scholarly journals LOOSE COMMITMENT IN MEDIUM-SCALE MACROECONOMIC MODELS: THEORY AND APPLICATIONS

2012 ◽  
Vol 18 (1) ◽  
pp. 175-198 ◽  
Author(s):  
Davide Debortoli ◽  
Junior Maih ◽  
Ricardo Nunes
Keyword(s):  
Monetary Policy ◽  
Interest Rate ◽  
Business Cycle ◽  
Optimal Policy ◽  
Large Scale ◽  
American Economic Review ◽  
Macroeconomic Models ◽  
Medium Scale ◽  
Business Cycle Fluctuations ◽  
Scale Models

This paper proposes a method and a toolkit for solving optimal policy with imperfect commitment. As opposed to the existing literature, our method can be employed in the medium- and large-scale models typically used in monetary policy. We apply our method to the Smets and Wouters model [American Economic Review97(3), 586–606 (2007)], for which we show that imperfect commitment has relevant implications for interest rate setting, the sources of business cycle fluctuations, and welfare.

scholarly journals OPTIMAL POLICY IN RATIONAL EXPECTATIONS MODELS: NEW SOLUTION ALGORITHMS

2007 ◽  
Vol 11 (1) ◽  
pp. 31-55 ◽  
Author(s):  
RICHARD DENNIS
Keyword(s):  
Business Cycle ◽  
Optimal Policy ◽  
Rational Expectations ◽  
Large Scale ◽  
New Keynesian ◽  
Small Scale ◽  
Structural Form ◽  
Optimization Constraints ◽  
Solution Algorithms ◽  
Scale Models

This paper develops methods to solve for optimal discretionary policies and optimal commitment policies in rational expectations models. These algorithms, which allow the optimization constraints to be conveniently expressed in second-order structural form, are more general than existing methods and are simple to apply. We use several New Keynesian business cycle models to illustrate their application. Simulations show that the procedures developed in this paper can quickly solve small-scale models and that they can be usefully and effectively applied to medium- and large-scale models.

scholarly journals LOAN PRODUCTION AND MONETARY POLICY

2017 ◽  
Vol 23 (1) ◽  
pp. 101-143
Author(s):  
Miguel Casares ◽  
Luca Deidda ◽  
Jose E. Galdon-Sanchez
Keyword(s):  
Monetary Policy ◽  
Interest Rate ◽  
Business Cycle ◽  
Financial Frictions ◽  
New Keynesian ◽  
New Keynesian Model ◽  
Optimal Monetary Policy ◽  
External Finance ◽  
Business Cycle Fluctuations ◽  
Keynesian Model

We examine optimal monetary policy in a New Keynesian model with unemployment and financial frictions where banks produce loans using equity as collateral. Firms and households demand loans to finance externally a fraction of their flows of expenditures. Our findings show amplifying business-cycle effects of a more rigid loan production technology. In the monetary policy analysis, the optimal rule clearly outperforms a Taylor-type rule. The optimized interest-rate response to the external finance premium turns significantly negative when either banking rigidities are high or when financial shocks are the only source of business cycle fluctuations.

OPTIMAL MONETARY POLICY FOR THE EMU ACCESSION COUNTRIES. A NEW KEYNESIAN APPROACH

2014 ◽  
Vol 19 (7) ◽  
pp. 1427-1475 ◽  
Author(s):  
Anna Lipińska
Keyword(s):  
Monetary Policy ◽  
Interest Rate ◽  
Optimal Policy ◽  
Nominal Exchange Rate ◽  
Nominal Interest Rate ◽  
Output Gap ◽  
Optimal Monetary Policy ◽  
Accession Countries ◽  
Dynamic Stochastic ◽  
Maastricht Criteria

This paper uses a dynamic stochastic general equilibrium model of a two-sector small open economy to analyze how the Maastricht criteria modify a fully credible optimal monetary policy in the Economic and Monetary Union accession countries. We show that if the country is not constrained by the criteria, optimal policy should stabilize fluctuations in PPI inflation, in the aggregate output gap, and in the domestic and international terms of trade. The optimal policy constrained permanently by the Maastricht criteria is characterized by reduced variability of the nominal exchange rate, CPI inflation, and the nominal interest rate and by lower optimal targets for CPI inflation and nominal interest rate. This policy results in higher variability and nonzero means for both PPI inflation and output gap, thus leading to additional, but small, welfare costs compared with the unconstrained policy.

Business cycles in Ethiopia under alternative monetary policy rules

2019 ◽  
Vol 10 (3) ◽  
pp. 299-313
Author(s):  
Wondemhunegn Ezezew Melesse
Keyword(s):  
Monetary Policy ◽  
Interest Rate ◽  
Business Cycle ◽  
Central Bank ◽  
Capital Mobility ◽  
Developing Economies ◽  
Dsge Models ◽  
Money Growth ◽  
Content Type ◽  
Policy Shocks

Purpose The purpose of this paper is to compare business cycle fluctuations in Ethiopia under interest rate and money growth rules. Design/methodology/approach In order to achieve this objective, the author constructs a medium-scale open economy dynamic stochastic general equilibrium (DSGE) model. The model features several nominal and real distortions including habit formation in consumption, price rigidity, deviation from purchasing power parity and imperfect capital mobility. The paper also distinguishes between liquidity-constrained and Ricardian households. The model parameters are calibrated for the Ethiopian economy based on data covering the period January 2000–April 2015. Findings The main result suggests that: the model economy with money growth rule is substantially less powerful or more muted for the amplification and transmission of exogenous shocks originating from government spending programs, monetary policy, technological progress and exchange rate movements. The responses of output to fiscal policy shocks are relatively stronger under autarky which appears to confirm the findings of Ilzetzki et al. (2013) who suggest bigger multipliers in self-sufficient, closed economies. With regard to positive productivity shock, however, the model with interest rate feedback rule generates a decline in output and an increase in inflation, which are at odds with conventional empirical regularities. Research limitations/implications The major implication is that a central bank regulating some measure of monetary stocks should not expect (fear) as much expansion (contraction) in output following currency devaluation (liquidity withdrawal) as a sister central bank that relies on an interest rate feedback rule. As emphasized by Mishra et al. (2010) the necessary conditions for stronger transmission of interest-rule-based monetary policy shocks are hardly existent in emerging and developing economies targeting monetary aggregates; hence the relatively weaker responses of output and inflation in the model economy with money growth rule. Monetary policy authorities need to be cautious when using DSGE models to analyze business cycle dynamics. Quite often, DSGE models tend to mimic the proverbial “crooked house” built to every man’s advise. Whenever additional modification is made to an existing baseline model, previously established regularities break down. For instance, this paper documented negative response of output to technology shock. Such contradictions are not uncommon. For example, Furlanetto (2006) and Ramayandi (2008) have also found similarly inconsistent responses to fiscal and productivity shocks, respectively. Originality/value Using DSGE models for research and teaching purposes is not common in developing economies. To the best of the author’s knowledge, only one other Ethiopian author did apply DSGE model to study business cycle fluctuation in Ethiopia albeit under the implausible assumption of perfect capital mobility and a central bank following interest rate rule. The contribution of this paper is that it departs from these two unrealistic assumptions by allowing international risk premium as a function of the net foreign asset position of the country and by applying money growth rule which closely mimics the behavior of central banks in low-income economies such as Ethiopia.

Testing monetary policy optimality using volatility outcomes: a novel approach

2016 ◽  
Vol 16 (2) ◽  
Author(s):  
Federico Ravenna
Keyword(s):  
Monetary Policy ◽  
Interest Rate ◽  
Optimal Policy ◽  
The United States ◽  
New Keynesian ◽  
Model Parameters ◽  
Dsge Models ◽  
Optimal Monetary Policy ◽  
Novel Approach ◽  
Interest Rate Volatility

AbstractWe propose a method to assess the efficiency of macroeconomic outcomes using the restrictions implied by optimal policy DSGE models for the volatility of observable variables. The method exploits the variation in the model parameters, rather than random deviations from the optimal policy. In the new Keynesian business cycle model this approach shows that optimal monetary policy imposes tighter restrictions on the behavior of the economy than is readily apparent. The method suggests that for the historical output, inflation and interest rate volatility in the United States over the 1984–2005 period to be generated by any optimal monetary policy with a high probability, the observed interest rate time series should have a 25% larger variance than in the data.

scholarly journals Taxes and the Structure of Production

1998 ◽  
Vol 16 (2) ◽  
pp. 145-159 ◽  
Author(s):  
Walter Block
Keyword(s):  
Monetary Policy ◽  
Fiscal Policy ◽  
Interest Rate ◽  
Business Cycle ◽  
Time Preference ◽  
Causal Relation ◽  
Austrian Business Cycle ◽  
The Business Cycle ◽  
The Interest Rate ◽  
Structure Of Production

Abstract In Austrian theory, the business cycle is caused by expansive monetary policy, which artificially lowers the interest rate below equilibrium rates, necessarily lengthening the structure of production. Can tax alterations also cause an Austrian business cycle? Only if they affect time preference rates, the determinant of the shape of the Hayekian triangle. It is the contention of this paper that changes in taxes possibly can (but need not) impact time preference rates. Thus there may be a causal relation between fiscal policy and the business cycle, but this is not a necessary connection, as there is between monetary policy and the business cycle. This is contentious, since some Austrians argue that there is a praxeological link between tax policy and time preference rates.

Essays on financial sector and optimal monetary policy

2016 ◽  
Author(s):  
◽  
Ting Wang
Keyword(s):  
Monetary Policy ◽  
Business Cycle ◽  
Central Bank ◽  
Financial Sector ◽  
Supply Side ◽  
Financial Shocks ◽  
External Finance ◽  
Business Cycle Fluctuations ◽  
The Relationship

[ACCESS RESTRICTED TO THE UNIVERSITY OF MISSOURI AT REQUEST OF AUTHOR.] The 2007-2009 economic events have renewed interests in the relationship between the financial sector and the macroeconomy and suggested that shocks originated in the financial sector may be a potential source of business cycle fluctuations. In this regard, this dissertation focuses on quantifying and assessing the role of shocks originated from the financial sector in driving business cycle fluctuations and how monetary policy could possibly respond from a welfare prospective. The dissertation consists of three chapters. The first chapter attempts to model the relationship between the financial sector and the macroeconomy theoretically. Specifically, I build a dynamic stochastic general equilibrium (DSGE) model by incorporating a financial sector with frictions between investors and banks. The existence of such frictions affect the healthiness of the financial sector and increase its riskiness, whereas would not affect those of the non-financial sector by much. I regard this type of frictions as supply-side financial shocks that are originated in the financial sector. Under this framework, the external finance premium in the financial sector can be determined endogenously. To study how the financial shocks would affect the dynamics of the model, impulse responses are used to show that the inclusion of those financial shocks yield larger amplification effects. Thus the model is able to generate higher volatility in aggregate outcomes, especially in the financial sector. This provides theoretical grounds to study the role of supply-side financial shocks for the next two chapters. Chapter two seeks to quantify empirically the effects of the financial shocks on the macroeconomy in a structural vector autoregression (SVAR) model. Based on the model implications derived from Chapter one, two types of financial shocks can be discriminated|the demand-side financial shock that comes from the entrepreneurial sector and the supply-side financial shock that comes from the financial sector. The identification strategy is that these two types of shocks affect the standards deviation of the equity returns in financial and entrepreneurial sectors in opposite directions. The overall SVAR results show that the effects of financial shocks on the real economic activities are non-trivial, although not major. In particular, the supply-side financial shocks originating from the financial sector explain a non-negligible part of the variabilities for the key macro variables; whereas for the financial variables, they are the main drivers, especially during the 2007-2009 crisis period. Chapter three studies how monetary policy should respond to this type of supplyside financial shocks from a prospective of social welfare. In particular, I consider a Taylor-type monetary policy rule augmented with a financial variable|the external finance premium. By doing so, it allows the central bank to react to the changes in the riskiness of the financial sector, in addition to the conventional output and inflation targets. The welfare results show that it is optimal for the central bank to respond to the financial variable. In other words, when there are shocks originated in the financial sector, the riskiness of the financial sector increases, and so do the external financing costs and the external finance premium in the financial sector. The banks' balance sheet conditions worsen and the central bank should cut its policy rate. The welfare analysis also implies that the inflation stabilization is still the most important target of the central bank, which in line with the literature that emphasizes the importance of inflation targeting.

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