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on Monetary Economics |
| By: | Yunus Aksoy (School of Economics, Mathematics and Statistics, Birkbeck College, University of London); Athanasios Orphanides (Board of Governors of the Federal Reserve System, Washington); David Small (Board of Governors of the Federal Reserve System, Washington); Volker Wieland (Goethe University of Frankfurt, CEPR, and Center for Financial Studies); David Wilcox (Board of Governors of the Federal Reserve System, Washington) |
| Abstract: | Under a conventional policy rule, a central bank adjusts its policy rate linearly according to the gap between inflation and its target, and the gap between output and its potential. Under “the opportunistic approach to disinflation” a central bank controls inflation aggressively when inflation is far from its target, but concentrates more on output stabilization when inflation is close to its target, allowing supply shocks and unforeseen fluctuations in aggregate demand to move inflation within a certain band. We use stochastic simulations of a small-scale rational expectations model to contrast the behavior of output and inflation under opportunistic and linear rules. |
| Keywords: | Inflation targeting, monetary policy, interest rates, policy rules, disinflation |
| JEL: | E31 E52 E58 E61 |
| Date: | 2005–01–19 |
| URL: | http://d.repec.org/n?u=RePEc:cfs:cfswop:wp200519&r=mon |
| By: | Klaus Adam (European Central Bank); Roberto Billi (Center for Financial Studies) |
| Abstract: | Ignoring the existence of the zero lower bound on nominal interest rates one considerably understates the value of monetary commitment in New Keynesian models. A stochastic forward-looking model with lower bound, calibrated to the U.S. economy, suggests that low values for the natural rate of interest lead to sizeable output losses and deflation under discretionary monetary policy. The fall in output and deflation are much larger than in the case with policy commitment and do not show up at all if the model abstracts from the existence of the lower bound. The welfare losses of discretionary policy increase even further when inflation is partly determined by lagged inflation in the Phillips curve. These results emerge because private sector expectations and the discretionary policy response to these expectations reinforce each other and cause the lower bound to be reached much earlier than under commitment. |
| Keywords: | Nonlinear Optimal Policy, Occasionally Binding Constraint, Sequential Policy, Markov Perfect Equilibrium, Liquidity Trap |
| JEL: | E31 E52 |
| Date: | 2005–01–16 |
| URL: | http://d.repec.org/n?u=RePEc:cfs:cfswop:wp200516&r=mon |
| By: | Keith Küster (University of Frankfurt); Volker Wieland (University of Frankfurt) |
| Abstract: | In this paper, we examine the cost of insurance against model uncertainty for the Euro area considering four alternative reference models, all of which are used for policy-analysis at the ECB.We find that maximal insurance across this model range in terms of aMinimax policy comes at moderate costs in terms of lower expected performance. We extract priors that would rationalize the Minimax policy from a Bayesian perspective. These priors indicate that full insurance is strongly oriented towards the model with highest baseline losses. Furthermore, this policy is not as tolerant towards small perturbations of policy parameters as the Bayesian policy rule. We propose to strike a compromise and use preferences for policy design that allow for intermediate degrees of ambiguity-aversion.These preferences allow the specification of priors but also give extra weight to the worst uncertain outcomes in a given context. |
| Keywords: | Model uncertainty, robustness, monetary policy rules, minimax, euro area. |
| JEL: | E52 E58 E61 |
| Date: | 2005–01–13 |
| URL: | http://d.repec.org/n?u=RePEc:cfs:cfswop:wp200513&r=mon |
| By: | Roberto Billi (Center for Financial Studies) |
| Abstract: | This paper characterizes the optimal inflation buffer consistent with a zero lower bound on nominal interest rates in a New Keynesian sticky-price model. It is shown that a purely forward-looking version of the model that abstracts from inflation inertia would significantly underestimate the inflation buffer. If the central bank follows the prescriptions of a welfaretheoretic objective, a larger buffer appears optimal than would be the case employing a traditional loss function. Taking also into account potential downward nominal rigidities in the price-setting behavior of firms appears not to impose significant further distortions on the economy. |
| Keywords: | Inflation Inertia, Downward Nominal Rigidity, Nonlinear Policy, Liquidity Trap |
| JEL: | C63 E31 E52 |
| Date: | 2005–01–17 |
| URL: | http://d.repec.org/n?u=RePEc:cfs:cfswop:wp200517&r=mon |