A close look at model-dependent monetary policy design

This article first explores the implications of model specification on the design of targeting rules in a world of model certainty. As a general prescription, a targeting rule must counterbalance the private-sector dynamics: The more backward-looking behavior is observed in either the output gap or inflation, the more forward-looking monetary policy should be. Likewise, a more forward-looking economy would require stronger backward-looking reactions of the nominal interest rate to the output gap or inflation. The article also analyzes the effects of implementing monetary policy in an environment with uncertainty. Our results indicate that a simple model-invariant rule of the style proposed by Taylor (1993) performs better than a model-dependent targeting rule in the presence of moderate parameter uncertainty.Monetary policy

ECB interest-rate smoothing

Interest rates

Price setting and the steady-state effects of inflation

This paper examines how price setting plays a key role in explaining the steady-state effects of inflation in a monopolistic competition economy. Three pricing variants (optimal prices, indexed prices, and unchanged prices) are introduced through a generalization of the Calvo-type setting that allows the possibility of price indexation, i.e., prices may be adjusted by the rate of inflation. We found that in an economy with less indexed prices the steady-state negative impact of inflation on output is higher. In the extreme case without no price indexation at all (purely Calvo-type economy), unrealistically heavy falls in capital and output were reported when steady-state inflation increases. Regarding welfare analysis, our results support a long-run monetary policy aimed at price stability with a close-to-zero inflation target. This finding is robust to any price setting scenario. JEL Classification: E13, E31, E50price setting, superneutrality, welfare cost of inflation

An Optimizing IS-LM Framework with Endogenous Investment

Dynamic optimizing models with an IS-LM-type structure and slow price adjustments have been used for much recent monetary policy analysis, but usually with capital and investment treated as exogenous a significant restriction. This paper demonstrates that investment decisions can be endogenized without undue complexity in such models and that these can be calibrated to provide reasonably realistic dynamic behavior. It is necessary, however, to include capital adjustment costs; models with no adjustment costs match cyclical data very poorly. Indeed, their match is considerably poorer than models with constant capital. The paper also finds that the preferred adjustment-cost specification is not close to quadratic.

Business cycle and monetary policy analysis in a structural sticky-price model of the euro area

Structural models are a powerful tool for business cycle and monetary policy analysis because they are invariant to either policy changes or external shocks. In this paper, we derive a Sidrauski-type model in which both the demand and supply side are structural in the sense that the behavioral equations obtained are rigorously calculated from optimizing decisions of the individuals. Moreover, we introduce price stickiness on the supply side decisions so as to have relevant short-run real effects of monetary policy through the real interest rate channel. The resulting medium-size model will be calibrated and estimated for the euro area, some simulations on business cycle and monetary policy analysis will be carried out. JEL Classification: E20, E32, E52

Time-to-build approach in a sticky price, sticky wage optimizing monetary model

One of the most significant characteristics of optimizing models is that the behavioral equations involved are typically forward looking, i.e. agents are concerned about the futures rather than the past. This creates difficulties when modelling some of the business-cycle patterns widely observed in modern economies. For example, it is not easy to obtain the delay in the response of the rate of inflation to a monetary shock. This paper shows that an optimizing monetary model with endogenous capital, sticky prices, sticky wages, and adjustment costs of investment, can replicate a lag in the maximum response of both output and inflation to an interest rate shock when taking into account a time-to-build requirement for investment projects. JEL Classification: E12, E22, E47

Data Revisions in the Estimation of DSGE Models

Revisions of US macroeconomic data are not white-noise. They are persistent, correlated with real-time data, and with high variability (around 80% of volatility observed in US real-time data). Their business cycle effects are examined in an estimated DSGE model extended with both real-time and final data. After implementing a Bayesian estimation approach, the role of both habit formation and price indexation fall significantly in the extended model. The results show how revision shocks of both output and inflation are expansionary because they occur when real-time published data are too low and the Fed reacts by cutting interest rates. Consumption revisions, by contrast, are countercyclical as consumption habits mirror the observed reduction in real-time consumption. In turn, revisions of the three variables explain 9.3% of changes of output in its long-run variance decomposition.The authors would like to acknowledge financial support from the Spanish government (research projects ECO2011-24304 and ECO2010-16970 from Ministerio de Ciencia e Innovación)

An Estimated New-Keynesian Model with Unemployment as Excess Supply of Labor

Wage stickiness is incorporated to a New-Keynesian model with variable capital to drive endogenous unemployment uctuations de ned as the log di¤erence between aggregate labor supply and aggregate labor demand. We estimated such model using Bayesian econometric techniques and quarterly U.S. data. The second-moment statistics of the unemployment rate in the model give a good t to those observed in U.S. data. Our results also show that wage-push shocks, demand shifts and monetary policy shocks are the three major determinants of unemployment fl uctuations. Compared to an estimated New-Keynesian model without unemployment (Smets and Wouters, 2007): wage stickiness is higher, labor supply elasticity is lower, the slope of the New-Keynesian Phillips curve is flatter, and the importance of technology innovations on output variability increases.Miguel Casares would like to thank both the Spanish government (research project ECO2011-24304) and Fundación Ramón Areces (VII Concurso Investigación en Economía) for their nancial support. Antonio Moreno and Jesús Vázquez would also like to thank the Spanish government (research projects ECO2009-11151 and ECO2010-16970, respectively) for their nancial support