Does Global Slack Matter More than Domestic Slack in Determining U.S. Inflation?

This paper employs a structural model to estimate whether global output gap has become an important determinant of U.S. inflation dynamics. The results provide support for the relevance of global slack as a determinant of U.S. inflation after 1985. The role of domestic output gap, instead, seems to have diminished over time.Globalization; Global Slack; Inflation Dynamics; Phillips Curve; Bayesian Estimation

Political Business Cycles in the New Keynesian Model

This paper tests various Political Business Cycle theories in a New Keynesian model with a monetary and fiscal policy mix. All the policy coefficients, the target levels of inflation and the budget deficit, the firms' frequency of price setting, and the standard deviations of the structural shocks are allowed to depend on 'political' regimes: a pre-election vs. post-election regime, a regime that depends on whether the President (or the Fed Chairman) is a Democrat or a Republican, and a regime under which the President and the Fed Chairman share party affiliation in pre-election quarters or not. The model is estimated using full-information Bayesian methods. The assumption of rational expectations is relaxed: economic agents can learn about the effect of political variables over time. The results provide evidence that several coefficients depend on political variables. The best-fitting specification is one that allows coefficients to depend on a pre-election vs. non-election regime. Monetary policy becomes considerably more inertial before elections and fiscal policy deviations from a simple rule are more common. The results overall support the view of an independent Fed that avoids taking policy decisions right before elections. There is some evidence, however, that policies become more expansionary before elections, but this evidence seems to disappear in the post-1985 sample. The estimates also indicate that firms similarly delay their price-setting decisions until after the upcoming Presidential election.Political business cycles; Opportunistic cycles; Partisan cycles; Monetary and fiscal policy; Adaptive learning; Bayesian estimation

Expectations, Learning and Macroeconomic Persistence

This paper presents an estimated model with learning and provides evidence that learning can improve the fit of popular monetary DSGE models and endogenously generate realistic levels of persistence. The paper starts with an agnostic view, developing a model that nests learning and some of the structural sources of persistence, such as habit formation in consumption and inflation indexation, that are typically needed in monetary models with rational expectations to match the persistence of macroeconomic variables. I estimate the model by likelihood-based Bayesian methods, which allow the estimation of the learning gain coefficient jointly with the "deep" parameters of the economy. The empirical results show that when learning replaces rational expectations, the estimated degrees of habits and indexation drop near zero. This ?nding suggests that persistence arises in the model economy mainly from expectations and learning. The posterior model probabilities show that the specification with learning fits significantly better than does the specification with rational expectations. Finally, if learning rather than mechanical sources of persistence provides a more appropriate representation of the economy, the implied optimal policy will be different. The policymaker will also incur substantial costs from misspecifying private expectations formation.Persistence, Constant-gain learning, Expectations, Habit formation in consumption, Inflation inertia; Phillips curve; Bayesian econometrics; New-Keynesian model.

Expectations, Learning and Macroeconomic Persistence

This paper presents an estimated model with learning and provides evidence that learning can improve the fit of popular monetary DSGE models and endogenously generate realistic levels of persistence. The paper starts with an agnostic view, developing a model that nests learning and some of the structural sources of persistence, such as habit formation in consumption and inflation indexation, that are typically needed in monetary models with rational expectations to match the persistence of macroeconomic variables. I estimate the model by likelihood-based Bayesian methods, which allow the estimation of the learning gain coefficient jointly with the `deep' parameters of the economy. The empirical results show that when learning replaces rational expectations, the estimated degrees of habits and indexation drop near zero. This finding suggests that persistence arises in the model economy mainly from expectations and learning. The posterior model probabilities show that the specification with learning fits significantly better than does the specification with rational expectations. Finally, if learning rather than mechanical sources of persistence provides a more appropriate representation of the economy, the implied optimal policy will be different. The policymaker will also incur substantial costs from misspecifying private expectations formation.persistence, constant-gain learning, expectations, habit formation in consumption, inflation inertia, Phillips curve, Bayesian econometrics, New-Keynesian model.

A Bayesian DSGE Model with Infinite-Horizon Learning: Do "Mechanical" Sources of Persistence Become Superfluous?

This paper estimates a monetary DSGE model with learning introduced from the primitive assumptions. The model nests infinite-horizon learning and features, such as habit formation in consumption and inflation indexation, that are essential for the model fit under rational expectations. I estimate the DSGE model by Bayesian methods, obtaining estimates of the main learning parameter, the constant gain, jointly with the deep parameters of the economy. The results show that relaxing the assumption of rational expectations in favor of learning may render mechanical sources of persistence superfluous. In particular, learning appears a crucial determinant of inflation inertia.Infinite-horizon learning; DSGE model; Bayesian estimation; Non-rational expectations; Inflation persistence; Habit formation

Has globalization transformed U.S. macroeconomic dynamics?

This paper estimates a structural New Keynesian model to test whether globalization has changed the behavior of U.S. macroeconomic variables. Several key coefficients in the model--such as the slopes of the Phillips and IS curves, the sensitivities of domestic inflation and output to "global" output, and so forth--are allowed in the estimation to depend on the extent of globalization (modeled as the changing degree of openness to trade of the economy), and, therefore, they become time-varying. The empirical results indicate that globalization can explain only a small part of the reduction in the slope of the Phillips curve. The sensitivity of U.S. inflation to global measures of output may have increased over the sample, but it remains very small. The changes in the IS curve caused by globalization are similarly modest. Globalization does not seem to have led to an attenuation in the effects of monetary policy shocks. The nested closed economy specification still appears to provide a substantially better fit of U.S. data than various open economy specifications with time-varying degrees of openness. Some time variation in the model coefficients over the postwar sample exists, particularly in the volatilities of the shocks, but it is unlikely to be related to globalization.Globalization ; Macroeconomics - Econometric models ; Inflation (Finance) ; Monetary policy ; Banks and banking, Central ; Phillips curve

The Evolution of the Fed's Inflation Target in an Estimated Model under RE and Learning

This paper aims to infer the evolving Fed's inflation target by estimating a monetary model under the assumptions of RE and learning. The results emphasize how different assumptions about expectations may have important effects on the inferred target movements.Time-varying inflation target; Learning, Expectations, Bayesian estimation

Learning about the Interdependence between the Macroeconomy and the Stock Market

How strong is the interdependence between the macroeconomy and the stock market? This paper estimates a New Keynesian general equilibrium model, which includes a wealth effect from asset price fluctuations to consumption, to assess the quantitative importance of interactions among the stock market, macroeconomic variables, and monetary policy. The paper relaxes the assumption of rational expectations and assumes that economic agents learn over time and form near-rational expectations from their perceived model of the economy. The stock market, therefore, affects the economy through two channels: through a traditional ``wealth effect" and through its impact on agents' expectations. Monetary policy decisions also affect and are potentially affected by the stock market. The empirical results show that the direct wealth effect is modest, but asset price fluctuations have had important effects on output expectations. Shocks in the stock market can account for a large portion of output fluctuations. The effect on expectations, however, has declined over time.Stock market; Wealth channel; Monetary policy; Constant-gain learning; Bayesian estimation; Expectations

Adaptive Learning and Inflation Persistence

What generates persistence in inflation? Is inflation persistence structural? This paper investigates learning as a potential source of persistence in inflation. The paper focuses on the price-setting problem of firms and presents a model that nests structural sources of persistence (indexation) and learning. Indexation is typically necessary under rational expectations to match the inertia in the data and to improve the fit of estimated New Keynesian Phillips curves. The empirical results show that when learning replaces the assumption of fully rational expectations, structural sources of persistence in in?ation, such as indexation, become unsupported by the data. The results suggest learning behavior as the main source of persistence in inflation. This finding has implications for the optimal monetary policy. The paper also shows how one's results can heavily depend on the assumed learning speed. The estimated persistence and the model fit, in fact, vary across the whole range of constant gain values. The paper derives the best-fitting constant gains in the sample and shows that the learning speed has substantially changed over time.Adaptive learning; Inflation persistence; Sticky prices; Best-fitting constant gain; Learning speed; Expectations

Global Slack and Domestic Inflation Rates: A Structural Investigation for G-7 Countries

Recent papers have argued that one implication of globalization is that domestic inflation rates may have now become more a function of ``global", rather than domestic, economic conditions, as postulated by closed-economy Phillips curves. This paper aims to assess the empirical importance of global output in determining domestic inflation rates by estimating a structural model for a sample of G-7 economies. The model can capture the potential effects of global output fluctuations on both the aggregate supply and the aggregate demand relations in the economy and it is estimated using full-information Bayesian methods. The empirical results reveal a significant effect of global output on aggregate demand in most countries. Through this channel, global economic conditions can indirectly affect inflation. The results, instead, do not seem to provide evidence in favor of altering domestic Phillips curves to include global slack as an additional driving variable for inflation.Globalization; Global Slack; Inflation Dynamics; Phillips Curve; Bayesian Estimation