fed likely satisfied the taylor principle before volcker the us economy was still subject to self fulfilling fluctuations in the 1970s ii the us economy switched to determinacy during the volcker disinflation and iii the switch reflected changes in the fed s response to macroeconomic variables and the decline in trend inflation jel e12 e23 e31 e32 e52

unique equilibrium in a model of self fulfilling currency attacks even though self fulfilling currency attacks lead to multiple equilibria when fundamentals are common knowledge we demonstrate the uniqueness of equilibrium when speculators face a small amount of noise in their signals about the fundamentals this unique equilibrium depends not only on the fundamentals but also on financial variables such as the quantity of hot money in circulation and the costs of speculative trading in contrast to multiple equilibrium models our model allows analysis of policy proposals directed at curtailing currency attacks

international financial crises causes prevention and cures dale jorgenson has bestowed a great honor and no small challenge by inviting me to give this lecture a great honor because of the distinguished list of economists who have preceded me a challenge because of the standard they have set and because there is no greater challenge for any economist than providing a coherent account of significant events to his scientific peers i am sometimes asked by friends about the differences between academic life and life as a public official there are many two stand out first as an academic the gravest sin one can commit is to sign one s name to something one did not write as a public official it is a mark of effectiveness to do so as often as possible second as an academic if a problem is too hard and does not admit of a satisfactory solution there is an obvious response work on a different problem that is not a luxury that one has in government i have been reminded of this often in recent years as we have grappled with financial crises in a number of what had previously been considered emerging markets with unrestrained futures anyone who doubts the social importance of what economists do should consider the debates surrounding these crises hundreds of millions of people who expected rapidly rising standards of living have seen their living standards fall hundreds of thousands if not millions of children have been forced to drop out of school and go to work hundreds of billions of dollars of apparent wealth has been lost the stability of large nations as nations has been called into question and the united states has made its largest nonmilitary foreign policyrelated financial commitments since the marshall plan almost all the issues involved in understanding preventing and mitigating these crises are the stuff of economics courses and research fixed versus flexible exchange rates moral hazard and multiple equilibria speculation and liquidity fiscal and monetary policies regulation and competition what economists think say and do has profound implications for the lives of literally billions of their fellow citizens whether it is discussing the role of derivatives in signaling exchange rate commitments with chinese premier zhu rongji or discussing an nber working paper on inflation targeting with the brazilian central bank governor arminio fraga or discussing alternative approaches to bankruptcy law with indonesia s economic team or optimal debt durations with the mexican authorities i am consistently struck by the impact of the kind of research discussed at the aea meetings the future well being of the world s people in large part will depend on how the ongoing process of global integration works out this is a strong statement but one that is supported by the global economy s post world war i failure and its post world war ii success central to global integration is financial integration the flow of funds and of capital across international borders and as the events of the late 1920 s and early 1930 s remind us central to global disintegration can be international financial breakdowns today i want to reflect on the issue of global financial integration in light of the dramatic and largely unpredicted events of recent years it is perhaps a good time for reflection there has been enough repair that priority can shift from u s department of the treasury 1500 pennsylvania avenue washington dc 20005 this lecture reflects many things i have learned from experiences i have shared with colleagues in the united states government and governments around the world i thank brad delong marty feldstein stephanie flanders ken rogoff andrei shleifer and ted truman for useful comments and suggestions i am especially grateful to nouriel roubini and stephanie flanders for valuable discussions and assistance in the preparation of this lecture the usual disclaimer applies

dancing to the donors tune policy choice in aid dependent countries current aid rhetoric emphasizes the selective allocation of otherwise unconditional funds in support of the recipients own plans in contrast to the old donor practice of bundling money and policies i show that when recipients have private information policies reflecting their preferences and knowledge might result in such a regime however generous transfers can also induce them to conform to the outcome oriented expectations of donors at the expense of lower aid impact such behaviour is consistent with an abundance of case study evidence moderate disagreements over what the optimal policy is could actually produce better results certain forms of both donor competition and coordination might also eliminate this distortion while a donor concern for need only removes incentives for aid seeking in the least needy countries in summary optimal aid policies are highly context specific and donors should thus concentrate their efforts to practise more informed selectivity

price indexation habit formation and the generalized taylor principle abstract we prove that the generalized taylor principle under which the nominal interest rate reacts more than one for one to a change in inflation in the long run is a necessary and under some extra mild restrictions on parameters sufficient condition for determinacy in a sticky price model with interest rate smoothing in monetary policy partial dynamic price indexation and habit formation in consumption

monetary policy rules and macroeconomic stability some new evidence in a seminal paper richard clarida jordi gall and mark gertler 2000 studied the implica tions of monetary policy for macroeconomic fluctuations using a prototypical forward looking sticky price model of the monetary transmission mechanism they proposed simple forward looking equations for the reaction function of monetary policy to deviations of inflation and output from their implicit targets they estimated these equations over sample periods before and after paul volcker became chairman of the fed they found that the policy rate did not react sufficiently strongly to expected deviations of inflation from target prior to volcker thus violat ing the taylor principle and opening up the possibility of sunspot fluctuations induced by self fulfilling expectations in contrast policy over the volcker greenspan era was found to satisfy the taylor principle and this was seen as an important factor contributing to the conquest of us inflation 1

optimal taxation without state contingent debt in an economy studied by lucas and stokey tax rates inherit the serial correlation structure of government expenditures belying barro s earlier result that taxes should be a random walk for any stochastic process of government expenditures to recover a version of barro s random walk tax smoothing outcome we modify lucas and stokey s economy to permit only risk free debt having only risk free debt confronts the ramsey planner with additional constraints on equilibrium allocations beyond one imposed by lucas and stokey s assumption of complete markets the ramsey outcome blends features of barro s model with lucas and stokey s in our model the contemporaneous effects of exogenous government expenditures on the government deficit and taxes resemble those in lucas and stokey s model but incomplete markets put a near unit root component into government debt and taxes an outcome like barro s however we show that without ad hoc limits on the government s asset holdings outcomes can diverge in importa

identifying fiscal inflation abstract fiscal theorists warn about the risk of future inflation as a consequence of fiscal imbalances in the us because actual inflation remains historically low and data on inflation expectations do not corroborate such risks warnings for fiscal inflation are often ignored in policy and academic circles this paper shows that a canonical nk dsge model enables identifying an anticipated component of inflation expectations that is closely related to fiscal policy estimation results suggest that fiscal inflation concerns have induced a 1 6 points increase in long run inflation since 2001 the model also rationalizes why data on inflation expectations do not reveal such concerns outright

monetary policy inflation expectations and the price puzzle this article re examines the var evidence on the price puzzle and proposes a new theoretical interpretation using actual data and two identification strategies based on zero restrictions and model consistent sign restrictions we find that the positive response of prices to a monetary policy shock is historically limited to the sub samples that are typically associated with a weak interest rate response to inflation using pseudo data generated by a sticky price model of the us economy we then show that the structural vars are capable of reproducing the price puzzle only when monetary policy is passive the omission in the vars of a variable capturing expected inflation is found to account for the price puzzle observed in simulated and actual data structural vector autoregressions svars are widely used for measuring and understanding the effects of monetary policy innovations on the aggregate economy while most results in the var literature are consistent with economic intuition and macroeconomic theory the typically found positive and significant reaction of the price level on impact to a monetary policy shock is a fact that most monetary models

investigating inflation persistence across monetary regimes under inflation targeting estimates of the indexation parameter in hybrid new keynesian phillips curves are either equal to zero or very low in the united kingdom canada sweden and new zealand analogous results hold for the euro area under the european monetary union and for switzerland under the new monetary regime under stable regimes with clearly defined nominal anchors inflation appears to be purely forward looking these results question the notion that the intrinsic inflation persistence found in post wwii u s data is structural in the sense of lucas carnegie rochester conference series on public policy 1 1976 19 46 and suggest that hardwiring inflation persistence in macroeconomic models is potentially misleading

globalization and the confidence game abstract we show that governments in developing countries have an incentive to play the confidence game wherein the need to win the confidence of the international capital market can actually prevent a country from following otherwise sensible policies and force it to follow policies that it would normally consider perverse this incentive arises because of a combination of a conformity bias and good news bias in governmental decision making in an open economy which results in inefficient outcomes which increases rather than decreases the threat of devaluation while institutions that encourage greater transparency and the public revelation of information may often mitigate this inefficiency on some occasions increased transparency may even exacerbate the inefficiency

monetary fiscal policy interactions and fiscal stimulus abstract increases in government spending trigger substitution effects both inter and intra temporal and a wealth effect the ultimate impacts on the economy hinge on current and expected monetary and fiscal policy behavior studies that impose active monetary policy and passive fiscal policy typically find that government consumption crowds out private consumption higher future taxes create a strong negative wealth effect while the active monetary response increases the real interest rate this paper estimates markov switching policy rules for the united states and finds that monetary and fiscal policies fluctuate between active and passive behavior when the estimated joint policy process is imposed on a conventional new keynesian model government spending generates positive consumption multipliers in some policy regimes and in simulated data in which all policy regimes are realized the paper reports the model s predictions of the macroeconomic impacts of the american recovery and reinvestment act s implied path for government spending under alternative monetary fiscal policy combinations

stepping on a rake the role of fiscal policy in the inflation of the 1970s abstract the inflation of the 1970s in the us is often discussed as if the only type of policy action that could have prevented the inflation were monetary policy actions and the only type of policy errors that might have induced the inflation were monetary policy errors yet fiscal policy underwent dramatic shifts in the 1970s and economic theory makes clear that in an environment of uncertainty about future fiscal policy monetary policy instruments may lose potency or have perverse effects this paper documents the vagaries of fiscal policy in this period and argues that people at the time must have been uncertain about fiscal policy s future course it also lays out a theoretical framework for understanding the effects of fiscal uncertainties on monetary policy and shows that fiscal variables have predictive value in dynamic models even if traditional monetary policy indicators are included in the system

overcoming the zero bound on nominal interest rates with negative interest on currency gesell s solution an economy is in a liquidity trap when monetary policy cannot influence either real or nominal variables of interest a necessary condition for this is that the short nominal interest rate is constrained by its lower bound typically zero the paper considers two small analytical models one old keynesian the other new keynesian possessing equilibria where not only the short nominal interest rate but nominal interest rates at all maturities can be stuck at their zero lower bound when the authorities remove the zero nominal interest rate floor by adopting an augmented monetary rule that systematically keeps the nominal interest rate on base money including currency at or below the nominal interest rate on non monetary instruments the lower bound equilibria are eliminated thus allowing an economic system to avoid the trap or to escape from it this rule will involve paying negative interest on currency that is imposing a carry tax on currency an idea first promoted by gesell the administration costs associated with a currency carry tax must be set against the benefits of potentially lower shoe leather costs and lower menu costs which are made possible by the its introduction there are also output gap avoidance benefits from eliminating the zero lower bound trap

optimal monetary policy under commitment with a zero bound on nominal interest rates we determine optimal monetary policy under commitment in a forwardlooking new keynesian model when nominal interest rates are bounded below by zero the lower bound represents an occasionally binding constraint that causes the model and optimal policy to be nonlinear a calibration to the u s economy suggests that policy should reduce nominal interest rates more aggressively than suggested by a model without lower bound rational agents anticipate the possibility of reaching the lower bound in the future and this amplifies the effects of adverse shocks well before the bound is reached while the empirical magnitude of u s mark up shocks seems too small to entail zero nominal interest rates shocks affecting the natural real interest rate plausibly lead to a binding lower bound under optimal policy however this occurs quite infrequently and does not imply positive average inflation rates in equilibrium interestingly the presence of binding real rate shocks alters the policy response to non binding markup shocks

high trend inflation and passive monetary detours abstract does the long run taylor principle davig and leeper 2007 hold when both monetary and fiscal policies can switch and there is positive trend inflation we find that with high trend inflation passive monetary detours are no longer possible whatever fiscal policy is in place this has important policy implications in terms of flexibility and monetary fiscal authorities coordination

changes in the federal reserve s inflation target causes and consequences this paper estimates a new keynesian model to draw inferences about the behavior of the federal reserve s unobserved inflation target the results indicate that the target rose from 1 1 4 percent in 1959 to over 8 percent in the mid to late 1970s before falling back below 2 1 2 percent in 2004 the results also provide some support for the hypothesis that over the entire postwar period federal reserve policy has systematically translated short run price pressures set off by supply side shocks into more persistent movements in inflation itself although considerable uncertainty remains about the true source of shifts in the inflation target jel e31 e32 e52

investment shocks and business cycles abstract the origins of business cycles are still controversial among macroeconomists this paper contributes to this debate by studying the driving forces of fluctuations in an estimated new neoclassical synthesis model of the u s economy in this model most of the variability of output and hours at business cycle frequencies is due to shocks to the marginal efficiency of investment imperfect competition and to a lesser extent technological frictions are the key to their transmission although labor supply shocks explain a large fraction of the fluctuations in hours at very low frequencies they are irrelevant over the business cycle this finding is important because the microfoundations of these disturbances are widely regarded as unappealing

understanding economic policy reform one of the eventual consequences of the global debt crisis was a wave of market oriented economic reforms this paper discusses the state of our knowledge on the political economy of this process why were inefficient and often unsustainable policies maintained for so long why are so many governments reforming now after decades of adherence to policies of an opposite kind have the reformers internalized the correct lessons from the east asian experience finally are there any helpful rules for reformers to follow in guiding their policies through complicated political terrain

in search of the holy grail policy convergence experimentation and economic performance we consider a model of policy choice in which appropriate policies depend on a country s own circumstances but the presence of a successful leader generates an informational externality and results in too little policy experimentation corrupt governments are reined in while honest governments are disciplined inefficiently our model yields distinct predictions about the patterns of policy imitation corruption and economic performance as a function of a country s location vis aa vis successful leaders in particular it predicts a u shaped pattern in economic performance as we move away from the leader in the relevant space of characteristics close neighbors should do very well distant countries moderately well on average with considerable variance and intermediate countries worst of all an empirical test with the experience of post socialist countries provides supportive results

the time varying volatility of macroeconomic fluctuations we investigate the sources of the important shifts in the volatility of us mac roeconomic variables in the postwar period to this end we propose the esti mation of dsge models allowing for time variation in the volatility of the structural innovations we apply our estimation strategy to a large scale model of the business cycle and find that shocks specific to the equilibrium condition of investment account for most of the sharp decline in volatility of the last two decades jel c51 e32

on fiscal multipliers estimates from a medium scale dsge model this paper contributes to the debate on fiscal multipliers in the context of a structural model i estimate a micro founded dynamic stochastic general equilibrium model that features a rich fiscal policy block and a transmission mechanism for government spending shocks using bayesian techniques for us data

measuring prior sensitivity and prior informativeness in large bayesian models abstract in large bayesian models such as modern dsge models it is difficult to assess how much the prior affects the results this paper derives measures of prior sensitivity and prior informativeness that account for the high dimensional interaction between prior and likelihood information the basis for both measures is the derivative matrix of the posterior mean with respect to the prior mean which is easily obtained from markov chain monte carlo output we illustrate the approach by examining posterior results in the small model of lubik and schorfheide 2004 and the large model of smets and wouters 2007

regime switches agents beliefs and post world war ii u s macroeconomic dynamics the evolution of inflation and output over the last 50 years is examined through the lens of a micro founded model that allows for changes in the behavior of the federal reserve and in the volatility of structural shocks agents are aware of the possibility of regime changes and their beliefs have an impact on the law of motion underlying the macroeconomy the results support the view that there were regime switches in the conduct of monetary policy however the behavior of the federal reserve is identified by repeated fluctuations between a hawk and a dove regime instead of by the traditional pre and post volcker structure counterfactual simulations show that if agents had anticipated the appointment of an extremely conservative chairman inflation would not have reached the peaks of the late 70s and the inflation output trade off would have been less severe these beliefs counterfactuals are new in the literature finally the paper provides a bayesian algorithm to handle the technical difficulties that arise in a rational expectations model with markov switching regimes

asset market participation monetary policy rules and the great inflation this paper argues that limited asset market participation is crucial in explaining u s macroeconomic performance and monetary policy before the 1980s and their changes thereafter in an otherwise conventional sticky price model standard aggregate demand logic is inverted at low enough asset market participation interest rate increases become expansionary passive monetary policy ensures equilibrium determinacy and maximizes welfare this suggests that federal reserve policy in the pre volcker era was better than conventional wisdom implies we provide empirical evidence consistent with this hypothesis and study the relative merits of changes in structure and shocks for reproducing the conquest of the great inflation and the great moderation

solving and estimating indeterminate dsge models we propose a method for solving and estimating linear rational expectations models that exhibit indeterminacy and we provide step by step guidelines for implementing this method in the matlab based packages dynare and gensys our method redefines a subset of expectational errors as new fundamentals this redefinition allows us to treat indeterminate models as determinate and to apply standard solution algorithms we prove that our method is equivalent to the solution method proposed by lubik and schorfheide 2003 2004 and using the new keynesian model described in lubik and schorfheide 2004 we demonstrate how to apply our theoretical results with a practical exercise

the olympic effect why should countries offer to host costly mega events such as the olympic games we show that hosting a mega event increases exports this effect is statistically robust permanent and large trade is over 20 higher for host countries interestingly unsuccessful bids to host the olympics have a similar impact on exports we conclude that the olympic effect on trade is attributable to the signal a country sends when bidding to host the games rather than the act of actually holding a mega event we develop an appropriate formal model and derive conditions under which liberalising countries will signal through a mega event bid

indeterminacy change points and the price puzzle in an estimated dsge model abstract we extend lubik and schorfheide s 2004 testing for indeterminacy an application to u s monetary policy american economic review 94 190 217 likelihood based estimation of dynamic stochastic general equilibrium dsge models under indeterminacy to encompass a sample period the includes both determinacy and indeterminacy by implementing a change point methodology chib s 1998 estimation and comparison of multiple change point models journal of econometrics 86 221 241 by letting the data provide estimates of the dates of the determinacy regimes and allowing the estimates of structural parameters to be the same across regimes we obtain more precise estimates of the differences in characteristics such as the impulse responses across the regimes the most striking finding about the indeterminacy regime which is estimated to coincide with the great inflation of the 1970s is that it exhibits the price puzzle in that the inflation rate rises immediately and in a sustained manner following a positive interest rate shock thus the price puzzle might have been a genuine phenomenon under indeterminacy rather than a false finding to be excised through specification search and parameter restrictions

self fulfilling expectations and the inflation of the 1970s evidence from the livingston survey abstract using survey data on expectations we examine whether the response of monetary policy to sudden movements in expected inflation contributed to the persistent high inflation of the 1970s the evidence suggests that prior to 1979 the fed accommodated temporary shocks to expected inflation which then led to persistent increases in actual inflation we do not find this behavior in the post 1979 data among commonly cited factors oil and fiscal shocks do not appear to have triggered an increase in expected inflation that eventually resulted in higher actual inflation

the price puzzle reconsidered abstract a large literature has employed structural vector autoregressive svar models to investigate the empirical effects of u s monetary policy many of these models regularly produce a price puzzle a rise in the aggregate price level in response to a contractionary innovation to monetary policy unless commodity prices are included conventional wisdom maintains that commodity prices resolve the price puzzle because they contain information that helps the federal reserve forecast inflation i examine a number of plausible alternative indicator variables and find little correlation between an ability to forecast inflation and an ability to resolve the price puzzle additionally a sub sample investigation reveals that evidence of a price puzzle is associated primarily with the 1959 1979 sample period and that most indicators including commodity prices cannot resolve the puzzle over this period

when does government debt crowd out investment summary we examine when government debt crowds out investment for the us economy using an estimated new keynesian model with detailed fiscal specifications and accounting for monetary and fiscal policy interactions whether investment is crowded in or out in the short term depends on policy shocks triggering debt expansions higher debt can crowd in investment for cutting capital tax rates or increasing government investment contrary to the conventional view no systematic relationships between real interest rates and investment exist explaining why reduced form regressions are inconclusive about crowding out at longer horizons distortionary financing is important for the negative investment response to debt copyright 2013 john wiley sons ltd

when managers cover their posteriors making the decisions the market wants to see the stock market has opinions as to what choices firms should make we show that concern for current share prices may lead managers to make these choices rather than those suggested by their own superior information even when arbitrarily many privately informed firms have to make a similar decision the market s prejudices may still prevail we compare the distortions that arise from share price maximization with those due to herd behavior among profit maximizing firms and show that the former results in strictly less efficient use of information

monetary policy regime shifts and inflation persistence abstract using bayesian methods we estimate a markov switching new keynesian msnk model that allows shifts in the monetary policy reaction coefficients and shock volatilities with u s data we find that a more aggressive monetary policy regime was in place after the volcker disinflation and before 1970 than during the great inflation of the 1970s our estimates also indicate that a low volatility regime has been in place during most of the sample period after 1984 we connect the timing of the different regimes to a measure of inflation persistence

has monetary policy become more effective we investigate the implications of changes in the structure of the u s economy for monetary policy effectiveness estimating a vector autoregression over the pre and post 1980 periods we provide evidence of a reduced effect of monetary policy shocks in the latter period we estimate a structural model that replicates well the economy s response in both periods and perform counterfactual experiments to determine the source of the change in the monetary transmission mechanism and in the economy s volatility we find that by responding more strongly to inflation expectations monetary policy has stabilized the economy more effectively in the post 1980 period

policy regimes policy shifts and u s business cycles abstract using an estimated dsge model with monetary and fiscal policy interactions and allowing for equilibrium indeterminacy we find that a passive monetary and passive fiscal policy regime prevailed in the pre volcker period this gave rise to self fulfilling beliefs and unconventional transmission mechanisms of policy shifts unanticipated increases in interest rates increased inflation and output while unanticipated increases in lump sum taxes decreased inflation and output we show that had the monetary policy regime of the post volcker era been in place pre volcker inflation volatility would have been lower by 25 and the rise of inflation in the 1970s would not have occurred

optimal monetary policy at the zero interest rate bound what should a central bank do when faced with a weak aggregate demand even after reducing the short term nominal interest rate to zero to address this question we solve a central bank s intertemporal loss minimization problem in which the non negativity constraint on nominal interest rates is explicitly considered we find that the optimal path is characterized by policy inertia in the sense that a zero interest rate policy should be continued for a while even after the natural rate of interest returns to a positive level by making such a commitment the central bank is able to achieve higher expected inflation lower long term nominal interest rates and a weaker domestic currency in the adverse periods when the natural rate of interest significantly deviates from a steady state level

optimal monetary policy when interest rates are bounded at zero abstract this paper characterizes the optimal monetary policy reaction function in the presence of a zero lower bound on the nominal interest rate we analytically prove and numerically show that the function is highly non linear more expansionary and more aggressive than the taylor rule we then test its empirical validity taking the case of japan in the 1990s qualitatively we find some evidence of non linear monetary policy quantitatively we find the actual monetary policy to be too contractionary during the first half of the decade while the low interest policy during the latter half turns out to be fairly consistent with the simulated path

fiscal policies and the choice of exchange rate regime a common argument against either a monetary union or a regime or a fixed exchange rates is that they preclude flexible use of the inflation tax the authors address this point of view by comparing three alternative exchange rate regimes a pure float an ems regime in which the exchange rate is fixed but can be realigned and a monetary union the authors model the three regimes as alternative commitments on future seigniorage policies this approac h suggests that it is not possible to pareto rank the three regimes o n the other hand the authors provide intuitive conditions under which each of the systems is superior to the others copyright 1993 by royal economic society

trend inflation indexation and inflation persistence in the new keynesian phillips curve purely forward looking versions of the new keynesian phillips curve nkpc generate too little inflation persistence some authors add ad hoc backward looking terms to address this shortcoming we hypothesize that inflation per sistence results mainly from variation in the long run trend component of inflation which we attribute to shifts in monetary policy we derive a version of the nkpc that incorporates a time varying inflation trend and examine whether it explains the dynamics of inflation when drift in trend inflation is taken into account a purely forward looking version of the model fits the data well and there is no need for backward looking components jel e12 e31 e52 in this paper we consider the extent to which guillermo calvo s 1983 model of nominal price rigidities can explain inflation dynamics without relying on arbitrary backward looking terms in its baseline formulation the calvo model leads to a purely forward looking new keynesian

long term debt and optimal policy in the fiscal theory of the price level the fiscal theory says that the price level is determined by the ratio of nominal debt to the present value of real primary surpluses i analyze long term debt and optimal policy in the fiscal theory i find that the maturity structure of the debt matters for example it determines whether news of future deficits implies current inflation or future inflation when long term debt is present the government can trade current inflation for future inflation by debt operations this tradeoff is not present if the government rolls over short term debt the maturity structure of outstanding debt acts as a budget constraint determining which periods price levels the government can affect by debt variation alone in addition debt policythe expected pattern of future state contingent debt sales repurchases and redemptionsmatters crucially for the effects of a debt operation i solve for optimal debt policies to minimize the variance of inflation i find cases in which long term debt helps to stabilize inflation i also find that the optimal policy produces time series that are similar to u s surplus and debt time series to understand the data i must assume that debt policy offsets the inflationary impact of cyclical surplus shocks rather than causing price level disturbances by policy induced shocks shifting the objective from price level variance to inflation variance the optimal policy produces much less volatile inflation at the cost of a unit root in the price level this is consistent with the stabilization of u s inflation after the gold standard was abandoned

inflation dynamics the role of public debt and policy regimes abstract in a passive monetary and active fiscal policy regime changes in the value of public debt generate wealth effects on households then in contrast to the active monetary and passive fiscal policy regime inflation moves oppositely from the inflation target and a stronger reaction of interest rates to inflation increases the response of inflation to shocks moreover a higher level of public debt increases the response of inflation while a weaker reaction of taxes to debt decreases the response of inflation to shocks in a passive monetary and passive fiscal policy regime both monetary and fiscal policy parameters affect inflation

were there regime switches in u s monetary policy working paper 2004 14 june 2004 abstract a multivariate model identifying monetary policy and allowing for simultaneity and regime switching in coefficients and variances is confronted with u s data since 1959 the best fit is with a model that allows time variation in structural disturbance variances only among models that also allow for changes in equation coefficients the best fit is for a model that allows coefficients to change only in the monetary policy rule that model allows switching among three main regimes and one rarely and briefly occurring regime the three main regimes correspond roughly to periods when most observers believe that monetary policy actually differed and the differences in policy behavior are substantively interesting though statistically ill determined the estimates imply monetary targeting was central in the early 80s but was also important sporadically in the 70s the changes in regime were essential neither to the rise in inflation in the 70s nor to its decline in the 80s jel classification e52 e47 c53 key words counterfactuals lucas critique policy rule monetary targeting simultaneity volatility model comparison i the debate over monetary policy change in an influential paper clarida gali and gertler 2000 cgg presented evidence that us monetary policy changed between the 1970 s and the 1980 s indeed that in the 70 s it was drastically worse they found that the policy rule apparently followed in the 70 s was one that when embedded in most stochastic general equilibrium models would imply non uniqueness of the equilibrium and hence vulnerability of the economy to sunspot fluctuations of arbitrarily large size their estimated policy rule for the later period on the other hand eliminated this indeterminacy these results are a possible explanation of the volatile and rising inflation of the 70 s and of its subsequent decline the cgg analysis has two important weaknesses one is that it fails to account for stochastic volatility us macroeconomic variables and particularly the federal funds rate have gone through periods of tranquility and of agitation with forecast error variances varying greatly from period to period ignoring such variation does not lead to inconsistent estimates of model parameters when the forecasting equations themselves are constant but it strongly biases toward a finding of changed parameters tests of the stability of the forecasting equations the other weakness is that the cgg analysis rests on powerful and implausible identifying assumptions they require that we accept that the response of the monetary authority to expected future inflation and output does not depend on the recent history of inflation money growth or output it is hard to understand why this should be so especially in the 70 s when monetarism was a prominent theme in policy debates congress was requiring reports from the fed of projected time paths of monetary aggregates and financial markets were reacting sensitively to weekly money supply numbers the requirement for existence and uniqueness of equilibrium in dynamic models is that the monetary policy rule show a more than unit response of interest rates to the sum of the logs of all nominal variables that appear on the right hand side of the reaction function if we force a particular measure of expected future inflation to proxy for all the nominal variables that actually appear independently in the reaction function we are bound to get distorted conclusions on the one hand because expected future inflation will be a noisy measure of the full set of nominal influences on policy we might get downward bias in our estimates from the usual errorsin variables effect on the other hand to the extent that expected future inflation like most expected future values shows less variation than current nominal variables we could find a mistaken scaling up of coefficients

the collapse of the mexican peso what have we learned the collapse of the mexican peso what have we learned in the first quarter of 1995 mexico found itself in the grip of an intense financial panic foreign investors fled the country despite very high interest rates an undervalued currency and financial indicators that pointed to long term solvency the fundamental conditions of the mexican economy cannot account for the extent of the crisis the crisis was not the result of irresponsible fiscal behaviour the crisis was due to unexpected shocks that occurred in 1994 the inadequate policy response to those shocks the increased vulnerability to panic and finally panic itself in the aftermath of the march assassination the exchange rate experienced a nominal devaluation of around 10 and interest rates increased by 7 percentage points however capital outflows continued the policy response was to maintain the exchange rate rule and to prevent further increases in interest rates interest rates were held down by expanding domestic credit and by converting short term peso denominated government liabilities cetes falling due into dollar denominated bonds tesobonos a fall in international reserves and an increase in short term dollar denominated debt resulted the government simply ended up illiquid and therefore financially vulnerable illiquidity exposed mexico to a self fulfilling panic jeffrey sachs aaron tornell and andres velasco

on the fit of new keynesian models this article provides new tools for the evaluation of dynamic stochastic general equilibrium dsge models and applies them to a large scale new keynesian model we approximate the dsge model by a vector autoregression and then systematically relax the implied cross equation restrictions and document how the model fit changes we also compare the dsge model s impulse responses to structural shocks with those obtained after relaxing its restrictions we find that the degree of misspecification in this large scale dsge model is no longer so large as to prevent its use in day to day policy analysis yet is not small enough to be ignored

the backing of government bonds and monetarism abstract this paper examines the implications of the fiscal backing of government bonds for the effects of conventional macroeconomic policies and in particular for certain monetarist propositions it shows that the validity of some basic monetarist hypotheses requires a considerable degree of accommodation by the fiscal authority relative to the central bank otherwise government bonds may matter in a manner as described in the traditional literature e g mundell 1971 patinkin 1965 though some differences arise of perhaps independent interest the framework developed in the analysis is an intertemporal general equilibrium model with all the descriptive features of the conventional flexible price is lm model

policy measures to avoid a currency crisis this paper considers a number of policy measures that may be used to preserve a fixed exchange rate these are analyzed in a model where a switch of exchange rate regime is triggered by an optimizing policymaker in response to extreme economic conditions it is shown how a number of policy measures can be used to alter the balance between the costs and benefits of switching between regimes these policy measures have both a direct effect on the policymaker s choice of regime switching point and an indirect effect through private sector expectations of a regime switch copyright 1995 by royal economic society

crises and prices information aggregation multiplicity and volatility crises are volatile times when endogenous sources of information are closely monitored we study the role of information in crises by introducing a financial market in a coordination game with imperfect information the asset price aggregates dispersed private information acting as a public noisy signal in contrast to the case with exogenous information our main result is that uniqueness may not obtain as a perturbation from perfect information multiplicity is ensured with small noise in addition we show that a multiplicity may emerge in the financial price itself b less noise may contribute toward nonfundamental volatility even when the equilibrium is unique and c similar results obtain for a model where individuals observe one another s actions highlighting the importance of endogenous information more generally

capital account liberalization as a signal the authors present a model in which a government s current capital control policy signals future policies controls on capital outflows evolve in response to news on technology conditional on government attitudes toward taxation of capital when there is uncertainty over governmental types a policy of liberal capital outflows sends a favorable signal that may trigger a capital inflow this prediction is consistent with the experience of several countries that have liberalized their capital accounts copyright 1997 by american economic association