Endogenous Central Bank Credibility in a Small Forward-Looking Model of the U.S. Economy

The linkages between inflation and the economy's cyclical position are thought to be strongly affected by the credibility of monetary authorities. The author complements existing research by estimating a small forward-looking model of the U.S. economy with endogenous central bank credibility. His work differs from the existing literature in several ways. First, he endogenizes and estimates credibility parameters, allowing inflation expectations to be a mix of backward- and forward-looking agents. Second, his models include both outcome- and action-based credibility. Third, he estimates a non-linear relation between policy credibility and divergences of inflation from target, which is also assumed to change over history. Finally, the author's non-linear time-varying credibility indexes do not rely on a two-regime definition, but on a continuum of credibility regimes. The author finds strong, stable, and statistically significant outcome- and action-credibility effects that generate important inflation inertia. According to his results, the value of the endogenous credibility indexes has risen steadily across the different monetary policy regimes.Transmission of monetary policy; Econometric and statistical methods; Inflation and prices

Accounting for the determinants of banks’ credit ratings

The contribution of the banking industry to the recent financial crisis 2007/8 has raised public concerns about the excessive involvement of banks in risky activities. In addition there have been public concerns about the ability of credit rating agencies to evaluate these risks in advance. In this context, this study uses an ordered logit analysis to examine the determinants of banks’ credit ratings using a sample of US and UK banks’ accounting data from 1994 to 2009. Our intention is to examine to what extent banks’ ratings reflect banks’ risks. Our analysis shows that a small number of accounting variables, namely: bank size, liquidity, efficiency and profitability are able to correctly assign credit rating for approximately 74% to 78% the sample banks. Surprisingly, the association between banks’ credit ratings and each of leverage asset quality and capital is not robust, suggesting that the rating agency’s models did not pick them up despite their importance in the crisis. In addition, the relationship between banks’ credit ratings and liquidity is the reverse of that which an adequate early warning system would require. As banks benefit from higher credit ratings they will have addressed their determinants rather than taking care of systemic factors that affect underlying risk. Policy makers therefore need to intervene to address this market failure.This study was financially supported by the Institute of Chartered Accountants of Scotland (ICAS)

Learning, endogenous indexation and disinflation in the New-Keynesian Model

This paper introduces adaptive learning and endogenous indexation in the New-Keynesian Phillips curve and studies disinflation under inflation targeting policies. The analysis is motivated by the disinflation performance of many inflation-targeting countries, in particular the gradual Chilean disinflation with temporary annual targets. At the start of the disinflation episode price-setting firms’ expect inflation to be highly persistent and opt for backward-looking indexation. As the central bank acts to bring inflation under control, price-setting firms revise their estimates of the degree of persistence. Such adaptive learning lowers the cost of disinflation. This reduction can be exploited by a gradual approach to disinflation. Firms that choose the rate for indexation also re-assess the likelihood that announced inflation targets determine steady-state inflation and adjust indexation of contracts accordingly. A strategy of announcing and pursuing short-term targets for inflation is found to influence the likelihood that firms switch from backward-looking indexation to the central bank’s targets. As firms abandon backward-looking indexation the costs of disinflation decline further. We show that an inflation targeting strategy that employs temporary targets can benefit from lower disinflation costs due to the reduction in backward-looking indexation

Inflation Targeting in Brazil: Shocks, Backward-Looking Prices, and IMF Conditionality

This paper examines the recent evolution of monetary policy since the adoption of formal inflation targeting in Brazil. We argue that the new policy framework has been subject to a severe test in its first years of existence, represented by external shocks - oil prices, and increased international financial volatility. Moreover, we examine some selected issues that deserve due consideration given their importance to the conduct of monetary policy. The first issue is the presence of a substantial portion of prices with backward-looking adjustment, a fact that affects monetary policy reaction since it reduces the efficiency of domestic interest rates in controlling inflation. The second addresses the question of how inflation targets should be monitored in a country that has an ongoing economic program with the International Monetary Fund. This last issue is particularly important when considering the effects of shortening monitoring horizons on the variability of inflation and output.

Measuring the Taylor rule's performance

Using a recently developed econometric technique to determine how the original Taylor rule and subsequent variations perform using different measures of inflation, output and unemployment. We found that the rule remains relevant today, despite the changes wrought by globalization, financial market innovations and technological advances.