Forecasting inflation with thick models and neural networks

This paper applies linear and neural network-based “thick” models for forecasting inflation based on Phillips–curve formulations in the USA, Japan and the euro area. Thick models represent “trimmed mean” forecasts from several neural network models. They outperform the best performing linear models for “real-time” and “bootstrap” forecasts for service indices for the euro area, and do well, sometimes better, for the more general consumer and producer price indices across a variety of countries. JEL Classification: C12, E31bootstrap, Neural Networks, Phillips Curves, real-time forecasting, Thick Models

Inflation Targeting and Q Volatility in Small Open Economies

This paper examines the welfare implications of managing Q with inflation targeting by monetary authorities who have to "learn" the laws of motion for both inflation and the rate of growth of Q. Our results show that the Central Bank can achieve great success in reducing the volatility of GDP growth with basically the same inflation volatility, if it incorporates this additional target into its policy regime. However, the welfare effects are generally lower, in terms of consumption, when the monetary authorithy reacts to Q growth as well as inflationTobin's Q, monetary policy, learning

Volatility reversal from interest rates to the real exchange rate : financial liberalization in Chile, 1975-82

The authors analyze the dynamic adjustment of the real exchange rate, the domestic interest rate, and foreign borrowing under conditions of perfect and imperfect capital mobility during financial liberalization. Making use of a two-sector model with current and capital accounts interacting, they show that the domestic interest rate is more volatile under imperfect mobility and the real exchange rate more volatile under perfect mobility. So liberalizing the capital accounts does not eliminate variations in the domestic interest rate but shifts them to the real exchange rate. Studying data for Chile during the period of financial liberalization from 1975 to 1982, they found that the domestic interest rate became less volatile and less responsive to domestic variables - and more dependent on the covered international interest rate, while the real exchange rate became more responsive to domestic wealth. Foreign reserve holdings and net exports followed a similar pattern: the covered international rate had stronger effects on reserve changes while real wealth became more important for determining net exports.Economic Theory&Research,Macroeconomic Management,Economic Stabilization,Environmental Economics&Policies,Banks&Banking Reform

Financial liberation and adjustment in Chile and New Zealand

The authors analyze macrodynamic adjustment during financial liberalization in Chile and New Zealand. During the adjustment to more open capital accounts in the late 1970s or mid-1980s, both countries experienced appreciation of the real exchange rate and a collapse of net exports, while domestic interest rates slowly converged to international levels. The authors develop and estimate a two-sector dynamic model using both current and time-varying parameters. They find the domestic interest rate to be more responsive to shocks under imperfect capital mobility, the real exchange rate more responsive under perfect capital mobility. In short, liberalization of the capital account does not eliminate volatility but rather shifts it from the domestic interest rate to the real exchange rate.Economic Theory&Research,Macroeconomic Management,Economic Stabilization,Environmental Economics&Policies,Banks&Banking Reform

The money-age distribution: Empirical facts and economic modelling

The money-age distribution is found to be hump-shaped for the US economy. The variation (inequality) of cash holdings within generations increases (declines) with age. Furthermore, cash holdings are found to be only weakly correlated ith both income and wealth. We analyze three motives for money demand in an overlapping generations model in order to explain this effect: 1) money in the utility, 2) an economy with costlyc credit service, and 3) limited participation. Both the simple money-in-the-utility model and the economy with the cash-credit goods are able to replicate the hump-shape profiles of cash holdings and its variation, but not the decreasing inequality within generations over age. In addition, we discuss the optimality of the Friedman rule in heterogeneous-agent economies. In the three models, zero inflation and zero nominal interest rates imply significant welfare lossesMoney-age distribution, money demand

CENTRAL BANK LEARNING, TERMS OF TRADE SHOCKS & CURRENCY RISKS: SHOULD ONLY INFLATION MATTER FOR MONETARY POLICY?

This paper examines the role of interest rate policy in a small open economy subject to terms of trade shocks, and time-varying currency risks. The private sector makes optimal decisions in an intertemporal non-linear setting with rational, forward-looking expectations. In contrast, the monetary authority practices "least-squares learning" about the evolution of inflation, output growth, and exchange rate depreciation in alternative policy scenarios. Interest rates are set by linear quadratic optimization, with the objectives for inflation, output growth, or depreciation depending on current conditions. The simulation results show that the prefered stance is one which targets inflation only. Including other targets such as growth and exchange rate changes significantly increases output variability, and unambiguously decreases welfare.Currency risks, learning, parameterized expectations, policy targets

The Response of Australian Stock, Foreign Exchange and Bond Markets to Foreign Asset Returns and Volatilities

This paper is a data-analytic study of the relationships among international asset price volatilities and the time-varying correlations of asset returns in a small open economy (Australia) with international asset returns. Making use of recent developments in time-series approaches to volatility estimation, impulse response functions, variance decomposition, and Kalman filtering, I show that the Australian stock market volatility is most closely linked with volatility in the UK stock market, and the correlation of Australian stock returns with UK returns are high when there is increasing turbulence in financial markets. Volatility in the Australian dollar/US dollar exchange rate is most closely linked with volatility measures of the US dollar/Canadian dollar rate, and volatility in Australian long-term bond yields is most closely linked to volatility measures of long term German bond returns. The results indicate that asset markets in a small open economy can adapt in different ways during periods of high or increasing volatility. The ways in which domestic volatility measures react to foreign turbulence, and the ways in which domestic returns correlate with international returns, depend on the particular circumstances (such as transactions costs and degree of risk aversion) which prevail in each financial market.

The money-age distribution: empirical facts and limited monetary models

The money-age distribution is hump-shaped for the US post-war economy. There is no clear cut relation between the variation of money holdings within generations and age. Furthermore, money is found to be only weakly correlated with both income and wealth. We analyze three motives for money demand in an overlapping generations model in order to explain these observations: 1) money in the utility, 2) an economy with costly credit service, and 3) limited participation. All three models are consistent with the hump-shaped relation between average money holdings and age, yet they predict a much closer association between money holdings, income, wealth, and age than we find in the data. Only the limitedparticipation model partly replicates the low bivariate correlation between money and income as well as between money and interest bearing assets. None of the three models satisfactorily explains these stylized facts

Output Gap Estimation for Inflation Forecasting: The Case of the Philippines

This paper examines alternative estimation models for obtaining output gap measures for the Philippines. These measures are combined with the rates of growth of broad money, nominal wages and oil prices for forecasting inflation. We find that models which combine these leading indicators in a nonlinear way out-perform other linear combinations of these variables for out-of-sample forecasting performance

Output Gap Estimation for Inflation Forecasting: The Case of the Philippines

This paper examines alternative estimation models for obtaining output gap measures for the Philippines. These measures are combined with the rates of growth of broad money, nominal wages and oil prices for forecasting inflation. We find that models which combine these leading indicators in a nonlinear way out-perform other linear combinations of these variables for out-of-sample forecasting performance