Matching Theory and Data: Bayesian Vector Autoregression and Dynamic Stochastic General Equilibrium Models

This paper shows how to identify the structural shocks of a Vector Autore- gression (VAR) while at the same time estimating a dynamic stochastic general equilibrium (DSGE) model that is not assumed to replicate the data generating process. It proposes a framework to estimate the parameters of the VAR model and the DSGE model jointly: the VAR model is identified by sign restrictions derived from the DSGE model; the DSGE model is estimated by matching the corresponding impulse response functions.Bayesian Model Estimation, Vector Autoregression, Identification.

Optimal Policy Under Model Uncertainty: A Structural-Bayesian Estimation Approach

In this paper we propose a novel methodology to analyze optimal policies under model uncertainty in micro-founded macroeconomic models. As an application we assess the relevant sources of uncertainty for the optimal conduct of monetary policy within (parameter uncertainty) and across models (specification uncertainty) using EU 13 data. Parameter uncertainty matters only if the zero bound on interest rates is explicitly taken into account. In any case, optimal monetary policy is highly sensitive with respect to specification uncertainty implying substantial welfare gains of a robustly-optimal rule that incorporates this risk.Optimal monetary policy, model uncertainty, Bayesian model estimation.

Nested models and model uncertainty

Uncertainty about the appropriate choice among nested models is a central concern for optimal policy when policy prescriptions from those models differ. The standard procedure is to specify a prior over the parameter space ignoring the special status of some sub-models, e.g. those resulting from zero restrictions. This is especially problematic if a model's generalization could be either true progress or the latest fad found to fit the data. We propose a procedure that ensures that the specified set of sub-models is not discarded too easily and thus receives no weight in determining optimal policy. We find that optimal policy based on our procedure leads to substantial welfare gains compared to the standard practice.Optimal monetary policy, model uncertainty, Bayesian model estimation

Toward a Taylor rule for fiscal policy

This paper presents a procedure to determine policy feedback rules in dynamic stochastic general equilibrium (DSGE) models. We illustrate our approach with fiscal feedback rules for tax instruments in a standard medium-scale DSGE model. First, we approximate the optimal dynamic behavior of the economy using simple linear feedback rules. Then we calculate the elasticities of the model variables' moments with respect to the feedback coefficients. The feedback coefficients associated with the highest elasticities form the policy feedback rules to be estimated. Our results stress the importance of carefully modeled fiscal tax policy in two dimensions: (i) with respect to the dynamic responses of fiscal policy to exogenous shocks and (ii) with respect to the historical shock decomposition of fiscal policy. --Fiscal policy,Bayesian model estimation,Identification

Pre-announcement and Timing - The Effects of a Government Expenditure Shock

This paper investigates the effect of a government expenditure shock on consumption and real wages. I identify the shock by exploiting its pre-announced nature, i.e. different signs of the responses in investment, hours worked and output during the announcement and after the realization of the shock. Since pre-announcement leads to a non-stationary moving average representation, I estimate and identify a VMA model. The identifying restrictions are derived from a DSGE model, which is estimated by matching the impulse response functions of the VMA model. Private consumption is found to respond negatively during the announcement period and positively after the realization. The reaction of real wages is significantly positive on impact, decreases during the announcement horizon, and is again significantly positive for two quarters after the realization.Fiscal Policy shock, Bayesian Estimation, DSGE model, Vector Autoregression

Same, but different: Testing monetary policy shock measures

In this study, we test whether three popular measures for monetary policy, that is, Romer and Romer (2004), Barakchian and Crowe (2013), and Gertler and Karadi (2015), constitute suitable proxy variables for monetary policy shocks. To this end, we employ different test statistics used in the literature to detect weak proxy variables. We find that the measure derived by Gertler and Karadi (2015) is the most suitable in this regard

Implementable Fiscal Policy Rules

We use a novel procedure to identify fiscal feedback rules for the US: We start by estimating a DSGE model and on that basis compute the Ramsey optimal responses to structural shocks. Then we let the policy maker choose from a general set of rules to match the dynamic behavior of a number of key variables like output, debt, and consumption, in the competitive equilibrium with their corresponding dynamic behavior in the Ramsey equilibrium. In the next step we estimate the model again but employ the contingency derived previously. The policy rules derived are general, not as complex as Ramsey and easily implementable

Financial Repression in General Equilibrium

Financial repression allows governments to borrow at artificially low interest rates. Quantifying financial repression is challenging, because it relies on an estimate of the interest rate which would prevail in the absence of repression. In this paper, we put forward a quantitative business cycle model which features financial repression. We estimate the model on US times series for the period 1948-1979 in order to quantify the extent of financial repression and its impact on the economy

The Impact of Monetary Policy on Structural Reforms in the Euro Area. Bertelsmann Stiftung May 2020.

Since the euro area crisis, there has been an intense discussion about the potential side effects of ECB policy on reform efforts of euro area countries. This discussion is set to become even more intense in the wake of the corona crisis and the ECB’s forceful intervention. Opponents of expansionary monetary policy contend that it reduces reforms, whereas proponents argue that it spurs reforms. We test these arguments empirically by studying the effect of monetary policy shocks on structural reform adoption in the euro area. Using an event study approach, we find that surprise monetary expansions causally increase the likelihood of structural reforms significantly: For the period between 2006 and 2016, a monetary surprise expansion of 25 basis points by the ECB increased on average countries’ reform rate by roughly 20 percentage points after two years. This effect is stronger for countries with weaker macroeconomic fundamentals or tighter public budget constraints. The findings are consistent with the ‘room-for-manoeuver hypothesis’ that expansionary monetary policy spurs competition-friendly supply-side policy by reducing the shortrun costs of reforms and increasing governments’ financial leeway. More research will be required to establish whether the results are applicable in a post-corona economic environment

Monetary Policy at the Crossroads – How to Respond to the Climate Crisis

Climate change has wide-ranging effects on society and the economy, presenting challenges for central banks. These challenges encompass both physical risks stemming from climate change and transition risks related to the shift toward a more sustainable economy. On one side, central banks need to respond to fluctuations in the general price level caused by climate-related factors like “climateflation,” “fossilflation,” “greenflation,” and “RE-disinflation.” On the other side, both physical and transition risks pose threats to financial stability. To effectively address these challenges, central banks must adapt their monetary policies and macroprudential tools. Failing to do so could hinder their ability to achieve their core objectives, which include maintaining price stability and often promoting sustainable economic growth. This focus paper offers specific suggestions as to what these adaptations might look like. First, it proposes the introduction of targeted green refinancing lines. Second, it argues for an adjustment of central banks’ eligible collateral frameworks. Third, the authors propose excluding bonds issued by carbon intensive companies that lack credible green transition strategies from bond purchase programs. In addition, central banks should incorporate climate risks into their regulatory activities within financial markets. For example, this could include mandatory disclosure and reporting requirements regarding the sustainability of the portfolios held by banks, as well as the performance of regular stress tests focusing on climate risks. Moreover, in the realm of banking regulation, capital requirements should be adapted to account for climate and environmental risks. In principle, alterations in the use of policy instruments can lead to goal conflicts for the central bank. For example, an excessively loose monetary policy aimed at encouraging sustainable investment could result in a central bank failing to achieve its objective of price stability. In addition, some observers fear that the transition to a green economy might lead central banks to take over tasks that are primarily the responsibility of national governments. This could undermine a central bank’s independence and thus its ability to guarantee stable prices. However, this focus paper shows that with an appropriate choice of instruments, central banks need not expose themselves to goal conflicts, and that they can pursue their price stability mandate while also factoring in climate risks and impacts. Indeed, Indeed, the adjustments to a central bank’s policy instruments proposed here would actually help, for example, the ECB pursue its primary mandate while simultaneously fulfilling its secondary mandate of supporting EU economic policies