Non-linear multivariate adjustment of the UK real exchange rate

Based on a multivariate non-linear model, this paper recognises an important role for the real exchange rate in affecting UK labour market conditions. The short-run real exchange rate adjusts quickly to disequilibrium deviations of the real exchange rate from its long-run level outside a rather wide interval band. When the real exchange rate is undervalued, short-run unemployment falls as firms respond to an improvement in domestic competitiveness by increasing their demand for labour. Further, there is a strong response of short-run unemployment to the disequilibrium error outside a narrow interval band. To the extent that the real exchange rate equation reflects monetary policy considerations, our results imply that unemployment can be targeted by economic policy. Furthermore, if economic authorities want to avoid large swings in unemployment then they should be prepared to intervene in exchange markets with the aim of keeping real exchange rate movements within a narrow interval band

A Non-Linear Multivariate Model of the U.K. Real Exchange Rate

This paper discusses linearity testing for the UK real exchange rate within a multivariate framework. First we estimate a long-run real exchange rate relationship within a system involving real wages, the unemployment rate and the real price of oil. Then we adopt a logistic transition function for the estimated relationship and show that non-linearities in the discrepancy between the real exchange rate and its implied long-run level affect the short-run real exchange rate equation. We also find that when the real exchange rate is undervalued, unemployment falls as firms respond to an improvement in domestic competitiveness by increasing their demand for labour. At the same time, workers respond to the improvement in domestic competitiveness by demanding and getting higher wages. Further, the effect on unemployment and wages is nonlinear

Uncertainty and UK Monetary Policy

This paper provides empirical evidence on the response of monetary policymakers to uncertainty. Using data for the UK since the introduction of inflation targets in October 1992, we find that the impact of inflation on interest rates is lower when inflation is more uncertain and is larger when the output gap is more uncertain. These findings are consistent with the predictions of the theoretical literature. We also find that uncertainty has reduced the volatility but has not affected the average value of interest rates and argue that monetary policy would have been less passive in the absence of uncertainty

Uncertainty and Monetary Policy Rules in the United States

This paper analyses the impact of uncertainty about the true state of the economy on monetary policy rules in the US since the early 1980s. Extending the Taylor rule to allow for this type of uncertainty, we find evidence that the predictions of the theoretical literature on responses to uncertainty are reflected in the behaviour of policymakers, suggesting that policymakers are adhering to prescriptions for optimal policy. We find that the impact of uncertainty was most marked in 1983, when uncertainty increased interest rates by up to 140 basis points, in 1989-90, when uncertainty increased interest rates by up to 50 basis points and in 1996-2001 when uncertainty reduced interest rates by up to 50 basis points over five years

Testing the Opportunistic Approach to Monetary Policy

The Opportunistic Approach to Monetary Policy is an influential but untested model of optimal monetary policy. We provide the first tests of the model, using US data from 1983Q1-2004Q1. Our results support the Opportunistic Approach. We find that policymakers respond to the gap between inflation and an intermediate target that reflects the recent history of inflation. We find that there is no response of interest rates to inflation when inflation is within 1% of the intermediate target but a strong response when inflation is further from the intermediate target

Common risk factors in the US and UK interest swap markets-evidence from a non-linear vector autoregression approach

This paper produces evidence in support of the existence of common risk factors in the US and UK interest rate swap markets. Using a multivariate smooth transition autoregression (STVAR) framework, we show that the dynamics of the US and UK swap spreads are best described by a regime-switching model. We identify the existence of two distinct regimes in US and UK swap spreads; one characterized by a "flat" term structure of US interest rates and the other characterized by an "upward" slopping US term structure. In addition, we show that there exist significant asymmetries on the impact of the common risk factors on the US and UK swap spreads. Shocks to UK oriented risk factors have a strong effect on the US swap markets during the "flat" slope regime but a very limited effect otherwise. On the other hand, US risk factors have a significant impact on the UK swap markets in both regimes. Despite their added flexibility, the STVAR models do not consistently produce superior forecasts compared to less sophisticated autoregressive (AR) and vector autoregressive (VAR) models

Asymmetric and non linear adjustment in the revenue expenditure models

The purpose of this paper is to empirically analyse the revenue-expenditure models of public finance by considering the possibility of non-linear and asymmetric adjustment. A long-run relationship between general government expenditure and revenues is identified for Italy. Following system-wide shocks, the estimated relationship adjusts slowly to equilibrium, mainly due to complex administrative procedures that add to the sluggishness of tax collection and undermine the effective monitoring of public spending. Exogeneity of public expenditure implies that taxes rather than spending, carry the burden of short-run adjustment to correct budgetary disequilibria. Allowing for non-linear adjustment and the possibility of multiple equilibria, our findings show evidence of asymmetric adjustment around a unique equilibrium. In particular, we find that when government expenditure is too high, adjustment of taxes takes places at a faster rate than when it is too low. Further, there is evidence of a faster adjustment when deviations from the equilibrium level get larger, pointing to a Leviathan-style, revenue-maximiser government

Real-time Optimal Monetary Policy with Undistinguishable Model Parameters and Shock Processes Uncertainty

This paper studies optimal real-time monetary policy when the central bank takes the exogenous volatility of the output gap and inflation as proxy of the undistinguishable uncertainty on the exogenous disturbances and the parameters of its model. The paper shows that when the exogenous volatility surrounding a specific state variable increases, the optimal policy response to that variable should increase too, while the optimal response to the remaining state variables should attenuate or be unaffected. In this way the central bank moves preemptively to reduce the risk of large deviations of the economy from the steady state that would deteriorate the distribution forecasts of the output gap and inflation. When an empirical test is carried out on the US economy the model predictions tend to be consistent with the data

Non-linear adjustments in fiscal policy

This paper provides evidence that the Italian public finances are sustainable, as the country meets its intertemporal budget constraint. Nevertheless, the burden of correcting budgetary disequilibria is entirely carried by changes in taxes, which can have some detrimental economic effects, rather than changes in government spending or policy mixes. Our non-linear analysis, in particular, shows that taxes adjust more rapidly when deviations from the equilibrium level get larger, and that they are downward inflexible not only with respect to their long-run level, but also during periods of decreasing economic growth. In order to correct the undesirable trend of high fiscal pressure and high public debt in Italy, structural expenditure reforms aiming at a higher degree of government expenditure adjustment are needed. This would also relax the asymmetries reported in the paper

Non linear inflationary dynamics: evidence from the UK

This paper estimates a variety of models of inflation using quarterly data for the UK between 1965 and 2001. We find strong evidence that the persistence of inflation is nonlinear and that inflation adjusted more rapidly in periods of macroeconomic stress such as the mid-1970s, the early 1980s and the late 1980s-early 1990s. Our results imply that inflation will respond more strongly and more rapidly to changes in interest rates when the price level is further away from the steady state level. This has implications for optimal monetary policy