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

revisiting purchasing power parity for african countries with nonlinear panel unit root tests this study applies panel seemingly unrelated regressions sur kapetanios et al kapetanios shin snell kss surkss tests proposed by wu and lee 2009 to investigate the properties of long run purchasing power parity ppp in 15 african countries the empirical results from the univariate unit root and panel based unit root tests indicate that ppp does not hold for these 15 countries under study however panel surkss tests indicate that ppp is valid for four of these 15 countries these results have important policy implications for these 15 african countries under study

nonlinear dynamics in deviations from the law of one price a broad based empirical study abstract in this paper we test empirically the validity of the law of one price using data for five major bilateral us dollar exchange rates and nine goods sectors during the recent floating exchange rate regime since the early 1970s using threshold autoregressive models we find strong evidence of nonlinear mean reversion in deviations from the law of one price with plausible convergence speeds consistent with theoretical arguments on international goods markets arbitrage under transactions costs and with an emerging strand of empirical literature these results contribute towards forming a consensus view in favor of discrete regime switching in deviations from the law of one price and the presence of differing nonzero transactions costs across a broad range of goods and countries

are asian real exchange rates stationary by applying the newly developed nonlinear stationary test advanced by kapetanios et al journal of econometrics 112 2003 359 in examining the stationary property of 11 asian real exchange rates this paper rejects unit root in 8 us dollar based and 6 japanese yen based rates whereas the augmented dickey fuller adf test has led to no rejection at all

the high unemployment trap a model of the labor market under firing restrictions and endogenous quits is constructed it is shown that in the spirit of blanchard and summers the model can generate multiple equilibria for plausible parameter values with a low quits high unemployment equilibrium coexisting with a high quits low unemployment equilibrium

the case for open market purchases in a liquidity trap prevalent thinking about liquidity traps suggests that the perfect substitutability of money and bonds at a zero short term nominal interest rate renders open market operations ineffective for achieving macroeconomic stabilization goals we show that even were this the case there remains a powerful argument for large scale open market operations as a fiscal policy tool as we also demonstrate however this same reasoning implies that open market operations will be beneficial for stabilization as well even when the economy is expected to remain mired in a liquidity trap for some time thus the microeconomic fiscal benefits of open market operations in a liquidity trap go hand in hand with standard macroeconomic objectives motivated by japan s recent economic experience we use a dynamic general equilibrium model to assess the welfare impact of open market operations for an economy in japan s predicament we argue japan can achieve a substantial welfare improvement through large open market purchases of domestic government debt

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

the black market exchange rate vs the official rate in testing ppp which rate fosters the adjustment process abstract in testing the purchasing power parity theory ppp researchers hardly pay attention to the speed with which the exchange rate adjusts to a change in relative prices in this paper we show that the speed of adjustment is faster when the black market exchange rate is used in testing the ppp as compared to the official exchange rate this could be another reason as to why central banks should unify the two rates

attenuating the forward guidance puzzle implications for optimal monetary policy abstract we examine the implications of less powerful forward guidance for optimal policy using a sticky price model with an effective lower bound elb on nominal interest rates as well as a discounted euler equation and a discounted phillips curve when the private sector agents discount future economic conditions more in making their decisions today a future rate cut becomes less effective in stimulating current economic activity under a wide range of plausible degrees of discounting it is optimal for the central bank to compensate for the reduced effect of a future rate cut by keeping the policy rate at the elb for longer

real implications of the zero bound on nominal interest rates if monetary policy succeeds in keeping average inflation very low nominal interest rates may occasionally be constrained by the zero lower bound the degree to which this constraint has real implications depends on the monetary policy feedback rule and the structure of price setting policy rules that make the price level stationary lead to small real distortions from the zero bound if policy imparts persistence into the inflation rate the real implications of the zero bound are large in the presence of backward looking price setting and small if prices are set to maximize profits

does ppp hold in african countries further evidence based on a highly dynamic non linear logistic unit root test with a view to investigating whether the purchasing power parity ppp theory holds true for selected african countries during the january 1980 december 2003 period we employ a rigorous highly dynamic non linear logistic unit root test as first advanced by leybourne et al 1998 which is considerably more powerful than those tests traditionally used compared with the rejection of the null of the unit root process for only one of the 22 countries under study when we use the traditional adf pp kpss np and the df gls unit root tests with the leybourne et al 1998 test we strongly reject the null of the unit root process for a surprising six of the 22 countries these empirical results clearly indicate that ppp holds true for these six countries namely the central african republic the cote d ivoire kenya madagascar uganda and lesotho

long run purchasing power parity with asymmetric adjustment further evidence from african countries this study applies threshold cointegration test advanced by enders and siklos 2001 to investigate the properties of asymmetric adjustment in long run purchasing power parity ppp in 22 selected african countries during the period of january 1980 to december 2003 although there is evidence of long run ppp for most african countries the adjustment mechanism is asymmetric these results have particularly important policy implications for african countries

purchasing power parity with flexible fourier stationary test for central and eastern european countries this study applies stationary test with a fourier function proposed by enders and lee 2004 2009 to test the validity of long run purchasing power parity ppp to assess the nonstationary properties of the real exchange rate rer for seven central and eastern european countries ceecs we find that our approximation has higher power to detect u shaped breaks and smooth breaks than linear method if the true data generating process of exchange rate is in fact a stationary nonlinear process we examine the validity of ppp from the nonlinear point of view and provide robust evidence clearly indicating that the ppp holds true for all ceecs our findings point out their exchange rate adjustment is mean reversion towards ppp equilibrium values in a nonlinear way

purchasing power parity in less developed and transition economies a review paper abstract the concept of purchasing power parity ppp has been the subject of numerous studies many of which have been unable to prove conclusively this core principle of international finance although industrialized countries have received most of the attention studies that focus on less developed and transition economies have also attained mixed results this study surveys trends in this branch of the literature highlighting the econometric advances that have sought to solve this puzzle while pointing out that more needs to be done to address the reasons that might cause ppp not to hold

the inadequacy of linear autoregressive model for real exchange rates empirical evidence from asian economies utilizing the formal linearity test of luukkonen saikkonen and terasvirta biometrika 75 491 499 1998 as diagnostic tool the empirical finding suggests that the linear autoregressive ar model is inadequate in describing the real exchange rates behaviour of 11 asian economies it is noted that the conventional battery of diagnostic tests is capable of identifying the inadequacy of the linear model in only three of these series moreover the linearity nature of this behaviour has been formally rejected in favour of the non linear smooth transition autoregressive star model the finding of non linearity in the data generating process of these real exchange rates warrants that the use of linear framework in empirical modelling and statistical testing procedures in the field of exchange rates may lead to an inappropriate policy conclusions

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

government debt and optimal monetary and fiscal policy how do different levels of government debt affect the optimal conduct of monetary and fiscal policies and what do these optimal policies imply for the evolution of government debt over time to provide an answer this paper studies a standard monetary policy model with nominal rigidities and monopolistic competition and adds to it a fiscal authority that issues nominal non state contingent debt levies distortionary labor income taxes and determines the level of public goods provision higher government debt levels make it optimal to reduce public spending so as to dampen the adverse incentive effects of distortionary taxes but also strongly influence the optimal stabilization response following technology shocks in particular higher debt levels give rise to larger risks to the fiscal budget and to tax rates this makes it optimal to reduce government debt over time the optimal speed of debt reduction is missed when using first order approximations to optimal policies but is shown to be quantitatively significant in a second order approximation especially when technology movements are largely unpredictable in nature

technology shocks in the new keynesian model in the new keynesian model preference cost push and monetary shocks all compete with the real business cycle model s technology shock in driving aggregate fluctuations a version of this model estimated via maximum likelihood points to these other shocks as being more important for explaining the behavior of output inflation and interest rates in the postwar u s data these results weaken the links between the current generation of new keynesian models and the real business cycle models from which they were originally derived they also suggest that federal reserve officials have often faced difficult trade offs in conducting monetary policy

the zero interest rate bound and the role of the exchange rate for monetary policy in japan in this paper we study the role of the exchange rate in conducting monetary policy in an economy with near zero nominal interest rates as experienced in japan since the mid 1990s our analysis is based on an estimated model of japan the united states and the euro area with rational expectations and nominal rigidities first we provide a quantitative analysis of the impact of the zero bound on the effectiveness of interest rate policy in japan in terms of stabilizing output and inflation then we evaluate three concrete proposals that focus on depreciation of the currency as a way to ameliorate the effect of the zero bound and evade a potential liquidity trap finally we investigate the international consequences of these proposals

optimal monetary and fiscal policy with a zero bound on nominal interest rates i characterize optimal monetary and fiscal policy in a stochastic new keynesian model when nominal interest rates may occasionally hit the zero lower bound the benevolent policymaker controls the short term nominal interest rate and the level of government spending under discretionary policy accounting for fiscal stabilization policy eliminates to a large extent the welfare losses associated with the presence of the zero bound under commitment the gains associated with the use of the fiscal policy tool remain modest even though fiscal stabilization policy is part of the optimal policy mix

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

risk premium shocks and the zero bound on nominal interest rates there appears to be a disconnect between the importance of the zero bound on nominal interest rates in the real world and predictions from quantitative dsge models recent economic events have reinforced the relevance of the zero bound for monetary policy whereas quantitative models suggest that the zero bound does not constrain optimal monetary policy

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

optimal simple and implementable monetary and fiscal rules welfare maximizing monetary and fiscal policy rules are studied in a model with sticky prices money and distortionary taxation the ramsey optimal policy is used as a point of comparison the main findings are the size of the inflation coefficient in the interest rate rule plays a minor role for welfare it matters only insofar as it affects the determinacy of equilibrium optimal monetary policy features a muted response to output interest rate rules that feature a positive response to output can lead to significant welfare losses the welfare gains from interest rate smoothing are negligible optimal fiscal policy is passive the optimal monetary and fiscal rule combination attains virtually the same level of welfare as the ramsey optimal policy

do real exchange rates follow a nonlinear mean reverting process in developing countries in an effort to fight relatively high inflation many developing countries try to manage their nominal exchange rates through official intervention in addition developing countries tend to have high transportation costs tariffs and nontariff barriers these factors are among the sources of generating nonlinearity in real exchange rates and hence some nonlinear adjustment toward purchasing power parity ppp in developing countries in this paper we employ monthly real effective exchange rate reer data of 88 developing countries and test the null of nonstationarity versus an alternative of linear stationarity by the means of a conventional unit root test and compare the results with those obtained from a new test in which the null is the same but the alternative hypothesis is nonlinear stationarity the latter test supports the ppp theory in more developing countries compared with the former test suggesting that nonlinear adjustment toward ppp in developing countries is an important phenomenon reported country characterizations indicate that reversion in reer occurs more often for high inflation countries and for countries with high flexibility in their exchange rates

long run purchasing power parity in the 1920s abstract this paper presents an empirical analysis of long run purchasing power parity ppp during the 1920s float using recently developed methodology on the cointegration of economic time series our results are generally supportive of ppp as a long run equilibrium condition on which exchange rates tended to converge over the period for dollar sterling however there is some evidence of a non stationary drift away from fundamentals during the last year or so before britain s return to the gold standard perhaps due to speculation our results also appear to reconcile some apparently conflicting evidence in the literature

a new comparative approach to macroeconomic modeling and policy analysis in the aftermath of the global financial crisis the state of m acroeconomic modeling and the use of macroeconomic models in policy analysis has come under heavy criticism macroeconomists in academia and policy institutions are blamed for relying too much on a particular class of macroeconomic models that did not sufficiently this paper propose s a comparative approach to macroeconomic policy analysis that is open to competing modeling paradigms macroeconomic model comparison projects have helped produce some very influenti al insights such as the taylor rule however they have been infrequent and costly because they require the input of many teams of researchers and multiple meetings to obtain a limited set of comparative findings this paper provides a new comparative approach to model based research and policy analysis that enables individual researchers to conduct model comparisons easily frequently at low cost and on a large scale using this approach a model archive is built that incl udes many well known empirically estimated models that may be used for quantitative analysis of monetary and fiscal stabilization policies a computational platform is created that allows straightforward comparisons of models implications its application is illustrated by compa ring different monetary and fiscal policies across selected models researchers can easily include new models in the data base and compare the effects of novel extensions to established benchmarks thereby fostering a comparative instead of insular approach to model development

overcoming the zero bound on interest rate policy the paper proposes three options for overcoming the zero bound on interest rate policy a carry tax on money open market operations in long bonds and monetary transfers a variable carry tax on electronic bank reserves could enable a central bank to target negative nominal interest rates a carry tax could be imposed on currency to create more leeway to make interest rates negative quantitative policy monetary transfers and open market purchases of long bonds could stimulate the economy by creating liquidity broadly defined a central bank needs more fiscal support than usual from the treasury to pursue quantitative policy at the interest rate floor

do exchange rates follow a random walk process in middle eastern countries abstract in this note we employ the kpss test in addition to the adf test to determine whether the real effective exchange rates in middle eastern countries follow a random walk process or they are stationary while in most cases the kpss test supported the stationary of the real effective rates thus the ppp the adf test did not the failure to support the ppp by the adf test is said to be due to its low power

threshold based forward guidance abstract when the monetary policy rate is at the zero bound threshold based forward guidance tbfg is a state contingent promise to delay liftoff from the zero bound until macroeconomic variables breach particular thresholds we study tbfg within a stochastic version of the workhorse new keynesian model we show that tbfg can be used to provide temporary stimulus while also limiting the time inconsistency of policy promises existence of a unique equilibrium requires the policymaker to specify how the thresholds should be interpreted as well as their values with an appropriate choice of thresholds tbfg outperforms forward guidance based purely on calendar time and substantially reduces welfare losses compared to the optimal time consistent policy

figuring out the fed beliefs about policymakers and gains from transparency in this paper i use a markov chain monte carlo algorithm to estimate a model of private sector behavior that does not feature private sector knowledge of the monetary policymaking process and instead leaves firms and households uncertain about how monetary policy is set the private sector entertains two competing views of monetary policymaking which i estimate firms and households use bayes law on a rolling data sample to distinguish between those two models i use this setup to study the evolution of beliefs about the federal reserve and the possible gains from transparency

trend inflation wage and price rigidities and productivity growth abstract what are the steady state implications of inflation in a general equilibrium model with real per capita output growth and staggered nominal price and wage contracts surprisingly a benchmark calibration implies an optimal inflation rate of 1 9 percent the analysis also shows that trend inflation has important effects on the economy when combined with nominal contracts and real output growth steady state output and welfare losses are quantitatively important even for low values of trend inflation further nominal wage contracting is found to be quantitatively more important than nominal price contracting in generating the results this conclusion does not arise from price dispersion per se but from an effect of nominal output growth on the optimal markup of monopolistically competitive labour suppliers finally accounting for productivity growth is found to be important for calculating the welfare costs of inflation indeed the presence of 2 percent productivity growth increases the welfare costs of inflation in the benchmark specification by a factor of four relative to the no growth case

escaping from a liquidity trap and deflation the foolproof way and others existing proposals to escape from a liquidity trap and deflation including my foolproof way are discussed in the light of the optimal way to escape the optimal way involves three elements 1 an explicit central bank commitment to a higher future price level 2 a concrete action that demonstrates the central bank s commitment induces expectations of a higher future price level and jump starts the economy and 3 an exit strategy that specifies when and how to get back to normal a currency depreciation is a direct consequence of expectations of a higher future price level and hence an excellent indicator of those expectations furthermore an intentional currency depreciation and a crawling peg as in the foolproof way can implement the optimal way and in particular induce the desired expectations of a higher future price level i conclude that the foolproof way is likely to work well for japan which is in a liquidity trap now as well as for the euro area and the united states in case either would fall into a liquidity trap in the future

real exchange rate behavior in the middle east a re examination abstract this letter extends recent work by bahmani oskooee bahmani oskooee m do exchange rates follow a random walk process in middle eastern countries economics letters 1998 58 339 344 on testing long run purchasing power parity for middle eastern countries during the post bretton woods period using multivariate nonlinear models strong support is provided for highly nonlinear reversion of real exchange rates toward a stable equilibrium for each country examined

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

monetary regime switches and central bank preferences monetary policy objectives and targets are not necessarily constant over time the regime switching literature has typically analyzed and interpreted changes in policymakers behavior through simple interest rate rules this paper analyzes policy regime switches by explicitly modeling policymakers behavior and objectives we show that changes in the parameters of simple rules do not necessarily correspond to changes in policymakers preferences in fact capturing and interpreting regime changes in preferences through interest rate rules can lead to misleading results

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

the perils of nominal targets a monetary authority can be committed to pursuing an inflation price level or nominal gdp target yet systematically fail to achieve the prescribed goal constrained by the zero lower bound on the policy rate the monetary authority is unable to implement its objectives when private sector expectations stray far enough from the target low inflation expectations become self fulfilling resulting in an additional markov equilibrium in which the monetary authority falls short of the nominal target average output is below its efficient level and the policy rate is typically low introducing a stabilization goal for long term nominal rates can implement a unique markov equilibrium without fully compromising stabilization policy

the deflation bias and committing to being irresponsible i model deflation at zero nominal interest rate in a microfounded general equilibrium model i show that one can analyze deflation as a credibility problem if three conditions are satisfied first the government s only policy instrument is increasing the money supply by open market operations in short term bonds second the economy is subject to large negative demand shocks third the government cannot commit to future policy i call the credibility problem that arises under these conditions the deflation bias i propose several policies to solve it they all involve printing money or issuing nominal debt in addition they require cutting taxes buying real assets such as stocks or purchasing foreign exchange the government credibly commits to being irresponsible by pursuing these policies it commits to higher money supply in the future so that the private sector expects inflation instead of deflation this is optimal since it curbs deflation and increases output by lowering the real rate of return

transactions costs and nonlinear adjustment in real exchange rates an empirical investigation eolquilibrium models of real exchange rate determination in the presence of transactions costs imply a nonlinear adjustment process toward purchasing power parity ppp conventional cointegration tests which ignore the effect of transactions costs may be biased against the long run ppp hypothesis our results using both monthly data for the interwar period and annual data spanning two centuries clearly reject the linear framework in favor of an exponential smooth transition autoregressive process the systematic pattern in the estimates of the nonlinear models provides strong evidence of mean reverting behavior for ppp deviations and helps explain the mixed results of previous studies

optimal fiscal and monetary policy under sticky prices this paper studies optimal fiscal and monetary policy under sticky product prices the theoretical framework is a stochastic production economy without capital the government finances an exogenous stream of purchases by levying distortionary income taxes printing money and issuing one period nominally risk free bonds the main findings of the paper are first for a miniscule degree of price stickiness i e many times below available empirical estimates the optimal volatility of inflation is near zero this result stands in stark contrast with the high volatility of inflation implied by the ramsey allocation when prices are flexible the finding is in line with a recent body of work on optimal monetary policy under nominal rigidities that ignores the role of optimal fiscal policy second even small deviations from full price flexibility induce near random walk behavior in government debt and tax rates third sluggish price adjustment raises the average nominal interest rate above the one called for by the friedman rule finally an interest rate feedback rule whereby the nominal interest rate depends on inflation and output fits well the data emanating from the ramsey economy however the fitted rule is not of the taylor type for the implied inflation coefficient is less than one and close to zero and the output coefficient is negative jel classification e52 e61 e63

can more public information raise uncertainty the international evidence on forward guidance abstract central banks have used different types of forward guidance this paper reports cross country evidence showing that in general forward guidance mutes the response of government bond yields to macroeconomic news however calendar based guidance with a short horizon counter intuitively raises it using a stylized model where agents learn from market signals it shows that the public release of more precise information about future rates lowers the informativeness of market signals and as a consequence may increase uncertainty and amplify the reaction of expectations to macroeconomic news

have we underestimated the likelihood and severity of zero lower bound events prior to the financial crisis most economists probably did not view the zero lower bound zlb as a major problem for central banks using a range of structural and statistical models we find that previous research understated the zlb threat by ignoring uncertainty about model parameters and latent variables focusing too much on the great moderation experience and relying on structural models whose dynamics cannot generate sustained zlb episodes our analysis also suggests that the federal reserve s asset purchases while materially improving macroeconomic conditions did not prevent the zlb constraint from having first order adverse effects on real activity and inflation