optimal interest rate rules asset prices and credit frictions we study optimal taylor type interest rate rules in an economy with credit market imperfections our analysis builds on the agency cost framework of carlstrom and fuerst 1997 agency costs net worth and business fluctuations a computable general equilibrium analysis american economic review 87 893 910 which we extend in two directions first we embed monopolistic competition and sticky prices second we modify the stochastic structure of the model in order to generate a countercyclical premium on external finance this is achieved by linking the mean distribution of investment opportunities faced by entrepreneurs to aggregate total factor productivity we model monetary policy in terms of simple welfare maximizing interest rate rules we find that monetary policy should respond to increases in asset prices by lowering interest rates however when monetary policy responds strongly to inflation the marginal welfare gain of responding to asset prices vanishes within the class of linear interest rate rules that we analyze a strong anti inflationary stance always attains the highest level of welfare

the opportunistic approach to monetary policy and financial market conditions we test the concept of the opportunistic approach to monetary policy in south africa post 2000 inflation targeting regime the article contributes to the current debate on central banks having additional objectives over and above inflation and output by incorporating a measure of financial conditions in the modelling framework our findings support the two features of the opportunistic approach first we find that the models that include an intermediate target that reflects the recent history of inflation rather than simple inflation target improve the fit of the models second the data supports the view that the south african reserve bank sarb behaves with some degree of nonresponsiveness when inflation is within the zone of discretion but react aggressively otherwise recursive estimates from our preferred model reveal that overall there has been a subdued reaction to inflation output and financial conditions amidst the increased economic uncertainty of the 2007 2009 financial crisis

what asset prices should be targeted by a central bank this paper investigates the monetary policy design for restoring equilibrium determinacy our interests are whether a central bank should respond to asset price fluctuations and if so what asset prices should be targeted we show that a monetary policy response to the price of a productive tangible asset capital price is helpful for equilibrium determinacy while that to the price of an intangible asset that reflects a firm s profit share prices is a source of equilibrium indeterminacy this result comes from the two assets prices moving in opposite directions in response to a permanent increase in inflation

bank runs and institutions the perils of intervention we study ex post efficient policy responses to a run on the banking system and the ex ante incentives these responses create we show that the efficient response to a run is typically not to freeze all remaining deposits since doing so imposes heavy costs on some individuals instead once a run is underway benevolent government institutions would allow additional deposit withdrawals placing further strain on the banking system when depositors anticipate these extra withdrawals their incentive to participate in the run increases in fact ex post efficient interventions can generate the conditions necessary for a self fulfilling run to occur jel g21 g8

regional house price dynamics and voting behavior in the fomc i introduction interest rate decisions by the federal open market committee fomc are not always made unanimously different individual views about the appropriate monetary policy stance may lead to the result that members cast dissenting interest rate votes in fomc meetings that is they opt for a higher or lower interest rate than proposed by the chairman of the fomc several studies find that fomc members have different views about the appropriate monetary policy when casting interest rate votes belden 1989 chappell and mcgregor 2000 chappell mcgregor and vermilyea 2005 2008 2012 gildea 1990 1992 havrilesky and gildea 1991 1995 havrilesky and schweitzer 1990 meade and sheets 2005 meade 2010 tootell 1991 1996 an important source of such dissenting votes may be the regional bias of the fomc member which is constituted by its regional affiliation several studies have examined the impact of the regional unemployment rate on the interest rate votes of fomc members while gildea 1992 meade and sheets 2005 and chappell mcgregor and vermilyea 2008 find that a higher regional unemployment rate relative to the national rate increases decreases fomc members preference for monetary easing tightening tootell 1991 finds no significant evidence 1 in this article we analyze whether fomc members align their interest rate voting behavior with house price developments of the federal reserve district they represent in addition to the regional unemployment rate studied so far in this way we can test whether regional house prices and or regional unemployment rates have a significant impact on the voting behavior of fomc members and we examine whether there are systematic differences between regional bank presidents and board members various studies have examined the link between monetary policy and asset price developments according to gilchrist and leahy 2002 there are some good reasons why central banks should align their monetary policies with asset prices first the consumer price index cpi or gross domestic product gdp deflator are incomplete measures since they only signal information on the prices of goods consumed today whereas a more complete measure would also signal future cost of living such as the information contained in asset prices alchian and klein 1973 second asset prices may be useful in forecasting inflation goodhart and hofmann 2000 third asset prices may directly affect real economic activity and inflation since for example wealthier consumers spend more which may affect price developments carroll otsuka and slacalek 2011 whether central banks should react to asset prices is however debated in the literature the traditional view is that central banks should only react to asset prices to the extent that they feed back into the conventional monetary policy goals inflation and output bernanke and gertler 1999 2001 on the contrary cecchetti et al 2000 conclude that it may be reasonable for central banks to react to asset prices in particular house prices in order to avoid the buildup of asset price bubbles as the burst of asset price bubbles may lead to financial crises reinhart and rogoff 2009 leaning against the buildup of extreme asset price changes may therefore be a reasonable choice for central banks as a part of their mission to manage systemic risk allen and carletti 2009 bordo and jeanne 2002 another rationale that central banks should take asset prices particularly house prices into account is that house prices have been shown to be suitable early warning indicators for the outbreak of the recent financial crisis kemme and roy 2012 several empirical papers analyze the impact of asset prices on interest rate setting rigobon and sack 2003 and dupor and conley 2004 find evidence that fomc interest rate decisions are influenced by equity prices on the contrary fuhrer and tootell 2008 find that fomc interest rate decisions are not a direct response to equity price movements and are an indirect response only to the extent that equity prices helped forecast the conventional monetary policy goals

inflation and reputation in many macroeconomic models with rational expectations optimal policy is time inconsistent and therefore announced policy may not be credible this paper models the government s credibility explicitly using kreps and wilson s analysis time consistent optimal government policy emerges as a sequential equilibrium in a repeated game this policy is at least as good as the inconsistent optimal policy and dominates the consistent policy when reputational effects are ignored thus the analysis resolves the problem of specifying a credible optimal policy in such models the results show why attempts to disinflate may lead to recession even with perfectly flexible prices this abstract was borrowed from another version of this item

optimal monetary policy rules financial amplification and uncertain business cycles abstract this paper studies optimal monetary policy in the presence of uncertainty time variation in cross sectional dispersion of firms productive performance using a model with financial market imperfections the results suggest that i optimal policy is to dampen the strength of financial amplification by responding to uncertainty at the expense of creating mild degree of fluctuations in inflation ii higher uncertainty makes the welfare maximizing planner more willing to relax financial constraints iii credit spreads are a good proxy for uncertainty hence a non negligible response to credit spreads together with a strong anti inflationary policy stance achieves the highest aggregate welfare possible

what has and has not been learned about monetary policy in a low inflation environment a review of the 2000s as the world economy recovers from the worst financial crisis and most severe global slump in 75 years policymakers regulators and academics are focusing intensely and appropriately on lessons to be learned for monetary policy there are certainly many questions to answer among the most important are are inflation expectations well anchored what if any influence should asset quantities and prices have on monetary policy do we have sufficient confidence in our alternative monetary policy tools to stabilize the economy at the zero lower bound

a monetary policy strategy in good and bad times lessons from the recent past we evaluate the ecb s monetary policy strategy against some of the underlying economic features of the eurozone in normal times and during the financial crisis we show that in the years preceding the crisis the ecb s emphasis on monetary indicators and deliberate avoidance of excessive activism were justified by the underlying macroeconomic conditions that the ecb faced in the eurozone and contributed to avoid more volatile patterns of inflation and economic activity after the collapse of financial intermediation in late 2008 the strategy of the ecb was to adopt several non standard policy measures according to our quantitative evaluation of the impact of the main non standard policies decided in october 2008 and in may 2009 which notably did not include entering commitments regarding the future path of the policy rate such measures have significantly contributed to preserving price stability and forestalling a more disruptive collapse of the macroeconomy stephan fahr roberto motto massimo rostagno frank smets and oreste tristani

innovations and issues in monetary policy panel discussion martin feldstein 1 chairman alan greenspan s remarks today give us an opportunity to understand his thinking about monetary policy and about the federal reserve s actions during the past 15 years it was a period of substantial accomplishment that no doubt reflects in considerable measure the views of the chairman himself the fed s primary goal price stability has been achieved with inflation down from 4 percent at the end of the 1980 s to about 1 5 percent now the 2 percentage point difference between the interest rate on conventional treasury bonds and on inflation indexed bonds tips shows that financial markets expect inflation will remain at about 2 percent for at least the next decade

the interaction of monetary and macroprudential policies i analyze a new keynesian dynamic stochastic general equilibrium dsge model where the financing of productive investment is affected by a moral hazard problem i solve for jointly ramsey optimal monetary and macroprudential policies i find that when a financial friction is present in addition to the standard nominal friction the optimal policy can replicate the first best allocation if the social planner can conduct both monetary and macroprudential policy using monetary policy alone is not enough a policy trade off between stabilizing inflation and output gap emerges when policy follows simple rules the source of fluctuations is relevant for the choice of the appropriate policy mix

conservative central banks and nominal growth exchange rate and inflation targets a framework is developed in which inflation biases with different target variables are compared a nominal growth target measured in consumer prices may yield less stabilization bias than a nominal income growth target exchange rate and inflation targets result in less stabilization bias than an income growth target the more important the terms of trade stabilization persistence in output causes excessive stabilization of productivity shocks and of shocks to the terms of trade under discretion an inflation weight conservative central bank is more likely under an inflation target than under an exchange rate target and less likely under a nominal income growth target

deflating asset price bubbles with leverage constraints and monetary policy abstract we develop an experimental production economy to study the general equilibrium and welfare effects of speculation and stabilization policies participants playing the role of household investors interact in labor output and in some treatments asset markets without the ability to trade assets participants over supply costly labor to acquire saving the presence of asset markets improves welfare by allowing investors to substitute labor income for speculative gains asset prices deviate substantially from fundamental value leverage constraints that prevent investors from borrowing for speculation are ineffective at stabilizing asset prices households often circumvent the constraints by excessively supplying labor and generating increased wealth which can be used for speculation wealth inequality is worsened due to endogenously higher interest accumulated by borrowers and savers an asset inflation targeting policy fuels initial asset price growth but as interest rates rise rapidly effectively deflates asset price deviations with learning the policy stabilizes asset prices and consequently interest rates which enhances welfare and reduces inequality we develop a model of heterogeneous expectations to rationalize our experimental findings

monetary and macroprudential policies in an estimated model with financial intermediation abstract we estimate the smets wouters model featuring the gertler karadi banking sector on us data using real and financial observables we investigate the gains from coordination between a flexible inflation targeting central bank and a macroprudential regulator charged with safeguarding financial stability the potential gains from coordination depend on how much importance is given to the output gap in the macroprudential mandate coordination conflicts can be avoided by assigning similar importance to this common objective in the respective mandates of both policies when we derive optimal mandates for monetary and macroprudential policy under no coordination we find that both policy makers should place a higher weight than society on the output gap

stock market conditions and monetary policy in a dsge model for the u s abstract this paper investigates the interactions between stock market fluctuations and monetary policy within a dsge model for the u s economy first we design a framework in which fluctuations in households financial wealth are allowed but not necessarily required to exert an impact on current consumption this is due to the interaction in the financial markets of long time traders holding wealth accumulated over time with newcomers holding no wealth at all importantly we introduce nominal wage stickiness to induce pro cyclicality in real dividends additional nominal and real frictions are modeled to capture the pervasive macroeconomic persistence of the observables employed to estimate our model we fit our model to post wwii u s data and report three main results first the data strongly support a significant role of stock prices in affecting real activity and the business cycle second our estimates also identify a significant and counteractive response of the fed to stock price fluctuations third we derive from our model a microfounded measure of financial slack the stock price gap which we then contrast to alternative ones currently used in empirical studies to assess the properties of the latter to capture the dynamic and cyclical implications of our dsge model the behavior of our stock price gap is consistent with the episodes of stock market booms and busts occurred in the post wwii as reported by independent analyses and closely correlates with the current financial meltdown typically employed proxies of financial slack such as detrended log indexes or growth rates show limited capabilities of capturing the implications of our model consistent index of financial stress cyclical properties of the model as well as counterfactuals regarding shocks to our measure of financial slackness and monetary policy shocks are also proposed

do central banks react to the stock market the case of the bundesbank abstract in this paper we ask whether the bundesbank prior to the european central bank taking responsibility for monetary policy in 1999 reacted systematically to stock price movements in contrast to the results for the us our empirical findings show a generally weak relationship between german stock returns and short term interest rates at the daily and the monthly frequency the results are extremely robust to alternative model specifications the evidence is inconsistent with the hypothesis of a systematic reaction of the bundesbank to german stock prices however we do find that as in the us the bundesbank may have reacted to the stock market crash of 1987 by loosening monetary policy

the impact of monetary policy on stock market bubbles and trading behavior evidence from the lab we investigate the effect of monetary policy on stock market bubbles and trading behavior in experimental asset markets we introduce the possibility of investing in interest bearing bonds to the widely used laboratory asset market design of smith et al 1988 treatment groups face a variable interest rate policy which depends on asset prices while control groups are subjected to a constant interest rate we observe a strong impact of our interest rate policy on liquidity in the stock market but only a small impact on bubbles however we find that announcing the possibility of reserve requirements significantly reduces bubbles

optimal monetary policy and financial stability in a non ricardian economy this paper develops a model with discontinuous asset market participation in which all agents are infinitely lived and non ricardian and where heterogeneity among market participants implies financial wealth effects on aggregate consumption derivation of a welfare based loss function shows that financial stability arises as an additional and independent target besides infl ation and output stability evaluation of optimal policy under discretion and commitment reveals that price stability may no longer be optimal even absent inefficient supply shocks some fluctuations in output and infl ation are optimal as long as they reduce financial instability ignoring the heterogeneity among market participants in this economy may lead monetary policy to induce substantially higher welfare losses

financial stress economic activity and monetary policy in the asean 5 economies this article uses a structural vector autoregression approach to analyse the impact of financial stress on the economy and the relationship between monetary policy and financial stress in the asean 5 economies indonesia malaysia philippines singapore and thailand we find that an increase in financial stress leads to tighter credit conditions and lower economic activity in all five countries the estimated impact on the real economy displays an initial rapid decline followed by a gradual dissipation in malaysia the philippines and thailand the central banks tend to reduce policy interest rates irs when financial stress increases although there is substantial cross country variation in the magnitude and time dynamics the lower policy irs are found to have little significant effects in lowering financial stress but are still effective in stimulating economic activity through other channels these findings imply that easing monetary policy is likely necessary but insufficient to address growth s

inflation targeting during asset and commodity price booms the recent global economic crisis originated in the midst of a commodity price boom that had triggered sharp increases in inflation in many world countries the crisis also came in the context of a rally in asset prices and large domestic imbalances in the united states this paper uses a small open economy dynamic stochastic general equilibrum dsge model to design the correct monetary policy response to a protracted supply shock and examines how that response would change when many become credit constrained like in a credit crunch and when spending of those who can still borrow becomes very sensitive to the interest rates because of overleveraging using a version of the model with kalman learning the paper also evaluates the implications of a loss of target credibility showing how rules must be adjusted when the authorities commitment to the inflation target has been eroded the appropriate response to future evolutions of the price of oil including to large downward corrections from the current level is also evaluated copyright 2010 oxford university press

rethinking macroeconomics what failed and how to repair it the standard macroeconomic models have failed by all the most important tests of scientific theory they did not predict that the financial crisis would happen and when it did they understated its effects monetary authorities allowed bubbles to grow and focused on keeping inflation low partly because the standard models suggested that low inflation was necessary and almost sufficient for efficiency and growth after the crisis broke policymakers relying on the models floundered notwithstanding the diversity of macroeconomics the sum of these failures points to the need for a fundamental re examination of the models and a reassertion of the lessons of modern general equilibrium theory that were seemingly forgotten in the years leading up to the crisis this paper first describes the failures of the standard models in broad terms and then develops the economics of deep downturns and shows that such downturns are endogenous further the paper argues that there have been systemic changes to the structure of the economy that made the economy more vulnerable to crisis contrary to what the standard models argued finally the paper contrasts the policy implications of our framework with those of the standard models

learning monetary policy and asset prices this working paper should not be reported as representing the view s of the imf the views expressed in this working paper are those of the author s and do not necessarily represent those of the imf or imf policy working papers describe research in progress by the author s and are published to elicit comments and to further debate

from institutions to financial development and growth what are the links this paper presents an integrated overview of the literature linking institutions financial development and economic growth from the large body of research on institutional development the paper first selects those contributions that make it possible to study the role of institutional arrangements in ameliorating worsening the information frictions and transaction costs that characterize the development of financial markets the paper then investigates the theoretical mechanisms by which these specific frictions affect economic growth and presents the stock of empirical evidence quantifying the impact of institutions on growth through financial development

bailout uncertainty in a microfounded general equilibrium model of the financial system abstract this paper develops a micro founded general equilibrium model of the financial system composed of ultimate borrowers ultimate lenders and financial intermediaries the model is used to investigate the impact of uncertainty about the likelihood of governmental bailouts on leverage interest rates the volume of defaults and the real economy the distinction between risk and uncertainty is implemented by applying the multiple priors framework to beliefs about the probability of bailout results of the analysis include i an unanticipated increase in bailout uncertainty raises interest rates the volume of defaults in both the real and financial sectors and may lead to a total drying up of credit markets ii lower exante bailout uncertainty is conducive to higher leverage which in turn raises moral hazard and makes the economy more vulnerable to expost increases in bailout uncertainty iii bailout uncertainty affects the likelihood of bubbles the amplitude of booms and busts as well as the banking and the credit spreads iv higher bailout uncertainty is associated with higher returns variability in diversified portfolios and higher systemic risks v pre crisis expansionary monetary policy reinforces those effects by inducing higher aggregate leverage levels vi the larger the change in bailout uncertainty and the change in aversion to this uncertainty the stronger the pre crisis buildup and the deeper the ensuing crisis a central policy implication of the analysis is that the vaguest is bailout policy prior to a crisis the lower is the magnitude of investments destroyed or missed due to errors in evaluating bailout and other intervention policies on the other hand the clearer is bailout policy upon the eruption of a crisis the smaller the contraction of credit and the destruction of investment activity

central bank communication and monetary policy a survey of theory and evidence over the last two decades communication has become an increasingly important aspect of monetary policy these real world developments have spawned a huge new scholarly literature on central bank communication mostly empirical and almost all of it written in this decade we survey this ever growing literature the evidence suggests that communication can be an important and powerful part of the central bank s toolkit since it has the ability to move financial markets to enhance the predictability of monetary policy decisions and potentially to help achieve central banks macroeconomic objectives however the large variation in communication strategies across central banks suggests that a consensus has yet to emerge on what constitutes an optimal communication strategy

the meaning of internal balance thirty years on in his nobel prize lecture meade advocated allocating demand management policies to pursuing price stability reformed wage fixing institutions to achieving full employment and foreign exchange policies to maintaining balance of payments equilibrium but with respect to the first he advocated a target for nominal income rather than the price level i evaluate meade s programme with the benefit of hindsight and in the light of experience with inflation targets i also discuss some of the issues associated with the application of flexible inflation targets as well as the extent to which financial stability considerations should affect the conduct of monetary policy

optimal monetary policy with capital and a financial accelerator abstract whether there is a trade off between price and financial stability is an open question this paper characterises optimal monetary policy analytically in a new keynesian economy with capital and a financial accelerator in addition to stabilising inflation there is an incentive to smooth volatility in the net worth of borrowers and this presents a trade off for monetary policy this trade off can be eliminated if policymakers can additionally choose an optimal transfer to borrowers enriching the model with fire sales and countercyclical bankruptcy costs there is also an incentive to smooth volatility in default and the capital stock an optimal transfer to borrowers is not sufficient to eliminate the trade off in that case with fewer instruments than targets optimal transfers are state contingent and countercyclical while monetary policy stabilises inflation

identifying the role of risk shocks in the business cycle using stock price data i introduction the finance literature on the forecastibility of stock returns has concluded that stock market movements are by and large not because of changes in the expected future cash flow of firms but are primarily because of changes in the risk premium that is how the expected cash flows are discounted by stock market participants cochrane 2011 1 these changes in risk premia also have important implications for real variables in the economy especially for consumption and investment an increase in the risk premium prompts households to reduce current consumption as they start to discount expected future income more heavily more importantly changes in the required return on equity alter the cost of capital of corporations when they finance new investment for firms that rely on external debt to finance marginal investment a lower stock price translates into lower net worth and therefore a higher cost of borrowing bernanke gertler and gilchrist 1999 similarly firms that rely on new equity issues are able to raise less funds from each new share when their stock price is lower even for firms that finance investment exclusively through internal funds i e retained earnings plus depreciation allowance the required return on existing shares reveals the opportunity cost of internally financed investment tobin 1969 tobin and brainard 1977 this is because at least in principle these funds can be returned to existing shareholders as dividends and new funds can then be raised from the markets through new equity shares for which investors would demand a risk premium figure 1 omitted in the aggregate u s corporations are predominantly financed through equity the dotted line in figure 1 plots the credit market liabilities of u s non financial corporations as a percent of the sum of equity and credit market liabilities in their balance sheets 2 by this measure debt financing accounts for about a third of total financing averaged over the whole sample and equity financing accounts for about two thirds the solid line in figure 1 provides an alternative measure which takes into account all financial liabilities including items such as trade payables but nets out financial assets to obtain a measure of net debt mcgrattan and prescott 2005 now debt financing accounts for only 15 of total financing in the post war period and its importance has declined in the last two decades note that both of these series are stock measures as opposed to flow measures that is they refer to financing of all past investments and do not necessarily reflect how corporations are financing investment at the margin these measures can also be biased against debt financing because most debt items are recorded on a book value basis in the flow of funds but equity is recorded on a market value basis to overcome these caveats i consider the flow components of sources of funds i e internal funds net new equity and net new debt as a share of corporate tangible investment in figure 2 several patterns emerge first the ratio of internal funds to gross capital expenditures has been close to 1 throughout the post war period in other words at least in the aggregate u s corporate investment has been by and large financed internally second new equity issuance has not been an important source of financing in fact net new stock issues have been mostly negative in the latter part of the sample this mainly reflects the preference of corporations to distribute resources to shareholders through stock buybacks rather than ordinary dividend payments because of the preferential tax treatment of long term capital gains third net new debt has contributed to about a third of aggregate financing assuming that the discrepancy in the flow account is distributed proportionally to each financing component as internal funds and net new stock issues are fairly reliable data series we can reasonably lump the rather large discrepancy item in the ffa data with net debt

should central banks respond to movements in asset prices in recent decades asset booms and busts have been important factors in macroeconomic fluctuations in both industrial and developing countries in light of this experience how if at all should central bankers respond to asset price volatility we have addressed this issue in previous work bernanke and gertler 1999 the context of our earlier study was the relatively new but increasingly popular monetary policy framework known as inflation targeting see e g bernanke and frederic mishkin 1997 in an inflation targeting framework publicly announced medium term inflation targets provide a nominal anchor for monetary policy while allowing the central bank some flexibility to help stabilize the real economy in the short run the inflation targeting approach gives a specific answer to the question of how central bankers should respond to asset prices changes in asset prices should affect monetary policy only to the extent that they affect the central bank s forecast of inflation to a first approximation once the predictive content of asset prices for inflation has been accounted for there should be no additional response of monetary policy to assetprice fluctuations in use now for about a decade inflationtargeting has generally performed well in practice however so far this approach has not often been stress tested by large swings in asset prices our earlier research employed simulations of a small calibrated macroeconomic model to examine how an inflation targeting policy defined as one in which the central bank s instrument interest rate responds primarily to changes in expected inflation might fare in the face of a boom and bust cycle in asset prices we found that an aggressive inflationtargeting policy rule in our simulations one in which the coefficient relating the instrument interest rate to expected inflation is 2 0 substantially stabilizes both output and inflation in scenarios in which a bubble in stock prices develops and then collapses as well as in scenarios in which technology shocks drive stock prices intuitively inflation targeting central banks automatically accommodate productivity gains that lift stock prices while offsetting purely speculative increases or decreases in stock values whose primary effects are through aggregate demand conditional on a strong policy response to expected inflation we found little if any additional gains from allowing an independent response of central bank policy to the level of asset prices in our view there are good reasons outside of our formal model to worry about attempts by central banks to influence asset prices including the fact that as history has shown the effects of such attempts on market psychology are dangerously unpredictable hence we concluded that inflationtargeting central banks need not respond to asset prices except insofar as they affect the inflation forecast in the spirit of recent work on robust control the exercises in our earlier paper analyzed the performance of policy rules in worst case discussants robert shiller yale university glenn rudebusch federal reserve bank of san francisco kenneth rogoff harvard university

does the reserve bank of australia follow a forward looking nonlinear monetary policy rule abstractthe conventional monetary policy rule describes a simple linear relationship between the domestic interest rate inflation rate and output gap an important extension to this rule is to inc

monetary policy and dividend growth in germany long run structural modelling versus bounds testing approach this study examines the long run relationship between monetary policy and dividend growth in germany for this purpose cointegration is tested for between both variables in the period 1974 to 2003 however problems related to spurious regression arise from the mixed order of integration of the series used from mutual causation between the variables and from the lack of a long run relationship among the variables of the model these problems are addressed by applying the bounds testing approach to cointegration in addition to a more standard long run structural modelling approach in principle both procedures are capable of dealing with the controversial issue of the exogeneity of monetary policy vis a vis dividend growth however the structural modelling approach still leaves a certain degree of uncertainty about the integration properties of the interest rate and the dividend growth hence one feels legitimized to refer to the bounds testing procedure and to conclude that in the longer term short t

the impact of monetary policy shocks on stock prices evidence from canada and the united states abstract using structural var models with short run restrictions appropriate for canada and the united states we empirically examine whether trade and financial market openness matter for the impact on and transmission to stock prices of monetary policy shocks we find that in canada the immediate response of stock prices to a domestic contractionary monetary policy shock is small and the dynamic response is brief whereas in the united states the immediate response of stock prices to a similar shock is relatively large and the dynamic response is relatively prolonged we find that these differences are largely driven by differences in financial market openness and hence different dynamic responses of monetary policy shocks between the two countries that we model in this paper

monetary policy and financial imbalances facts and fiction following the financial crisis many have argued that monetary policy should lean against asset price increases and that deviations of credit and asset prices from trend can be used to capture financial imbalances we study quarterly data spanning 1986 2008 for a sample of 18 countries and argue that such measures contain little information useful for forecasting the future economic conditions this casts doubts on the leaning against the wind view we also argue that tightening monetary policy in response to such imbalances are likely to depress real growth substantially that finding however is sensitive to the lucas critique katrin assenmacher wesche and stefan gerlach

turning bagehot on his head lending at penalty rates when banks can become insolvent ever since bagehot s 1873 pioneering work it is a widely accepted wisdom that in order to alleviate ex ante bank moral hazard a lender of last resort should lend at penalty rates only in a model in which banks are subject to shocks but can exert effort to affect the likelihood of these shocks we show that the validity of this argument crucially relies on banks always remaining solvent the reason is that when banks become insolvent bagehot s prescription dictates to let them fail penalty rates charged when banks are illiquid but solvent then reduce banks incentives to avoid insolvency ex ante and thus increase bank moral hazard we derive a condition which shows precisely when this effect on ex ante incentives outweighs the traditional one and show that it is fulfilled under plausible scenarios

joseph schumpeter lecture the great moderation the great panic and the great contraction this lecture examines the causes of the recent financial crisis and subsequent recession on the macroeconomic side the great moderation encouraged an overly optimistic assessment of risk combined with low interest rates reflecting both loose monetary policy and relatively high asian savings rates that encouraged a build up of excessive leverage in the banking system on the microeconomic side distorted incentives led to a concentration and mispricing of risk informational complexities associated with new financial assets and the interconnectedness of financial institutions then resulted in the closure of funding markets and a flight to safety when loan defaults rose unexpectedly the episode indicates the need to focus on agency and information problems between banks and their funders in addition to those between the banks and their borrowers it also suggests that the process of financial intermediation should play a more prominent role in macroeconomic models jel e32 e44 e52 e58 f32 g01 g21

learning about monetary policy rules when the housing market matters abstract in this paper we study a general equilibrium model with a housing market and use stability under adaptive learning as a criterion to evaluate monetary policy rules an important feature of the model is that there exist credit constrained borrowers who use their housing assets as collateral to finance purchases we evaluate both conventional taylor rules and rules that incorporate other targets such as housing prices we find that the effect of responding to housing prices in addition to output and inflation depends critically on the assumed information structure of the economy

inflation targeting a new framework for monetary policy he world s central bankers and their staffs meet regularly in venues from basle to washington to share ideas and discuss common problems perhaps these frequent meetings help explain why changes in the tactics and strategy of monetary policymaking such as the adoption of money growth targets in the 1970s the intensification of efforts to reduce inflation in the 1980s and the recent push for increased institutional independence for central banks tend to occur in many countries more or less simultaneously whatever their source major changes in the theory and practice of central banking are of great importance for both individual countries and the international economy in this article we discuss a new strategy for monetary policy known as inflation targeting which has sparked much interest and debate among central bankers and monetary economists in recent years this approach is characterized as the name suggests by the announcement of official target ranges for the inflation rate at one or more horizons and by explicit acknowledgment that low and stable inflation is the overriding goal of monetary policy other important features of inflation targeting include increased communication with the public about the plans and objectives of the monetary policymakers and in many cases increased accountability of the central bank

monetary policy and asset prices with belief driven fluctuations abstract we present a heterogeneous agents new keynesian model subject to a cost channel of monetary policy transmission constant turnover between long time traders and newcomers in market activities combined with restricted trading opportunities introduces a feedback from the stock market to real activity making stock prices non redundant for the business cycle we show that strict inflation targeting can lead to equilibrium indeterminacy even if the policy rule satisfies the taylor principle a belief driven shock to stock price generates relative volatilities of key financial variables which are very close to what is observed in u s data this result hints to the possibility that the financial instability witnessed since the mid to late 1990s was the result of waves of rational exuberance and pessimism in financial markets our analysis suggests that a mild response to stock prices in the central bank s policy rule can restore equilibrium determinacy and therefore rule out non fundamental volatility

optimal monetary policy in a regime switching economy the response to abrupt shifts in exchange rate dynamics abstract this paper examines the trade offs that a central bank faces when the exchange rate can experience sustained deviations from fundamentals and occasionally collapse the economy is modelled as switching randomly between different regimes according to time invariant transition probabilities we compute both the optimal regime switching control rule for this economy and optimised linear taylor rules in the two cases where the transition probabilities are known with certainty and where they are uncertain the simple algorithms used in the computation are also of independent interest as tools for the study of monetary policy under general forms of asymmetric additive and multiplicative uncertainty an interesting finding is that policies based on robust minmax values of the transition probabilities are usually more conservative

uncertainty and monetary policy rules in the united states this paper analyses the impact of uncertainty about the true state of the economy on monetary policy rules in the us since the early 1980s extending the taylor rule to allow for this type of uncertainty we find evidence that the predictions of the theoretical literature on responses to uncertainty are reflected in the behaviour of policymakers suggesting that policymakers are adhering to prescriptions for optimal policy we find that the impact of uncertainty was most marked in 1983 when uncertainty increased interest rates by up to 140 basis points in 1989 90 when uncertainty increased interest rates by up to 50 basis points and in 1996 2001 when uncertainty reduced interest rates by up to 50 basis points over five years

monetary policy and stock prices in an open economy this paper studies monetary policy in a two country perpetual youth model where agents can invest their wealth in both stock and bond markets in our economy the foreign country is financially dominant in the sense that it hosts the only active equity market where all agents also residents of the home country can trade stocks of listed foreign firms we show that contrary to what happens in a closed economy the central bank in the economy endowed with an active stock market should grant a dedicated response to movements in stock prices driven only by local productivity shocks moreover we show that the other central bank should also optimally respond to stock price movements in the other economy as they affect the budget constraint of domestic residents optimal monetary policy pursuing price stability requires dedicated response to stock price dynamics driven by productivity shocks in addition to what implied by the simple existence of the terms of trade channel of policy transmission determinacy of rational expectations equilibria and approximation of the optimal policy by simple monetary rules are also investigated

asset prices and expected monetary policy evidence from daily data this article explores the relationships among libor gold prices the exchange rate oil prices fed funds futures prices and stock prices at a daily frequency this article examines whether expected monetary policy measured by changes in the prices of fed funds futures contracts reacts to high frequency changes in asset prices and in turn whether asset prices respond to changes in expected monetary policy the article reveals that there are statistically significant relationships between expected us monetary policy and shocks to libor and exchange rates it also reveals that there is no evidence of a systematic relationship between stock prices and expected monetary policy changes splitting the data into expansionary and recessionary periods using nber dating we find results for the expansionary periods that are very similar to the results for the entire period for the periods of recession we find little evidence of significant linkages between markets

financial market segmentation stock market volatility and the role of monetary policy we explore the role of monetary policy in a world of segmented nancial markets where the agents who trade stocks encounter nancial income risk although the rest do not in such an economy we ask the question of how the monetary authority operates when it aims to maximize total welfare we nd that optimal monetary policy has the novel role of sharing the nancial market risk traders face among all agents in the economy this nding holds for any concave utility function and is not sensitive to the degree of market segmentation when risk is shared perfectly in this way consumption is equalized between the two groups and agents if given the choice would be indierent between participating or not in the nancial markets we also explore the implications that this policy has for the volatility of stock prices and of ination when compared to the policies of constant money supply ination targeting and nominal interest rate pegging we nd that optimal monetary policy is not necessarily associated either with minimal stock price volatility or with minimal ination volatility

allocating bank regulatory powers lender of last resort deposit insurance and supervision abstract we examine the optimal institutional allocation of bank regulation we find that centralizing the lending of last resort and deposit insurance functions in a regulator leads to excessive forbearance it also leads the bank to invest suboptimally in loans giving this regulator supervision improves on both problems but it still does not lead to the efficient outcome in the multi regulator arrangement we find that it is beneficial to give supervision to the deposit insurer the choice between the unified regulator arrangement and the multi regulator arrangement involves a trade off the multi regulator arrangement reduces the forbearance problem at high levels of liquidity shortage but may exacerbate it at low levels these results assume the absence of information frictions when banks are better informed than regulators we show that regulators may have an incentive not to share private information suggesting it is important to consider regulators informational advantages when deciding on the allocation of regulation

monetary policy and asset prices a markov switching dsge approach summary this paper estimates a markov switching dynamic stochastic general equilibrium model by incorporating stock prices in monetary policy rules in order to identify the federal reserve s stance toward them based on the data from 1984 q1 to 2009 q2 i find that historical evidence of the policy reaction toward stock prices is weak except for the stock market bubble of the 1990s a counterfactual exercise shows that the rapid growth in stock prices during that period would have been significantly higher if monetary policy had been independent of the stock market however unconditional macroeconomic volatility increases with the degree of policy responsiveness toward stock prices copyright 2017 john wiley sons ltd

inflation targeting learning and q volatility in small open economies this paper examines the welfare implications of managing asset price with consumer price inflation targeting by monetary authorities who have to learn the laws of motion for both inflation rates the central bank can reduce the volatility of consumption as well as improve welfare more effectively if it adopts state contingent taylor rules aimed at inflation and q growth targets in this learning environment however under perfect model certainty pure inflation targeting dominates combined consumer and asset price inflation targeting

the effort maximizing contest with heterogeneous prizes we establish the effort maximizing rule of allocating heterogeneous prizes when contestants privately observe their effort efficiencies with ex ante symmetric players and increasing virtual effort efficiency an all pay auction maximizes the total expected effort

heterogeneous beliefs and housing market boom bust cycles abstract this paper presents a business cycle model capturing the stylized features of housing market boom bust cycles in developed countries the model implies that over optimism of mortgage borrowers generates housing market boom bust cycles if mortgage borrowers are credit constrained and savers do not share their optimism this result holds without price stickiness if price stickiness is introduced into the model then the model replicates a low policy interest rate during a housing boom as an endogenous reaction to a low inflation rate given a taylor rule thus monetary easing observed during housing booms are consistent with the presence of over optimism causing boom bust cycles

a sheep in wolf s clothing can a central bank appear tougher than it is abstract central banks cbs in europe and the us have been providing virtually unlimited amounts of liquidity to banks for quite some time now this may lead banks to expect that these cbs will be lenient in the future will this expectation be justified i present a model in which a commercial bank subject to idiosyncratic liquidity shocks faces uncertainty about whether the cb is tough hawk or lenient dove specifically the cb knows its nature but the bank does not when uncertainty is high the cb can use this to its advantage and try to build a reputation for toughness in response the bank chooses higher liquidity reserves in equilibrium furthermore increasing bank capital and penalty rates make it easier to build a reputation while bailouts by the fiscal government make it more difficult

rethinking monetary policy after the crisis abstract this lecture examines how the recent global financial crisis changes our thinking about how monetary policy should be conducted it starts with a discussion of the science and practice of monetary policy before the crisis and then uses the lessons from the crisis to argue how the practice of monetary policy should be rethought along six dimensions flexible inflation targeting response to asset price bubbles dichotomy between monetary policy and financial stability policy risk management and gradualism fiscal dominance and forward guidance

quantitative easing and the loan to collateral value ratio we study optimal monetary policy in a new keynesian model at the zero bound interest rate where households use cash alongside house equity borrowing to conduct transactions the amount of borrowing is limited by a collateral constraint when either the loan to value ratio declines or house prices fall we observe a decrease in the money multiplier we argue that the central bank should respond to the fall in the money multiplier and therefore to the reduction in house prices or the loan to collateral value ratio we also find that optimal monetary policy generates a large and persistent fall in the money multiplier in response to the drop in the loan to collateral value ratio

savings asset scarcity and monetary policy abstract this paper analyzes optimal monetary policy regarding asset markets in a model where money and savings are essential and asset markets matter the model is able to explain why different regimes for the correlation of real interest rates and stock price dividend ratios exist and offers two explanations why the correlation vanished after 2007 a decrease in inflation or changes in the supply of risky and safe assets the results on optimal policy show that away from the friedman rule fiscal policy can improve welfare by increasing the amount of outstanding government debt if the fiscal authority is not willing or able to increase debt the monetary authority can improve welfare of current generations by reacting procyclically to asset return shocks

monetary policy and financial stability cross country evidence central banks may face challenges in achieving their price stability goals when financial stability risks are present there is however considerable heterogeneity among central banks with respect to how they manage these potential trade offs

coordination failures and the lender of last resort was bagehot right after all the classical doctrine of the lender of last resort lolr elaborated by bagehot 1873 asserts that the central bank should lend to illiquid but solvent banks under certain conditions several authors have argued that this view is now obsolete in modern interbank markets a solvent bank cannot be illiquid this paper provides a possible theoretical foundation for rescuing bagehot s view our theory does not rely on the multiplicity of equilibria that arises in classical models of bank runs we built a model of banks liquidity crises that possesses a unique bayesian equilibrium in this equilibrium there is a positive probability that a solvent bank cannot find liquidity assistance in the market we derive policy implications about banking regulation solvency and liquidity ratios and interventions of the lender of last resort furthermore we find that public bailout and private bail in involvement are complementary in implementing the incentive efficient solution and that bagehot s lender of last resort facility must work together with institutions providing prompt corrective action and orderly failure resolution finally we derive similar implications for an international lender of last resort ilolr jel g21 g28

should central banks burst bubbles some microeconomic issues anti bubble policy is examined in a finite horizon greater fool bubble model with rational agents asymmetric information and short sales constraints this permits the use of standard tools of welfare economics to analyse bubble policies policy is modelled as deflating overpriced assets by revealing information about this overpricing if the central bank is following such a policy then the market interprets inaction as an implicit endorsement of asset prices which raises these prices also the central bank can deflate overpriced assets even if it has no informational advantage over any investors about this overpricing however unless it has such an informational advantage a bubble bursting rule may only make things worse

the lender of last resort abstract this paper develops a model of the lender of last resort lolr from a central bank cb viewpoint the model in a static setting suggests that the cb would only rescue banks which are above a threshold size consistent with the insight of too big to fail in a dynamic setting cb s optimal policy in liquidity support depends on the trade off between contagion and moral hazard effects our results show that contagion is the key factor affecting cb s incentives in providing lolr and they also provide a rationalization for constructive ambiguity

optimal monetary policy in a model with agency costs this paper integrates a fully explicit model of agency costs into an otherwise standard dynamic new keynesian model in a particularly transparent way a principal result is the characterization of agency costs as endogenous markup shocks in an output gap version of the phillips curve the model s utility based welfare criterion is derived explicitly and includes a measure of credit market tightness that we interpret as a risk premium the paper also fully characterizes optimal monetary policy and provides conditions under which zero inflation is the optimal policy finally optimal policy can be expressed as an inflation targeting criterion that depending upon parameter values can be either forward or backward looking

learning by doing short sightedness and indeterminacy this article introduces firm specific learning by doing into a real business cycle rbc model this assumption results in indeterminacy of the wage over a large portion of the parameter space when firms use sufficiently high discount factors and when newly employed labour is relatively unproductive when firms and households use the same discount factor the effects of indeterminacy are limited to adding volatility to the wage rate if these discount factors differ however then indeterminacy also destabilises newly employed labour and total hours this result helps to explain the high amount of volatility that newly employed labour exhibits in the us data

the monetary policy implications of behavioral asset bubbles i introduce behavioral asset pricing rules into a wider dynamic stochastic general equilibrium framework asset price bubbles emerged endogenously within the model i find that in this model monetary policy rules that target the mispricing of the asset have a destabilizing effect however a monetary policy rule that targets deviations in the price of the asset from its trend can be welfare enhancing such a rule would also have the benefit of being straightforward to implement

destructive effects of constructive ambiguity in risky times unclear bailout policy underinvestment and calls for greater responsibility by bankers are some of the observations from the recent financial crisis the paper explains underinvestment as an inefficient equilibrium under ambiguous bailout policy agents suffer from a lack of information about the insolvency resolution methods the beliefs of bankers regarding whether an insolvent bank is liquidated may differ from those of depositors even if bankers and depositors possess absolutely symmetric information about the economy this disrupts the flow of funds through the banking channel if the investment climate is characterized by high aggregate risk the paper suggests policy implications aimed at a reduction of the anxiety of agents and at aligning their beliefs to restore efficiency

monetary and macroprudential policies in a leveraged economy we examine the optimal monetary policy in the presence of endogenous feedback loops between asset prices and economic activity when macroprudential policies can also be pursued absent macroprudential policies the optimal monetary policy leans against asset prices and can be closely approximated using a speed limit rule that responds to the growth of financial variables an endogenous feedback loop is crucial for this result price stability is otherwise quasi optimal similarly a simple macroprudential rule that links reserve requirements to credit growth dampens the endogenous feedback loop and leads to near price stability state contingent taxes on lending are shown to be welfare improving

house prices capital inflows and macroprudential policy this paper evaluates the monetary and macroprudential policies that mitigate the procyclicality arising from the interlinkages between current account deficits and financial vulnerabilities we develop a two country dynamic stochastic general equilibrium dsge model with heterogeneous households and collateralised debt the model predicts that external shocks are important in driving current account deficits that are coupled with run ups in house prices and household debt in this context optimal policy features an interest rate response to credit and a ltv ratio that countercyclically responds to house price dynamics by allowing an interest rate response to changes in financial variables the monetary policy authority improves social welfare because of the large welfare gains accrued to the savers the additional use of a countercyclical ltv ratio that responds to house prices increases the ability of borrowers to smooth consumption over the cycle and is pareto improving domestic and foreign shocks account for a similar fraction of the welfare gains delivered by such a policy

the effect of bank credit on asset prices evidence from the japanese real estate boom during the 1980s bernanke bs 2001 am econ rev v91 p253 doi 10 1257 aer 91 2 253 cargill thomas 2000 financial policy cen gerlach s 2005 j bank financ v29 p461 doi 10 1016 j jbankfin 2004 05 015 hoshi t 2000 nber macroecon annu v14 p129 hoshi t 1993 4421 nber hoshi t 2001 monetary ec studies v19 p1 hutchison m 1997 political ec japanes ito t 1996 monetary ec studies v14 p143 ito t 2004 japans lost decade o p17 kindleberger c 1978 financial crises the kitagawa h 1994 financial dev japan p81 kiyotaki n 1997 j polit econ v105 p211 doi 10 1086 262072 peek j 2000 am econ rev v90 p30 doi 10 1257 aer 90 1 30 petersen ma 2002 j financ v57 p2533 doi 10 1111 1540 6261 00505 ueda k 2000 crisis change japane p59 ueda k 1994 japanese main bank s p89 weinstein de 1998 j financ v53 p635 doi 10 1111 0022 1082 254893

bank bailouts and moral hazard evidence from germany we use a structural econometric model to provide empirical evidence that safety nets in the banking industry lead to additional risk taking to identify the moral hazard effect of bailout expectations on bank risk we exploit the fact that regional political factors explain bank bailouts but not bank risk the sample includes all observed capital preservation measures and distressed exits in the german banking industry during 1995 2006 a change of bailout expectations by two standard deviations increases the probability of official distress from 6 6 to 9 4 which is economically significant

financial markets and investment externalities this address explores the link between financial market shocks investment choices and various externalities that can arise from these choices my analysis which emphasizes differences between shocks to debt and equity markets provides insights about some stylized facts from the macro finance literature these insights are illustrated with a discussion of the technology boom and bust in the late 1990s and early 2000s and the housing boom and bust in the mid 2000s

interest rate rules under financial dominance abstract we study the equilibrium properties of a business cycle model with financial frictions and price adjustment costs capital constrained entrepreneurs finance risky projects by borrowing from banks banks in turn make loans using equity and deposits because financial contracts are not contingent on aggregate risk bank balance sheets are hit when entrepreneurial defaults are higher than expected macroprudential policy imposes a positive response of the bank capital ratio to lending our main result is that the taylor principle is violated when this response is too weak then macroprudential policy is ineffective in stabilizing debt and monetary policy is subject to financial dominance a too aggressive response of the interest rate to inflation can lead to debt disinflation dynamics that destabilize the financial sector

how did the fed react to the 1990s stock market bubble evidence from an extended taylor rule how did the federal reserve bank react to the stock market bubble of the late 1990s at a symposium sponsored by the federal reserve bank of kansas city in jackson hole wyoming on august 30 2002 chairman alan greenspan remarked that economists do not currently have a way to measure a stock market bubble convincingly he also argued that in the absence of such a measure it was difficult for the fed to justify with some degree of certainty a preemptive tightening that would likely be necessary to neutralize such a bubble this paper extends the taylor rule methodology to include three measures of stock market overvaluation and confirms greenspan s statement that the fed did not neutralize the bubble however the extended taylor rule methodology also shows that the fed perhaps unintentionally by keeping the fed funds rate below those suggested by the taylor rule may have actually contributed to the growth of the bubble

financial stability under model uncertainty abstract this paper studies how asset price model misspecification affects the conduct of monetary policy under commitment in a new keynesian model using robust control techniques we find that monetary policy reacts aggressively to both asset price and inflation shocks to guard herself against worst case outcome