Managing Expectations:Instruments vs. Targets*

2020 ◽  
Author(s):  
George-Marios Angeletos ◽  
Karthik A Sastry
Keyword(s):  
General Equilibrium ◽  
Interest Rates ◽  
Rational Expectations ◽  
Policy Instrument ◽  
Central Banks ◽  
Financial Accelerator ◽  
Liquidity Trap ◽  
Depth Of Knowledge ◽  
Optimal Approach ◽  
Limited Depth

Abstract Should policy communications aim at anchoring expectations of the policy instrument (“keep interest rates at zero until date x”) or of the targeted outcome (“do whatever it takes to bring unemployment down to $u\%$”)? We study how the optimal approach depends on a departure from rational expectations. People have limited depth of knowledge and rationality, or form otherwise distorted beliefs about the behavior of others and the general equilibrium (GE) effects of policy. The bite of this distortion on implementability and welfare is minimized by target-based guidance if and only if GE feedback is strong enough. This offers a rationale for why central banks should shine the spotlight on unemployment when faced with a prolonged liquidity trap, a steep Keynesian cross, or a large financial accelerator.

scholarly journals Confidence in future monetary policy as a way to overcome the liquidity trap

2019 ◽  
Vol 5 (2) ◽  
pp. 117-135
Author(s):  
Olga Kuznetsova ◽  
Sergey Merzlyakov ◽  
Sergey Pekarski
Keyword(s):  
Monetary Policy ◽  
Interest Rates ◽  
Large Scale ◽  
Global Financial Crisis ◽  
Time Consistency ◽  
Central Banks ◽  
Time Inconsistency ◽  
Liquidity Trap ◽  
Developed Economies ◽  
The Global Financial Crisis

The global financial crisis of 2007–2009 has changed the landscape for monetary policy. Many central banks in developed economies had to employ various unconventional policy tools to overcome a liquidity trap. These included large-scale asset purchase programs, forward guidance and negative interest rate policies. While recently, some central banks were able to return to conventional monetary policy, for many countries the effectiveness of unconventional policies remains an issue. In this paper we assess diverse practices of unconventional monetary policy with a particular focus on expectations and time consistency. The principal aspect of successful policy in terms of overcoming a liquidity trap is the confidence that interest rates will remain low for a prolonged period. However, forming such expectations faces the problem of time inconsistency of optimal policy. We discuss some directions to solve this problem.

scholarly journals Understanding Benign Liquidity Traps: The Case of Japan

2017 ◽  
Vol 18 (3) ◽  
pp. 267-282 ◽  
Author(s):  
Stefan Homburg
Keyword(s):  
Monetary Policy ◽  
General Equilibrium ◽  
Interest Rates ◽  
Equilibrium Model ◽  
General Equilibrium Model ◽  
Anglo Saxon ◽  
Liquidity Trap ◽  
Approach Zero

Abstract Japan has been in a benign liquidity trap since the 1990s. In a benign liquidity trap, interest rates approach zero and monetary policy is ineffective but output and employment perform decently. Such a pattern contradicts traditional macro theories. This paper introduces a monetary general equilibrium model that is compatible with Japan’s performance and resolves puzzles associated with liquidity traps. Possible conclusions for Anglo-Saxon countries and eurozone members are also discussed.

A NOTE ON FOREIGN EXCHANGE INTERVENTIONS AT ZERO INTEREST RATES

2012 ◽  
Vol 16 (5) ◽  
pp. 802-817 ◽  
Author(s):  
Shigeru Iwata ◽  
Shu Wu
Keyword(s):  
Exchange Rate ◽  
Interest Rates ◽  
Foreign Exchange ◽  
Inflation Targeting ◽  
Policy Instrument ◽  
Liquidity Trap ◽  
Working Paper ◽  
Policy Goals ◽  
Rate Environment ◽  
The Exchange Rate

This note uses a nonlinear structural vector autoregression model to empirically investigate the effectiveness of official foreign exchange (FX) interventions in an economy when interest rates are constrained to the zero level, based on Japanese data in the 1990s. The model allows us to estimate the effects of FX interventions operating through different channels. We find that FX interventions are still capable of influencing the foreign exchange rate in a zero-interest-rate environment, even though their effects are greatly reduced by the zero lower bound on interest rates. Our results suggest that although it might be feasible to use the exchange rate as an alternative monetary policy instrument at zero interest rates as proposed by McCallum (Inflation Targeting and the Liquidity Trap, NBER working paper 8225, 2000), the exchange rate–based Taylor rule may not be very effective in achieving the ultimate policy goals.

scholarly journals 'Captivated by Liquidity' – Theoretical Traps and Practical Mazes

2021 ◽  
Vol 66 (1) ◽  
pp. 50-67
Author(s):  
Zsuzsanna Novák ◽  
Tibor Tatay
Keyword(s):  
Interest Rate ◽  
Interest Rates ◽  
Global Financial Crisis ◽  
Great Influence ◽  
Economic Recession ◽  
Central Banks ◽  
Liquidity Trap ◽  
Theoretical Approaches ◽  
Lower Interest Rate ◽  
The Usa

There is no uniform theoretical standpoint on the effects of changing interest rates and the role of money among economists. Though these disputes exercise a great influence on the economic policy measures adopted as well. For the management of the 2008 global financial crisis many central banks entered into forceful interest rate cuts to contribute to the revitalisation of the economy. The economic recession caused by the pandemic of 2020 again raises the issue how central banks can stimulate growth. In this study we deal with the liquidity trap issue attributed to Keynes. Keynes pointed out that there might exist a lower interest rate limit under which money demand becomes infinite. His conceptions put the foundations to the question, at what interest rate levels might the liquidity trap – a term coined later by Robertson – phenomenon become effective. He was followed by numerous renowned economists dealing with the conception. In this paper we are discussing the most important theoretical approaches – among others the views of Hansen, Hicks, Tobin, Patinkin, Krugman, Brunner and Meltzer and Eggertson. We provide an overview on the effects of low interest rate levels adopted by Japan, by the central banks of Japan, the USA and the ECB aimed at stimulating the economy. Based on the study it can be confirmed that central banks can contribute to economic growth keeping interest rates low and therewith fostering investment. Nevertheless, beyond keeping short-term interest rates low, it might be adequate to control interest rates of other maturities and, especially under deflationary expectations, central banks should express their prolonged commitment to low interest rates.

scholarly journals Robust Monetary Policy Under Uncertainty About the Lower Bound

2020 ◽  
Vol 0 (0) ◽  
Author(s):  
Peter Tillmann
Keyword(s):  
Monetary Policy ◽  
Lower Bound ◽  
Central Bank ◽  
Interest Rates ◽  
Central Banks ◽  
Worst Case ◽  
Liquidity Trap ◽  
Nominal Interest Rates ◽  
True Location ◽  
Discretionary Monetary Policy

AbstractCentral banks face uncertainty about the true location of the effective lower bound (ELB) on nominal interest rates. We model optimal discretionary monetary policy during a liquidity trap when the central bank designs policy that is robust with respect to the location of the ELB. If the central bank fears the worst-case location of the ELB, monetary conditions will be more expansionary in the period before the liquidity trap.

scholarly journals Regular Econometric Model of Taylor for Albania

2016 ◽  
Vol 5 (1) ◽  
pp. 123
Author(s):  
Ergys Misha
Keyword(s):  
Economic Growth ◽  
Monetary Policy ◽  
Interest Rates ◽  
Financial Stability ◽  
Inflation Targeting ◽  
Inflation Rate ◽  
Stock Exchange ◽  
Central Banks ◽  
Financial Assets

The Taylor’s Rule Central Banks is applying widely today from Central Banks for design the monetary policy and for determination of interest rates. The purpose of this paper is to assess monetary policy rule in Albania, in view of an inflation targeting regime. In the first version of the Model, the Taylor’s Rule assumes that base interest rate of the monetary policy varies depending on the change of (1) the inflation rate and (2) economic growth (Output Gap).Through this paper it is proposed changing the objective of the Bank of Albania by adding a new objective, that of "financial stability", along with the “price stability”. This means that it is necessary to reassess the Taylor’s Rule by modifying it with incorporation of indicators of financial stability. In the case of Albania, we consider that there is no regular market of financial assets in the absence of the Stock Exchange. For this reason, we will rely on the credit developmet - as a way to measure the financial cycle in the economy. In this case, the base rate of monetary policy will be changed throught: (1) Targeting Inflation Rate, (2) Nominal Targeting of Economic Growth, and (3) Targeting the Gap of the Ratio Credit/GDP (mitigating the boom cycle, if the gap is positive, and the contractiocycle if the gap is negative).The research data show that, it is necessary that the Bank of Albania should also include in its objective maintaining the financial stability. In this way, the contribution expected from the inclusion of credit gap indicators in Taylor’s Rule, will be higher and sustainable in time.

scholarly journals Present-biased Government, Creative Accounting and a Pitfall in Balanced Budget Rules

2021 ◽  
Author(s):  
Marcela De Castro-Valderrama
Keyword(s):  
General Equilibrium ◽  
Interest Rates ◽  
Equilibrium Model ◽  
Hyperbolic Discounting ◽  
Goods And Services ◽  
Creative Accounting ◽  
Welfare Losses ◽  
Fiscal Rule ◽  
Balanced Budget Rule ◽  
Balanced Budget

I propose a general equilibrium model with a quasi-hyperbolic discounting government that optimally decides upon using creative accounting in order to evaluate a balanced budget rule and a debt rule. In that context, I find that a binding balanced budget rule could fail to properly constrain public overindebtedness when government uses creative accounting while a debt rule is effective, since targets are set on total public liabilities. Results suggest that a balanced budget fiscal rule can also deteriorate welfare due to the higher interest rates derived from doing operations under the line, implying future expenditure cuts that are harmful for households, who value public goods and services. A debt rule is also preferred for its capacity to reverse some welfare losses generated by the present-biased government.

scholarly journals Risks and the influence of negative interest rates on economic activity: a case study of Sweden, Denmark, and Switzerland

2020 ◽  
Vol 15 (1) ◽  
pp. 30-41
Author(s):  
Liběna Černohorská ◽  
Darina Kubicová
Keyword(s):  
Time Series ◽  
Interest Rates ◽  
Granger Causality ◽  
Economic Activity ◽  
Central Banks ◽  
Time Interval ◽  
Short Term ◽  
Stock Indices ◽  
Negative Interest Rates ◽  
The Impact

The purpose of this paper is to analyze the impact of negative interest rates on economic activity in a selected group of countries, in particular Sweden, Denmark, and Switzerland, for the period 2009–2018. The central banks of these countries were among the first to implement negative interest rates to revive the economic growth. Therefore, this study analyzed long- and short-term relationships between interest rates announced by central banks and gross domestic product and blue chip stock indices. Time series analysis was conducted using Engle-Granger cointegration analysis and Granger causality testing to identify long- and short-term relationship. The first step, using the Akaike criteria, was to determine the optimal delay of the entire time interval for the analyzed periods. Time series that seem to be stationary were excluded based on the results of the Dickey-Fuller test. Further testing continued with the Engle-Granger test if the conditions were met. It was designed to identify co-integration relationships that would show correlation between the selected variables. These tests showed that at a significance level of 0.05, there is no co-integration between any time series in the countries analyzed. On the basis of these analyses, it was determined that there were no long-term relationships between interest rates and GDP or stock indices for these countries during the monitored time period. Using Granger causality, the study only confirmed short-term relationship between interest rates and GDP for all examined countries, though not between interest rates and the stock indices. Acknowledgment The paper has been created with the financial support of The Czech Science Foundation GACR 18-05244S – Innovative Approaches to Credit Risk Management.

scholarly journals Negative Interest Rate Risk. Atavism or Normalization of Central Banks’ Monetary Policy

2019 ◽  
Vol 3 (342) ◽  
pp. 89-116
Author(s):  
Irena Pyka ◽  
Aleksandra Nocoń
Keyword(s):  
Monetary Policy ◽  
Interest Rate ◽  
Interest Rates ◽  
Financial Stability ◽  
Global Financial Crisis ◽  
Central Banks ◽  
Interest Rate Risk ◽  
Interest Rate Policy ◽  
Rate Policy ◽  
Negative Interest Rate Policy

In the face of the global financial crisis, central banks have used unconventional monetary policy instruments. Firstly, they implemented the interest rate policy, lowering base interest rates to a very low (almost zero) level. However, in the following years they did not undertake normalizing activities. The macroeconomic environment required further initiatives. For the first time in history, central banks have adopted Negative Interest Rate Policy (NIRP). The main aim of the study is to explore the risk accompanying the negative interest rate policy, aiming at identifying channels and consequences of its impact on the economy. The study verifies the research hypothesis stating that the risk of negative interest rates, so far unrecognized in Theory of Interest Rate, is a consequence of low effectiveness of monetary policy normalization and may adopt systemic nature, by influencing – through different channels – the financial stability and growth dynamics of the modern world economy.

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