erratum to why has u s inflation become harder to forecast the article journal of money credit and banking supplement to vol 39 no 1 february 2007 contains errors in figures 2 4 and tables 4 5 associated with a coding error in our program for estimating the uc sv model we thank ling hu of platinum grove asset management for finding this error and bringing it to our attention the corrected uc sv rows for tables 4 and 5 are given below corrected versions of figures 2 4 and corrected replication files can be found at http www princeton edu mwatson

secrecy signalling and the accuracy of expectations during the borrowed reserves operating regime abstract this paper demonstrates that the information in the undisclosed federal open market committee fomc policy directive is not completely incorporated into the yield curve one day before fomc meetings but is incorporated one day after meetings during the borrowed reserves operating regime these results suggest that monetary policy changes are informally but effectively disclosed to market participants through signals from the open market desk these findings indicate that the legislation before congress that would mandate the immediate release of the fomc policy directive would have had little impact on the accuracy of financial market expectations over the sample

real time density forecasts from bayesian vector autoregressions with stochastic volatility central banks and other forecasters are increasingly interested in various aspects of density forecasts however recent sharp changes in macroeconomic volatility including the great moderation and the more recent sharp rise in volatility associated with increased variation in energy prices and the deep global recession pose significant challenges to density forecasting accordingly this paper examines with real time data density forecasts of u s gdp growth unemployment inflation and the federal funds rate from bayesian vector autoregression bvar models with stochastic volatility the results indicate that adding stochastic volatility to bvars materially improves the real time accuracy of density forecasts this article has supplementary material online

federal reserve information during the great moderation using data from the period 1970 1991 romer and romer 2000 showed that that federal reserve forecasts of inflation and output were superior to those provided by commercial forecasters in this paper we show that this superior forecasting performance deteriorated after 1991 over the decade 1992 2001 the superior forecast accuracy of the fed held only over a very short time horizon and was limited to its forecasts of inflation in addition the performance of both the fed and the commercial forecasters in predicting inflation and output relative to that of naive benchmark models dropped remarkably during this period jel e58 e31

does central bank transparency impact financial markets a cross country econometric analysis blinder et al 2001 argues that more open public disclosure of central bank policies may enhance the efficiency of markets we examine this claim by studying for a set of seven industrialized countries whether selected central banks moves toward more open disclosure during the 1990s improved or worsened the predictability of the corresponding national financial markets employing methodologies analogous to campbell and schiller 1991 we find that for all countries the forecasting error has decreased for interest rates on the respective government bonds across most maturity lengths and that the expectations hypothesis has generally performed better at the short end of the yield curve our results also tentatively show that the effects are stronger for central banks that made the move to greater disclosure compared to those banks that resisted increasing the public s information set these findings are consistent with tabellini s 1987 view that central bank secrecy will hinder the smooth functioning of financial markets

informational implications of interest rate rules this paper compares interest rate and money supply rules the analysisis conducted within a rational expectations macro model that incorporates flexible prices and informational frictions with differential information interest rate targets can affect the information content of market prices and real activity but these realconsequences can always be replicated by an appropriately chosen moneystock rule with feedback to economic activity however when the policyauthority lacks information about the state of the economic system itfaces a discrete choice between an interest rate peg and strict moneystock control copyright 1986 by american economic association

inflation persistence the nairu and the great recession the rate of inflation fell far less over the period 2007 2013 than in the period 1979 1985 despite similar large increases in the unemployment rate this paper asks why possible explanations include a change in the persistence of inflation changes in nairu and other shocks a change in the persistence of inflation with inflation more anchored in the period 2007 2013 than in the period 1979 1985 is found to be important the level and change in the nairu cannot be precisely estimated but the data suggest an increase of nearly 1 percentage point since 2007

monetary mystique secrecy and central banking abstract the paper contains a discussion of the role of secrecy in the implementation of monetary policy it documents the federal reserve s defense of secrecy as argued in a recent freedom of information act suit the federal reserve s arguments are evaluated on the basis of economic theory theoretical papers related to the secrecy issue are reviewed the discussion highlights a number of potential benefits and costs of central bank secrecy and identifies some conditions under which secrecy could be socially beneficial

term structure inflation and real activity this paper estimates an internally consistent structural model that imposes cross sectional restrictions on the dynamics of the term structure of interest rates inflation and output growth distinct from previous term structure settings this model introduces both time varying central tendencies and a stochastic conditional mean of output growth the estimation of the model which is based on u s data over a 1960 to 2005 sample period provides reliable estimates for the implicit term structures of real interest rates expected inflation rates and inflation risk premia as well as for expectations of macroeconomic variables the model has better out of sample forecasting properties than a number of alternative models and it contradicts the puzzling evidence that during the great moderation in inflation subsequent to the mid 1980s the forecasting ability of structural models deteriorated with respect to atheoretic statistical models

the information in the high yield bond spread for the business cycle evidence and some implications the market for high yield below investment grade corporate bonds developed in the middle 1980s we show that since this time the high yield spread has had significant explanatory power for the business cycle we interpret this finding as possibly symptomatic of financial factors at work in the business cycle along the lines suggested by the financial accelerator we also show that over this period the high yield spread outperforms other leading financial indicators including the term spread the paper bill spread and the federal funds rate we conjecture that changes in the conduct of monetary policy over time may account for the reduced informativeness of these alternative indicators all of which are tied closely to monetary policy copyright 1999 by oxford university press

measuring price level uncertainty and instability in the united states 1850 2012 abstract we measure price level uncertainty and instability in the united states over the period 1850 to 2012 major outbreaks of price level uncertainty and instability occur both before and after world war ii alternating with three price level moderations one near the turn of the twentieth century another under bretton woods and a third in the 1990s there is no evidence that the price level was systematically more stable or less uncertain before or after world war ii moderations sometimes involved links to gold but the experience of the 1990s proves that a well managed fiat regime can achieve the same outcome

the new keynesian phillips curve from sticky inflation to sticky prices the new keynesian phillips curve nkpc model of inflation dynamics based on forward looking expectations is of great theoretical significance in monetary policy analysis empirical studies however often find that backward looking inflation inertia dominates the dynamics of the short run aggregate supply curve this inconsistency is examined by investigating multiple structural changes in the nkpc for the u s between 1960 and 2005 employing both inflation expectations survey data and a rational expectations approximation we find that forward looking behavior plays a smaller role during the high and volatile inflation regime to 1981 than in the subsequent period of moderate inflation providing empirical support for sticky price models over the last two decades a break in the intercept of the nkpc is also identified around 2001 and this may be associated with u s monetary policy in that period

an empirical study of credit shock transmission in a small open economy in this paper we identify and estimate the dynamic effects of foreign us and national canadian credit shocks in a small open economy we use standard credit spreads as proxies to the external finance premium our first result suggests that the us and canadian credit spreads contain substantial forecasting power for several measures of the canadian real economic activity especially during the recent financial crisis and its aftermath secondly an adverse us credit shock generates a significant and persistent economic slowdown in canada the national external finance premium rises immediately while interest rates credit aggregates output and employment indicators decline variance decomposition reveals that credit shocks have a sizeable effect on real activity measures leading indicators and credit spreads yet the unexpected shocks in domestic credit spreads are not able to generate any significant dynamic response of the real activity once we control for the us credit market conditions

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

measuring the level and uncertainty of trend inflation abstract firmly anchored inflation expectations are widely viewed as playing a central role for the conduct of monetary policy this paper presents estimates of trend inflation based on information contained in monthly data on realized inflation survey expectations and the term structure of interest rates in order to assess whether inflation expectations are anchored a timevarying volatility of trend shocks is estimated as well while there is some commonality in inflation and survey based estimates of trend inflation yield based trend estimates embed a highly persistent component orthogonal to trend inflation trimmed mean inflation rates and survey forecasts are most indicative of trend inflation

financial intermediation business failures and real business cycles in this paper a general equilibrium business cycle model is construct ed that when subjected to real disturbances mimics observed qualita tive comovements among real output money business failures risk pr emia intermediary loans and prices in contrast monetary disturban ces generate cycles that have several inconsistencies with empirical evidence thus providing support for real business cycle theory at th e expense of monetary theories of the business cycle financial inter mediation arises endogenously in the model and intermediation matters for business cycle behavior a credit supply mechanism acts in tande m with an intertemporal substitution effect in propagating stochastic disturbances copyright 1987 by university of chicago press

the role of bank capital in the propagation of shocks abstract the recent financial turmoil has underlined the importance of analyzing the link between banks balance sheets and economic activity we develop a dynamic stochastic general equilibrium model in which bank capital mitigates an agency problem between banks and their creditors as a result the capital position of banks affects their ability to attract loanable funds and therefore influences the business cycle through a bank capital channel of transmission we find that the bank capital channel greatly amplifies and propagates the effects of technology shocks on output investment and inflation moreover bank capital shocks create sizeable declines in output and investment

explaining the great moderation it is not the shocks this paper shows that the explanation of the decline in the volatility of gdp growth since the mid eighties is not the decline in the volatility of exogenous shocks but rather a change in their propagation mechanism

federal reserve system implementation of monetary policy analytical foundations of the new approach on october 6 1979 the federal reserve announced a change in its open market operating procedures that moved the focus of short run guides for open market operations away from the federal funds rate and toward reserve aggregates under the old procedures the trading desk maintained close week to week control over the federal funds rate within a range specified by the federal open market committee fomc alteration of the funds rate between fomc meetings was subject to guidelines conditional on behavior of the money supply relative to specified tolerance ranges under the new procedures the trading desk targets on a family of reserve aggregates principally nonborrowed and total reserves the reserve operating guides under the new procedures are derived from targets for growth of the monetary aggregates and are expressed as averages of weekly levels over the short run operating period normally the intermeeting period as a corollary less attention is paid to the federal funds rate and it is permitted to vary over a much wider range during the short run operating period as compared with the old procedures it should be understood that the october shift to a reserve operating guide for openmarket operations did not also encompass a change in either the proximate or ultimate objectives of monetary policy they continued to be respectively the money supply and goals for economic growth employment and prices rather the shift involved a change in the technique of achieving the proximate money supply objectives two reasons can be advanced for the shift first the old technique of operating on the federal funds rate seemed to be a less reliable means in practice of attaining the proximate policy objectives second in view of the worsening inflationary psychology at the time a shift to a different technique of operations would help to dramatize the federal reserve s continuing commitment to slowing money growth to curb inflation and thereby would work to reduce inflationary psychology this paper first summarizes the analytical framework underlying the choice between a reserve aggregate and a federal funds rate operating target as well as some previous research bearing on the issue next the technical aspects of implementing the new procedures are explained and contrasted to the theoretical paradigm underlying previous empirical results finally experience with the new procedures since last october is reviewed and some conclusions are drawn

a century of inflation forecasts abstract we investigate inflation predictability in the united states across the monetary regimes of the twentieth century the forecasts based on money growth and output growth were significantly more accurate than the forecasts based on past inflation only during the regimes associated with neither a clear nominal anchor nor a credible commitment to fight inflation these include the years from the outbreak of world war ii in 1939 to the implementation of the bretton woods agreements in 1951 and from nixon s closure of the gold window in 1971 to the end of volcker s disinflation in 1983

shocks structures or monetary policies the euro area and us after 2001 abstract the us federal reserve cut interest rates more vigorously in the recent recession than the european central bank did by comparison with the fed the ecb followed a more measured course of action we use an estimated dynamic general equilibrium model with financial frictions to show that comparisons based on such simple metrics as the variance of policy rates are misleading we find that because there is greater inertia in the ecb s policy rule the ecb s policy actions actually had a greater stabilizing effect than did those of the fed as a consequence a potentially severe recession turned out to be only a slowdown and inflation never departed from levels consistent with the ecb s quantitative definition of price stability other factors that account for the different economic outcomes in the euro area and us include differences in shocks and differences in the degree of wage and price flexibility

discount window borrowing monetary policy and the post october 6 1979 federal reserve operating procedure abstract a demand schedule for discount window borrowing based on profit maximizing bank behavior is derived a feature of non price rationing at the discount window making longer duration borrowing more costly is shown to make lagged borrowing and expected future spreads between the federal funds rate and the discount rate relevant to the current borrowing decision consequently both the size of the coefficients in the borrowing functions as well as the form of the function itself depend on expected fed policy toward the spread the demand function for discount window borrowing provides the critical link by which non borrowed reserve control affects short term interest rates and ultimately the money supply under post october 6 1979 reserve targeting the analysis suggests some reasons why the fed has experienced difficulty in specifying estimating and utilizing a discount window borrowing function in the non borrowed reserve operating procedure

varma versus var for macroeconomic forecasting in this article we argue that there is no compelling reason for restricting the class of multivariate models considered for macroeconomic forecasting to vector autoregressive var models given the recent advances in vector autoregressive moving average varma modeling methodology and improvements in computing power to support this claim we use real macroeconomic data and show that varma models forecast macroeconomic variables more accurately than vars

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

central bank secrecy interest rates and monetary control we construct a dynamic rational expectations model of the federal funds and deposit market that provides a rationale for central bank secrecy about current monetary aggregate objectives in this analysis the trading desk values secrecy because it reduces the influence of monetary control policy on interest rates we then examine actual u s experience with monetary control and determine that the reserve bias predicted by the model is present in the data from 1978 to 1985 finally we demonstrate that central bank secrecy may not lower the value of commercial banks

the october 1979 regime of monetary control and the behavior of the money supply in 1980 in october 1979 the federal reserve system instituted a regime of monetary control characterized by lagged reserve accounting and a nonborrowed reserves operating target section 2 of this paper provides an analytical framework for this regime section 3 appraises the efficacy for purposes of monetary control of this regime by comparing it to a regime characterized by contemporaneous reserve accounting and a total reserves operating target section 4 describes the actual implementation of the regime section s examines the question of why the rate of growth of the money supply was so variable within 1980

a theory of fed watching in a macroeconomic policy game this paper examines the phenomenon of fed watching within the context of a macroeconomic policy game following a cukierman and a h meltzer s 1986 article the policymaker s preferences are private information and noisy monetary control causes past observations of money growth to be a noisy signal of the monetary authority s future intentions individuals are allowed to acquire additional information about the monetary authority s preferences thus both past observations of money growth and costly information about the policymaker s preferences are used by agents in forming expectations about policy the public s acquisition of information alters the monetary authority s strategic calculus making noisy monetary control less desirable copyright 1992 by economics department of the university of pennsylvania and the osaka university institute of social and economic research association

monetary policy secrecy and federal funds rate behavior abstract the behavior of the federal reserve system can be characterized as secretive one common justification for this secrecy is the financial markets will overreact to information causing undue variability in interest rates this paper examines the credibility of this assertion under the post october 1979 non borrowed reserves operating procedure the major result is that conditional on this operating procedure secrecy can reduce the variability of the federal funds rate however in a result analogous to barro 1976 secrecy raises the variance of the forecasting error of the federal funds rate

evolving u s monetary policy and the decline of inflation predictability based on a structural var with time varying parameters and stochastic volatility for the post wwii u s we document a negative correlation between the evolution of the long run coefficient on inflation in the structural monetary rule and the evolution of the persistence and predictability of inflation relative to a trend component using an estimated sticky price model we show that a more aggressive policy stance towards inflation causes a decline in inflation predictability jel e37 e52 e58

factor augmented varma models with macroeconomic applications we study the relationship between vector autoregressive moving average varma and factor representations of a vector stochastic process we observe that in general vector time series and factors cannot both follow finite order var models instead a var factor dynamics induces a varma process while a var process entails varma factors we propose to combine factor and varma modeling by using factor augmented varma favarma models this approach is applied to forecasting key macroeconomic aggregates using large u s and canadian monthly panels the results show that favarma models yield substantial improvements over standard factor models including precise representations of the effect and transmission of monetary policy

the conduct of monetary policy nowadays the central bank of a country is the monopoly supplier of legal tender currency the commercial banks are committed to making their deposits convertible at par into such currency so the banks need to keep reserves in the form of currency and deposits at the central bank the central bank primarily conducts its policy by buying and selling financial securities e g treasury bills or foreign exchange in exchange for its own liabilities i e open market operations academic economists generally regard such operations as adjusting the quantitative volume of the banks reserve base and hence of the money stock with rates prices in such markets simultaneously determined by the interplay of demand and supply central bank practitioners almost always view themselves as unable to deny the banks the reserve base that the banking system requires and see themselves as setting the level of interest rates at which such reserve requirements are met with the quantity of money then simultaneously determined by the portfolio preferences of private sector banks and non banks this difference in perceptions is discussed again in section iii whether the monetary policy operations of central banks should be viewed primarily in terms of quantity or rate setting actions though of course one is the dual of the other these had allowed inflation and inflationary expectations to become entrenched by the end of the i970s a selection of representative statistics for a number of the leading industrialised countries is given in table i below this table indicates a common pattern among the countries of interaction between interest rates inflation and the growth of output the first period i969 78 is marked by high inflation negative real interest rates and slightly above average growth the second period i979 82 by very high nominal and high real interest rates high but falling inflation and very low output growth the final period i983 7 is marked by much lower inflation lower nominal but still high real interest rates and a recovery in output growth in some cases to above average rates in contrast the relationship in these countries between the growth of their chosen key monetary aggregate and nominal incomes appears much weaker also see clinton and chouraqui i987 especially p 7 whether measured in terms of monetary growth or in terms of real interest rates i e after adjustment for prospective future inflation policy during the

central bank secrecy fed watching and the predictability of interest rates abstract a common criticism of central bank secrecy is the assertion that it will lead to lower forecast accuracy on the part of private agents the model considered here demonstrates that reducing central bank secrecy can actually reduce the forecasting accuracy of many of the private agents in the economy when it is recognized that some agents engage in fed watching and others do not this result comes about because the interest rate process depends in part on the information that agents use in forecasting future interest rates

do financial variables help forecasting inflation and real activity in the euro area abstract this paper uses a large data set consisting of 447 monthly macroeconomic time series concerning the main countries of the euro area to simulate out of sample predictions of the euro area industrial production and the harmonized inflation index and to evaluate the role of financial variables in forecasting we considered two models which allow forecasting based on large panels of time series forni et al rev econom statist 82 2000 540 mimeo 2001b and stock and watson mimeo 1999 performance of both models were compared to that of a simple univariate ar model results show that multivariate methods outperform univariate methods for forecasting inflation at one three six and twelve months and industrial production at one and three months we find that financial variables do help forecasting inflation but do not help forecasting industrial production