The Inflation Bias under Calvo and Rotemberg Pricing.

New Keynesian models rely heavily on two workhorse models of nominal inertia - price contracts of random duration (Calvo, 1983) and price adjustment costs (Rotemberg, 1982) - to generate a meaningful role for monetary policy. These alternative descriptions of price stickiness are often used interchangeably since, to a first order of approximation they imply an isomorphic Phillips curve and, if the steady-state is efficient, identical objectives for the policy maker and as a result in an LQ framework, the same policy conclusions. In this paper we compute time-consistent optimal monetary policy in bench-mark New Keynesian models containing each form of price stickiness. Using global solution techniques we find that the inflation bias problem under Calvo contracts is significantly greater than under Rotemberg pricing, despite the fact that the former typically significant exhibits far greater welfare costs of inflation. The rates of inflation observed under this policy are non-trivial and suggest that the model can comfortably generate the rates of inflation at which the problematic issues highlighted in the trend inflation literature emerge, as well as the movements in trend inflation emphasized in empirical studies of the evolution of inflation. Finally, we consider the response to cost push shocks across both models and find these can also be significantly different. The choice of which form of nominal inertia to adopt is not innocuous.

An Empirical Assessment of Optimal Monetary Policy Delegation in the Euro Area

We estimate a New Keynesian DSGE model for the Euro area under alternative descriptions of monetary policy (discretion, commitment or a simple rule) after allowing for Markov switching in policy maker preferences and shock volatilities. This reveals that there have been several changes in Euro area policy making, with a strengthening of the anti-inflation stance in the early years of the ERM, which was then lost around the time of German reunification and only recovered following the turnoil in the ERM in 1992. The ECB does not appear to have been as conservative as aggregate Euro-area policy was under Bundesbank leadership, and its response to the financial crisis has been muted. The estimates also suggest that the most appropriate description of policy is that of discretion, with no evidence of commitment in the Euro-area. As a result although both ‘good luck’ and ‘good policy’ played a role in the moderation of inflation and output volatility in the Euro-area, the welfare gains would have been substantially higher had policy makers been able to commit. We consider a range of delegation schemes as devices to improve upon the discretionary outcome, and conclude that price level targeting would have achieved welfare levels close to those attained under commitment, even after accounting for the existence of the Zero Lower Bound on nominal interest rates.

Measuring the Euro-Dollar Permanent Equilibrium Exchange Rate using the Unobserved Components Model

This paper employs an unobserved component model that incorporates a set of economic fundamentals to obtain the Euro-Dollar permanent equilibrium exchange rates (PEER) for the period 1975Q1 to 2008Q4. The results show that for most of the sample period, the Euro-Dollar exchange rate closely followed the values implied by the PEER. The only significant deviations from the PEER occurred in the years immediately before and after the introduction of the single European currency. The forecasting exercise shows that incorporating economic fundamentals provides a better long-run exchange rate forecasting performance than a random walk process.

An Empirical Assessment of Optimal Monetary Policy Delegation in the Euro Area

We estimate a New Keynesian DSGE model for the Euro area under alternative descriptions of monetary policy (discretion, commitment or a simple rule) after allowing for Markov switching in policy maker preferences and shock volatilities. This reveals that there have been several changes in Euro area policy making, with a strengthening of the anti-inflation stance in the early years of the ERM, which was then lost around the time of German reunification and only recovered following the turnoil in the ERM in 1992. The ECB does not appear to have been as conservative as aggregate Euro-area policy was under Bundesbank leadership, and its response to the financial crisis has been muted. The estimates also suggest that the most appropriate description of policy is that of discretion, with no evidence of commitment in the Euro-area. As a result although both ‘good luck’ and ‘good policy’ played a role in the moderation of inflation and output volatility in the Euro-area, the welfare gains would have been substantially higher had policy makers been able to commit. We consider a range of delegation schemes as devices to improve upon the discretionary outcome, and conclude that price level targeting would have achieved welfare levels close to those attained under commitment, even after accounting for the existence of the Zero Lower Bound on nominal interest rates.

Multiple Objectives in Monetary Policy: A de Facto Analysis for ‘Advanced’ Countries

A statistical methodology is developed by which realised outcomes can be used to identify, for calendar years between 1974 and 2012, when policy makers in ‘advanced’ economies have successfully pursued single objectives of different kinds, or multiple objectives. A simple criterion is then used to distinguish between multiple objectives pure and simple and multiple objectives subject to a price stability constraint. The overall and individual country results which this methodology produces seem broadly plausible. Unconditional and conditional analyses of the inflation and growth associated with different types of objectives reveal that multiple objectives subject to a price stability constraint are associated with roughly as good economic performance as the single objective of inflation. A proposal is then made as to how the remit of an inflation-targeting central bank could be adjusted to allow it to pursue other objectives in extremis without losing the credibility effects associated with inflation targeting.

Monetary policy strategies, financial institutions and financial markets in the Middle East and North Africa: an overview

Three polar types of monetary architecture are identified together with the institutional and market infrastructure required for each type and the kinds of monetary policy feasible in each case: a ‘basic’ architecture where there is little or no financial system as such but an elementary central bank which is able to fix the exchange rate, as a substitute for a proper monetary policy; a ‘modern’ monetary architecture with developed banks, financial markets and central bank where policy choices include types of inflation targeting; and an ‘intermediate’ monetary architecture where less market-based monetary policies involving less discretion are feasible. A range of data is used to locate the various MENA countries with respect to these polar types. Five countries (Iran, Libya, Sudan, Syria and Yemen) are identified as those with the least developed monetary architecture, while Bahrain and Jordan are identified as the group at the other end of the spectrum, reaching beyond the intermediate polar type in some dimensions but not others. The countries in between vary on different dimensions but all lie between basic and intermediate architectures. The key general findings are that the MENA countries are both less differentiated and less ‘developed’ than might have been expected. The paper ends by calling for research on the costs and benefits of different types of monetary architecture.

Hierarchical Shrinkage in Time-Varying Parameter Models

In this paper, we forecast EU-area inflation with many predictors using time-varying parameter models. The facts that time-varying parameter models are parameter-rich and the time span of our data is relatively short motivate a desire for shrinkage. In constant coefficient regression models, the Bayesian Lasso is gaining increasing popularity as an effective tool for achieving such shrinkage. In this paper, we develop econometric methods for using the Bayesian Lasso with time-varying parameter models. Our approach allows for the coefficient on each predictor to be: i) time varying, ii) constant over time or iii) shrunk to zero. The econometric methodology decides automatically which category each coefficient belongs in. Our empirical results indicate the benefits of such an approach.

Quantile forecasts of inflation under model uncertainty

Bayesian model averaging (BMA) methods are regularly used to deal with model uncertainty in regression models. This paper shows how to introduce Bayesian model averaging methods in quantile regressions, and allow for different predictors to affect different quantiles of the dependent variable. I show that quantile regression BMA methods can help reduce uncertainty regarding outcomes of future inflation by providing superior predictive densities compared to mean regression models with and without BMA.

'Modern' Phillips Curves and the Implications For The Statistical Process of Inflation

'Modern' theories of the Phillips curve imply that inflation is an integrated, or near integrated process. This paper explains this implication and why these 'modern' theories are logically inconsistent with what is commonly known about the statistical process of inflation.