A critical analysis of dimensions and curve fitting practice in economics

When dealing with sustainability we are concerned with the biophysical as well as the monetary aspects of economic and ecological interactions. This multidimensional approach requires that special attention is given to dimensional issues in relation to curve fitting practice in economics. Unfortunately, many empirical and theoretical studies in economics, as well as in ecological economics, apply dimensional numbers in exponential or logarithmic functions. We show that it is an analytical error to put a dimensional unit x into exponential functions ( a x ) and logarithmic functions ( x a log ). Secondly, we investigate the conditions of data sets under which a particular logarithmic specification is superior to the usual regression specification. This analysis shows that logarithmic specification superiority in terms of least square norm is heavily dependent on the available data set. The last section deals with economists’ “curve fitting fetishism”. We propose that a distinction be made between curve fitting over past observations and the development of a theoretical or empirical law capable of maintaining its fitting power for any future observations. Finally we conclude this paper with several epistemological issues in relation to dimensions and curve fitting practice in economics

On optimal monetary and fiscal policy interactions in open economies

This paper studies monetary and fiscal policy interactions in a two country model, where taxes on firms sales are optimally chosen and the monetary policy is set cooperatively.It turns out that in a two country setting non-cooperative fiscal policy makers have an incentive to change taxes on sales depending on shocks realizations in order to reduce output production. Therefore whether the fiscal policy is set cooperatively or not matters for optimal monetary policy decisions. Indeed, as already shown in the literature, the cooperative monetary policy maker implements the flexible price allocation only when special conditions on the value of the distortions underlying the economy are met. However, if non-cooperative fiscal policy makers set the taxes on firms sales depending on shocks realizations, these conditions cannot be satisfied; conversely, when fiscal policy is cooperative, these conditions are fulfilled. We conclude that whether implementing the flexible price allocation is optimal or not depends on the fiscal policy regime.

Monetary policy rules and macroeconomic stability: Evidence and some theory

We estimate a forward-looking monetary policy reaction function for thepostwar United States economy, before and after Volcker's appointmentas Fed Chairman in 1979. Our results point to substantial differencesin the estimated rule across periods. In particular, interest ratepolicy in the Volcker-Greenspan period appears to have been much moresensitive to changes in expected inflation than in the pre-Volckerperiod. We then compare some of the implications of the estimated rulesfor the equilibrium properties of inflation and output, using a simplemacroeconomic model, and show that the Volcker-Greenspan rule is stabilizing.

Monetary policy with signal extraction from the bond market

Monetary policy is conducted in an environment of uncertainty. This paper sets upa model where the central bank uses real-time data from the bond market togetherwith standard macroeconomic indicators to estimate the current state of theeconomy more efficiently, while taking into account that its own actions influencewhat it observes. The timeliness of bond market data allows for quicker responsesof monetary policy to disturbances compared to the case when the central bankhas to rely solely on collected aggregate data. The information content of theterm structure creates a link between the bond market and the macroeconomythat is novel to the literature. To quantify the importance of the bond market asa source of information, the model is estimated on data for the United Statesand Australia using Bayesian methods. The empirical exercise suggests that thereis some information in the US term structure that helps the Federal Reserve toidentify shocks to the economy on a timely basis. Australian bond prices seemto be less informative than their US counterparts, perhaps because Australia is arelatively small and open economy.

The dynamics of US inflation: Can monetary policy explain the changes?

We investigate the relationship between monetary policy and inflation dynamics in theUS using a medium scale structural model. The specification is estimated with Bayesiantechniques and fits the data reasonably well. Policy shocks account for a part of the declinein inflation volatility; they have been less effective in triggering inflation responses overtime and qualitatively account for the rise and fall in the level of inflation. A number ofstructural parameter variations contribute to these patterns.

The monetary pillar and the great financial crisis

Since its inception, a most distinctive (and controversial) feature of the ECB monetary policy strategy has been its emphasis on money and monetary analysis, which constitute the basis of the so-called monetary pillar. The present paper examines the performance of the monetary pillar around the recent financial crisis episode, and discusses its prospects in light of the renewed emphasis on financial stability and the need for enhanced macro-prudential policies.

Fiscal policy, pricing frictions and monetary accommodation

We investigate the theoretical conditions for effectiveness of government consumptionexpenditure expansions using US, Euro area and UK data. Fiscal expansions taking placewhen monetary policy is accommodative lead to large output multipliers in normal times.The 2009-2010 packages need not produce significant output multipliers, may havemoderate debt effects, and only generate temporary inflation. Expenditure expansionsaccompanied by deficit/debt consolidations schemes may lead to short run output gains buttheir success depends on how monetary policy and expectations behave. Trade opennessand the cyclicality of the labor wedge explain cross-country differences in the magnitude ofthe multipliers.

Identifying monetary policy shocks in Japan

It is sometimes argued that the central banks influence the private economy in the short run through controlling a specific component of high powered money, not its total amount. Using a structural VAR approach, this paper evaluates this claim empirically, in the context of the Japanese economy. I estimate a model based on the standard view that the central bank controls the total amount of high powered money, and another model based on the alternative view that it controls only a specific component. It is shown that the former yields much more sensible estimates than thelatter.

Spanish monetary policy: A structural VAR analysis

Some past studies analyzed Spanish monetary policy with the standard VAR. Their problem is that this method obliges researchers to impose a certain extreme form of the short run policy rule on their models. Hence, it does not allow researchers to study the possibility of structural changes in this rule, either. This paper overcomes these problems by using the structural VAR. I find that the rule has always been that of partial accommodation. Prior to 1984, it was quite close to money targeting. After 1984, it became closer to the interest rate targeting, with more emphasis on the exchange rate.

Adoption of financial technologies: Implications for money demand and monetary policy

In this paper we argue that inventory models are probably not usefulmodels of household money demand because the majority of households does nothold any interest bearing assets. The relevant decision for most people is notthe fraction of assets to be held in interest bearing form, but whether to holdany of such assets at all. The implications of this realization are interesting and important. We find that(a) the elasticity of money demand is very small when the interest rate is small,(b) the probability that a household holds any amount of interest bearing assetsis positively related to the level of financial assets, and (c) the cost ofadopting financial technologies is positively related to age and negatively relatedto the level of education. Unlike the traditional methods of money demand estimation, our methodology allowsfor the estimation of the interest--elasticity at low values of the nominalinterest rate. The finding that the elasticity is very small for interest ratesbelow 5 percent suggests that the welfare costs of inflation are small. At interest rates of 6 percent, the elasticity is close to 0.5. We find thatroughly one half of this elasticity can be attributed to the Baumol--Tobin orintensive margin and half of it can be attributed to the new adopters or extensivemargin. The intensive margin is less important at lower interest rates and moreimportant at higher interest rates.

Monetary policy misspecification in VAR models

We examine the effects of extracting monetary policy disturbances with semi-structural and structural VARs, using data generated bya limited participation model under partial accommodative and feedback rules. We find that, in general, misspecification is substantial: short run coefficients often have wrong signs; impulse responses and variance decompositions give misleadingrepresentations of the dynamics. Explanations for the results and suggestions for macroeconomic practice are provided.