55 research outputs found
CPI Inflation Targeting and the UIP Puzzle: An Appraisal of Instrument and Target Rules
No full textEmploying an optimizing framework, this paper shows that a target rule dominates a simple instrument rule when the focus of monetary policy is on CPI inflation. The target rule approach produces a systematic relationship between the current CPI inflation rate and the lagged policy instrument that renders the former immune to the stochastic risk premium. No matter how policy parameters are set, the optimal simple instrument rule cannot replicate the superior stabilization results achieved by the target rule approach. The optimal simple instrument rule also fails to account for the UIP puzzle. In contrast, the target rule approach can motivate the widely reported phenomenon whereby high interest rate currencies tend to appreciate. In fact the degree of openness and the central bank’s relative aversion to CPI inflation variability determine the sensitivity of observed changes in the nominal exchange rate to the lagged interest rate differential.CPI Inflation Targeting; UIP Puzzle; Instrument Rule; Target Rule; Optimal Monetary Policy
Optimal discretionary monetary policy in the open economy: Choosing between CPI and domestic inflation as target variables
No full textIn open economy, a choice can be made between two measures of inflation for use as a target variable: CPI inflation or domestic inflation. This paper considers flexible and strict inflation targeting strategies and explores the circumstances under which a domestic inflation target is preferred to a CPI inflation target. This is done from the perspectives of the central bank and society as a whole. The quantitative results of this paper indicate that under suitable conditions the temporal properties of stochastic disturbances are instrumental in determining which inflation target is preferred. The choice of target variable from society’s viewpoint coincides almost perfectly with the choice of the central bank if the utility of the representative household serves as the welfare criterion for society. If qualitative aspects matter in the choice inflation target, then the role of temporal properties of the stochastic disturbances becomes less prominent. Policy conclusions are drawn with the help of a forward-looking model for a small open economy. This model has proper micro-foundations and exhibits two important features. First, the degree of openness affects the parameters of the IS relation and, second, under domestic inflation targeting, the existence of a direct exchange rate channel in the Phillips Curve impairs the perfect stabilising properties of monetary policy in the presence of demand-side disturbances.monetary policy, inflation target
Optimal discretionary monetary policy in the open economy: Choosing between CPI and domestic inflation as target variables
No full textIn open economy, a choice can be made between two measures of inflation for use as a target variable: CPI inflation or domestic inflation. This paper considers flexible and strict inflation targeting strategies and explores the circumstances under which a domestic inflation target is preferred to a CPI inflation target. This is done from the perspectives of the central bank and society as a whole. The quantitative results of this paper indicate that under suitable conditions the temporal properties of stochastic disturbances are instrumental in determining which inflation target is preferred. The choice of target variable from society’s viewpoint coincides almost perfectly with the choice of the central bank if the utility of the representative household serves as the welfare criterion for society. If qualitative aspects matter in the choice inflation target, then the role of temporal properties of the stochastic disturbances becomes less prominent. Policy conclusions are drawn with the help of a forward-looking model for a small open economy. This model has proper micro-foundations and exhibits two important features. First, the degree of openness affects the parameters of the IS relation and, second, under domestic inflation targeting, the existence of a direct exchange rate channel in the Phillips Curve impairs the perfect stabilising properties of monetary policy in the presence of demand-side disturbances.monetary policy; inflation target
On discretion versus commitment and the role of the direct exchange rate channel in a forward-looking open economy model
No full textIrrespective of whether discretion or commitment to a binding rule guides the conduct of monetary policy, the existence of a direct exchange rate channel in the Phillips Curve causes the behavior of the key economic variables in the open economy to be dramatically different from that in the closed economy. In the open economy, the policymaker can no longer perfectly stabilize real output and the rate of inflation in the face of IS and UIP shocks as well as shocks to foreign inflation. If the exchange rate channel in the Phillips Curve is operative, then in the open economy the policymaker faces an output-inflation tradeoff that differs substantially from its counterpart in the closed economy. ; Our analysis of the conduct of monetary policy reveals that the stabilization bias under discretion is weaker in the open economy relative to the closed economy. In the open economy, a “less conservative central banker”, one that attaches a smaller weight to the variance of inflation in the loss function, can be appointed to replicate the behavior of real output that eventuates under optimal policy. Evaluating the social loss function under discretion and commitment, we find that the existence of a direct exchange rate channel in the Phillips Curve mitigates the pronounced differences between the two strategies that exist in case of high persistence in the stochastic shocks.Monetary policy ; Foreign exchange rates ; Econometric models
The timeless perspective vs. discretion: theory and monetary policy implications for an open economy
No full textThis paper proposes an open-economy Phillips Curve that features a real exchange rate channel. The resulting target rule under optimal policy from a timeless perspective (TP) involves additional history dependence in the form of lagged inflation. The target rule also depends on the discount factor as well as IS and Phillips Curve parameters. This is in sharp contrast to a closed economy where the target rule depends only on the change in the output gap, the current rate of inflation and the structural parameter in the Phillips Curve. Because of the additional history dependence in an open economy, price level targeting is no longer consistent with optimal policy. If a real exchange rate channel does not exist in the Phillips Curve, monetary policy eases in the wake of a positive cost-push disturbance under policy from a TP and is thus diametrically opposed to same under discretion. Maximum gains accrue from commitment relative to discretion in an open economy where the real exchange rate is absent from the Phillips Curve and the policymaker places strong emphasis on maintaining price stability. --Timeless Perspective,Discretion,Price Level Targeting,Exchange Rate Channel
HOW CONSERVATIVE DOES THE CENTRAL BANKER HAVE TO BE? ON THE TREATMENT OF EXPECTATIONS UNDER DISCRETIONARY POLICYMAKING
No full textThis paper explores an issue that arises in the delegation process. The paper shows that a myopic central banker, one who treats expectations as constant in setting discretionary policy, can replicate the behaviour of output and inflation under policy from a timeless perspective. For that to happen, society must delegate a price level target or a speed limit policy to a central banker who is more weight-conservative than society. Copyright 2009 The Author. Journal compilation 2009 Blackwell Publishing Ltd/University of Adelaide and Flinders University.
Alternative Monetary Policy Rules and the Specification of the Phillips Curve: A Comparison of Nominal Income with Strict Inflation Targeting
No full textAlternative Regeln der Geldpolitik und die Formulierung der Phillips-Kurve: Ein Vergleich zwischen der nominellen BSP-Zielsteuerung und der Inflationszielsteuerung Auf der Basis eines simplen "backward-looking"-Makromodells erläutert dieser Beitrag, wie eine auf BSP-Steuerung bedachte instabile Geldpolitik verhindert werden kann, indem die Notenbank ein Hybrid-BSP-Ziel anstrebt. Ein Hybrid- BSP-Ziel ist eine spezielle Form der optimalen Geldpolitik. Mittels eines Vergleichs wird dann belegt, unter welchen Voraussetzungen das Hybrid-BSP-Ziel einer anderen Form der optimalen Geldpolitik, einer die ein Inflationsziel anstrebt, überlegen ist. Eine ähnliche Analyse der beiden geldpolitischen Strategien wird auch in einem "forward-looking"-Modell durchgeführt. Entgegen der U-förmigen Politikgrenzen (policy frontiers), die auf dem "backward-looking"-Modell basieren, implizieren die aus diesem Modell hervorgehenden Politikgrenzen einen monotonen Trade-off zwischen den relevanten Parametern des Modells. Je größer der Parameter der realen Outputlücke in der Phillips-Kurve, desto attraktiver gestaltet sich ein Inflationsziel im Vergleich mit dem Hybrid-BSP-Ziel. Es ist eher wahrscheinlich, daß eine starre Geldpolik, die auf einem Inflationsziel beharrt, einer Geldpolitik, die die Wachstumsrate des nominellen BSP – anstatt eines Hybrid-BSP – anstrebt, überlegen ist. Diese Schlußfolgerung hängt jedoch von der Größe des Parameters der Outputlücke in der Phillips-Kurve ab.Alternative Monetary Policy Rules and the Specification of the Phillips Curve: A Comparison of Nominal Income with Strict Inflation Targeting This paper shows that the instability of nominal income targeting in a simple backward-looking macro model disappears if the policymaker chooses to adopt a hybrid nominal income target, which is a special case of the optimal monetary policy. This form of nominal income targeting is compared to another form of optimal monetary policy, strict inflation targeting, so as to establish the conditions under which the former strategy is preferable to the latter. For most coefficient estimates reported in the literature hybrid nominal income targeting is likely to dominate strict inflation targeting as a strategy of monetary policy. We also analyze the two strategies of monetary policy using a forward-looking specification as our baseline model. In contrast to the policy frontier based on the backward-looking model, this policy frontier is not U-shaped; instead it implies a monotonic trade-off between the relevant parameters. In this model the strict inflation target becomes more attractive relative to the hybrid nominal income target as the Phillips Curve parameter increases in size. A strict inflation target is more likely to dominate a nominal income growth rate target than a hybrid nominal income target for certain values of the Phillips Curve parameter. (JEL E5
How Conservative Does the Central Banker Have to Be? On the Treatment of Expectations under Discretionary Policymaking
No full textThis paper explores an issue that arises in the delegation process. The paper shows that a myopic central banker, one who treats expectations as constant in setting discretionary policy, can replicate the behavior of output and inflation under policy from a timeless perspective. For that to happen, society must delegate a price level target or a speed limit policy to a central banker who is more weight-conservative than society.New Keynesian Model; Price Level Targeting; Speed Limit Policy; Conservative Central Banker
"Leaning with the wind"? An open-economy example
No full textThis paper uses a forward-looking open-economy optimizing model to show that the existence of a real exchange rate channel in the Phillips Curve dramatically alters the conduct of optimal monetary policy. The central bank's optimal reaction function can produce a "lean with the wind" response to domestic IS disturbances and the foreign output gap provided that both a pronounced exchange rate channel exists and the disturbances are highly persistent. The more potent the real exchange rate channel in the Phillips Curve becomes, the greater (smaller) the fluctuations in the output gap (real exchange rate). How this channel affects the variability of the nominal variables depends on the degree of persistence of the disturbances.
The Output-Inflation Tradeoff in the United States: Evidence on the New Classical vs. New Keynesian Debate
No full textThe empirical examination of the output-inflation tradeoff in the United States over a 30 year period reveals that both aggregate uncertainty and average inflation were instrumental in shaping the output-inflation tradeoff. The division of the whole sample period into two distinct sets of subintervals suggests that the New Keynesian view according to which the output-inflation tradeoff is sensitive to changes in average inflation held only unambiguously in the latter part of the respective sample period. The empirical results suggest further that the tradeoff appears to have been sensitive only to changes in aggregate uncertainty in the early part of the sample period, a fact consistent with the New Classical view
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