Ascari Flashcards
In response to a contractionary monetary policy shock
interest rates up money supply down price responds little initially output down (hump shaped)
Price puzzle
initially positive response of inflation in VAR IRFs
omitted variable
Look at a model intended to explain it none the less (with wage bills borrowed)
Monetary policy shocks
Non-endogenous response
That’s why they have little output effect
Good sign for policy
Superneutrality
No long-run trade-off between the rate of inflation and unemployment
5 steps to solve classic model
- Solve agents’ optimal problems
- Steady state
- Log-linearise around steady state
- System of difference equations and solve for recursive law of motion
- Calculate IRFs in response to shocks
Classic monetary model results
Neutral and superneutral in long-run
Neutral also in short run
(so real variables don’t depend on mon. pol.)
Price level responds more than one-of-one with increase in mon. sup.
nominal interest rate increases after increase in money supply (no liquidity effect)
An exogenous path for the interest rate leads to
indeterminacy (all nominal variables)
Taylor principle to pin down unique equilibrium
Response to inflation >1
General approaches to including money
Money in utility function
Transaction costs/ transaction technology
Search
OLG intertemporal transfers
VAR effects of mon pol shock
output significant
unemployment significant
inflation significant and puzzling
Neoclassical with money cannot repeat
NK frictions needed
Sticky prices (nominal rigidity) Monopolistic competition (price setting)
Is excluding sales to get price stickiness a problem
Yes for distributional consequences
No for aggregate policy response
Frequency may not be independent of policy
2 stages to NK household problem
- Decide amount of consumption and labour (normal way)
2. Decide how to allocate consumption across goods
Firms’ marginal costs
Identical across i due to constant returns to scale
=Wt/At
Optimal price markup
e/(e-1)>1
e is really epsilon
P=markupMC
Calvo
proportion of firms can change price (1-theta), rest have to stay at previous price
implied average change 1/(1-theta)
higher theta, greater price stickiness
NKPC
New-Keynesian Phillips Curve
All in deviations
inflation=Amc+BE(inflationt+1)
A is a constant which depends on theta and B
inflation equals PDV of future marginal costs
it does, remember this!
=AEsum(B^k*mct+k)
Higher degree of price stickiness leads to what in NKPC
Weaker effect of change in future mc on output
2nd equation in NKPC model
IS:
output deviation from natural rate=E(output deviation from natural rate t+1)-constant*(i-E(inflation t+1)- natural rate of interest)
Output gap = what function of real rate deviations?
Proportional to sum of current and expected deviations of short real rate from natural rate
3 NK equations
NKPC
IS
Taylor rule (interest rate policy rule)
How to check determinacy
write NK model in the form contemporaneous inflation and output= A (expectations) + B (rate and shock) Key thing is A need both eigenvalues in the unit circle means det(A)<1 trace(A)<1+det(A)
Taylor princible
Necessary and sufficient condition for unique equilibrium:
k(fipi-1)+(1-B)fiy>0
implies fipi>0 when fiy=0
(1-B)/k is long run multiplier of inflation on output
Can be generalised for different Taylor rules
Under aggressive monetary policy (Taylor principle) belief shocks…
have no macroeconomic effects
so high expected inflation equilibrium cannot be supported by rational expectations
nominal and real rates move in same direction
Under weak policy, belief shocks may
lead to self-fulfilling inflation expectations
Effects of mon pol shock
i up means r higher than natural
relative prices up so HHs postpone cons
y falls
therefore pi falls too
Effects of a tech shock
natural y up, mc down, natural r down y up but not to new natural yet so output gap <0 inflation down due to -ve output gap interest rates down too, more than 1-2-1 with pi
Money supply rule instead of interest rates
model always determined under exog money supply
relatively in line with empirical evidence but no humped shaped responses, persistence is due to shock assumptions (not endog)
Inflation persistence problem
Fuhrer and Moore 1995
Inflation autocorrelation remains positive for 4 years
Problem because traditional NKPC is purely forward looking jump variable
Also implies disinflationary booms (ie rise in unemployment leads to higher expected inflation)
Theoretical vs empirical output gap
Detrended GDP potentially poor proxy for theoretical output gap
Hybrid Phillips Curve
Derivation of NKPC with past inflation
Ways of generating intrinsic inflation persistence
- Rule of thumb firms (Gali Gertler)
- Indexation
- Sticky expectations (adaptive or learning)
- Sticky info
- Sheedy
Indexation
Non-reoptimising price firms partially update prices according to past inflation
But extent of indexation is not structural parameter in Lucas sense
Sticky info
Inflation depends on past expectations of current variables rather than current expectations of future
(maybe can’t accurately observe contemporaneous inflation so must guess it)
Sheedy
Hazard function
Key feature of evidence on inflation persistence
Breaks in persistence
Reason for indeterminacy in 70s
Didn’t meet Taylor principle in policy
Need to react more aggressively
Is this really what happened?
Why might they not have missed Taylor principle in 70s?
Measurement error
Data suggesting they did is not the data they were making decisions with at the time
Real time Taylor rule very close to actual policy rate
Volker policy more aggressive than real time taylor rule (but maybe he was updating his beliefs after misses before- in the end he was more accurate)
Mismeasurement trends in 70s
Inflation constantly underpredicted
underestimated the NAIRU
Note on indeterminacy and temporary taylor principle violations
Still unique equil as long as agents expect policy to satisfy Taylor principle on average
As depends on what people think is steady state
Counterfactual analysis of monetary policy impact on great moderation
Changes in monetary policy had relatively small role
Lucky with good shocks!
Rank of Fed chairs with higher inflation response parameter top
Volker
Burns-Miller (70s)
Greenspan
Maybe Greenspan the worst and luckiest fed chair
there you go
Evidence on Taylor summary
Evidence of breaks in policy and shock volatility Systematic mon pol important for inflation dynamics Tech shocks (particularly investment-specific) responsible for evolution of output growth
effects of expansionary monetary policy shock in VAR
- Real variables effected
- Hump shaped with peak after 1.5-2yrs
- inflation response sluggish, hump shaped peaking 2yrs
- Interest rate falls for 1yr
- real profits, wages, labour productivity rise
- Liquidity effect: growth rate of money rises immediately
How solve hump shaped response in cons and persistent fall in real rate?
Habit persistence
marginal utility of cons inversely proportional to change in cons not level
How solve investment hump shaped response problem
Adjustment costs in changing investment (so also 2nd order sort of thing)
How solve inflation persistence with hump (and output)
Make marginal cost inertial
Can add wage staggering (some market power for labour)
Also problem with forward looking so add some inertia like indexation
Also could have variable capital utilisation
Firm specific factor inputs (means firms internalise the effect their demand has on the price of that input)
How to get the price puzzle?
Hardest thing
Working capital - firms borrow the wage bill
Even still depends on parameter values which would have to be unrealistic
How to get the liquidity effect?
Also really hard
Limited participation like cash in advance
2 types of frictions
real
nominal
Real frictions
habit adjustment costs variable utilisation - muted response of mc, output and inflation persistence there firm specific indicator intermediate goods
Nominal frictions
Sticky prices
Sticky wages
Backward looking indexation - increased persistence
Limited participation in asset market - liq. effect
Working capital
Investment shocks and costs are relevant
they improve forecast power
they are the most relevant
Many frictions may be subject to…
Lucas Critique!
