Taylor’s rule, political cycle, and Latin America—An analysis of time series in search of responsibility for monetary stabilization

The decades before 1990 were dramatic for Latin American economies. However, from 1990 onwards, a set of policies followed by the various states in the region acheived economic stabilization with real income recovery. The attribution of this success has been disputed by politicians, economists and officials from international economic support institutions. This work will analyze the responsibility for this success in 4 economies in the region (Brazil, Colombia, Mexico and Peru). Through the combined analysis of ARDL, Markov states and structural breaks, we highlight different sources of responsibility in different periods. Additionally, detailing the states of each regime, we verify the duration of the regimes related to inflation rates and to interest rates in the region. We identify specific governments as associated with moments of economic stabilization in the region, so the hypothesis of the political cycle cannot be rejected for the set of results achieved. As policy implication, we claim that Taylor rules are endogenous to Political Budget Cycles and so stabilization plans are restricted to political tenures.

Credit-Market Imperfection and Monetary Policy Within DSGE Models

This survey presented the various ways that are utilized in the literature to include financial market frictions in dynamic stochastic general equilibrium (DSGE) models. It focuses on the fundamental issue: to what extent the Taylor rules are optimal when the central bank introduces the goal of financial stability. Indeed, the latest financial crisis shows that the vulnerability of the credit cycle is considered the main source for the amplification of a small transitory shock. This conclusion changed the instrument that drives the transmission of monetary policy through the economy and pushed the policymakers to include financial stability as a second objective of the central bank.

Monetary Policy

This chapter discusses monetary policy. It is informally divided in two parts: The former discusses the rationale for and the main features of the current institutional ‘architecture’ related to monetary policy. A formal analysis of time inconsistency of optimal discretionary policy and the concomitant inflationary bias is followed by analyses of commitment and reputation. Subsequently, the Chapter looks at possible resolutions of the difficulties associated with discretionary policy, including independent Central Banks and inflation targeting. It also discusses the new features and proposals that emerged post-2007–9. A ‘policy in practice’ section looks at Taylor rules. In the latter part, we review the recent analyses on financial structure and the ‘credit channel(s)’ of monetary policy transmission. The chapter concludes with a review of Quantitative Easing, macroprudential regulation, and the current thinking on monetary policy as part of a wider package of optimal stabilization policy.

SVAR (Mis)Identification and the Real Effects of Monetary Policy Shocks

I argue that the seemingly disparate findings of the recent empirical literature on monetary policy transmission are all consistent with the same standard macro models. Weak sign restrictions, which suggest that contractionary monetary policy, if anything, boosts output, present as policy shocks what actually are expansionary demand and supply shocks. Classical zero restrictions are robust to such misidentification, but miss short-horizon effects. Two recent approaches—restrictions on Taylor rules and external instruments—instead work well. My findings suggest that empirical evidence is consistent with models in which the real effects of monetary policy are larger than commonly estimated. (JEL C32, E12, E32, E43, E52)

Should Inequality Factor into Central Banks' Decisions?

Inequality is increasingly a concern. Fiscal and structural policies are well-understood mitigators. However, less is known about the potential role of monetary policy. This paper investigates how inequality matters for monetary policy within a tractable Two-Agent New Keynesian model that captures important dimensions of inequality. We find some support for making inequality an explicit target for monetary policy, particularly if central banks follow standard Taylor rules.

Monetary and Macroprudential Policies in an Intangible Economy

Advanced economies are increasingly based on intangible capital. Intangible capital has at least two special characteristics compared to tangible capital. First, it can be simultaneously used to produce different goods. Second, it is less suitable as collateral for obtaining external funds than tangible capital. These features could influence monetary and macroprudential policies. Against this backdrop, we study the effects of monetary and macroprudential policies by using a dynamic stochastic general equilibrium model with intangible capital and a banking sector. In our model, sector-specific productivity shocks to tangible and intangible production have different effects on the economy, in particular on inflation and loans. In addition, the two shocks lead to different reactions of monetary and macroprudential policies. As a result, the volatility of macroeconomic variables differs across shocks and policy rules. In particular, augmented Taylor rules increase the volatility of loans after an intangible productivity shock and, from this perspective, appear to be less desirable than macroprudential rules after this type of shock. However, welfare effects of different policy rules are not qualitatively different across shocks because of similar impacts on the volatility of consumption.

A narrative approach to a fiscal DSGE model

Structural DSGE models are used for analyzing both policy and the sources of business cycles. Conclusions based on full structural models are, however, potentially affected by misspecification. A competing method is to use partially identified SVARs based on narrative shocks. This paper asks whether both approaches agree. Specifically, I use narrative data in a DSGE‐SVAR that partially identify policy shocks in the VAR and assess the fit of the DSGE model relative to this narrative benchmark. In developing this narrative DSGE‐SVAR, I develop a tractable Bayesian approach to proxy VARs and show that such an approach is valid for models with a certain class of Taylor rules. Estimating a DSGE‐SVAR based on a standard DSGE model with fiscal rules and narrative data, I find that the DSGE model identification is at odds with the narrative information as measured by the marginal likelihood. I trace this discrepancy to differences in impulse responses, identified historical shocks and policy rules. The results indicate monetary accommodation of fiscal shocks.