The A W Phillips memorial lecture to the New Zealand Association of Economists: Monetary Policy – should it move onto a price level target?

We examine whether inflation targeting should be regarded as optimal. Targeting inflation implies (undesirably) that price level variance tends to infinity: we produce some evidence from both a representative agent model and a long-used forecasting model that, once an endogenous indexation response is allowed for, price level targeting imposes no extra costs of macro variability, indeed gives significant gains.montary policy targeting

Commentary on "Economic projections and rules of thumb for monetary policy "

Monetary policy

MONETARISM

Monetarism is hard to define because it is not the doctrine of a school that is sharply differentiated from the rival Keynesian and new classical schools. While some ecconomists are clearly monetarists, others take intermediate positions that make it more or less arbitrary whether to call them monetarists. The basic theoretical propositions of monetarism, that changes in the quantity of money (defined as currency plus at least checkable deposits) play the central role in the determination of nominal income. differs only in degree from the view held by most Keynesians that changes in th~e quantity of money are a major (and in the long run the dominant) determinant of changes in nominal income. There is little disagreement between Keynesians, monetarists and new clac+A economists about long run equilibrium. But while new classical economists think that this equilibrium is reached rapidly, and Keynesians think it is reached slowly, monetarists take an intermediate position. That is an important difference because many policy questions relate to this intermediate run. To be sure, much of the monetarist research strategy focuses on changes in the sdpply of and demand for money, while the Keynesian strategy is to look also at the propensity to consume, the marginal efficiency of investment, government expenditures and net exports. But this difference relates only to the way of proceeding with research, and not directly to how the economy functions. There is greater disagreement on policy. Some monetarists agree with K~ynesians, that - in principle - fiscal policy can have a significant effect on nominal income, but deny that in practice it has a large effect. Others deny that even in principle fiscal policy has a significant effect on income. While hard-core monetarists believe that the money supply should grow at a fixed rate, other merely want the growth rate of money to be stable, a position not so different from that of some Keynesians who oppose %ne-tuning"". There are several major sources of monetarism. One is the work of MiRon Friedman (1 912-) (see Friedrnan, 1956, l969), a leader of the Chicago school, and Anna Schwartz (1915-). The other is the work of Karl Brunner (1916-89) and Allan Meker (1 928 -).(See Bwnner and Mettzer, 1989; 1993) Brunner and Meltzer''s work temds to focus somewhat more on theoretical issues than does Friedman''s. For a time

Testing macro models for policy use - An insurrection in applied modelling

I describe a new departure in classical testing methods based on Indirect Inference. I argue that it gives policymakers, anxious to know if their models give reliable policy conclusions, a way to find out. I discuss how using Monte Carlo experiments my co-authors and I have found that in the small samples typically available in macroeconomic modelling, the Indirect Inference Wald, IIW, test has considerably more power than the popular direct inference test using the Likelihood Ratio, LR. This is both because the LR is applied after re-estimation of the model error processes and because the IIW test uses the false model's own restricted distribution for the auxiliary model's coefficients. This greater power allows users to focus this test more narrowly on features of interest, trading off power against tractability. If they can find a model version that is not rejected by the test, they can then discover the robustness of their model results to the parameter variations that might also have passed the test

Being in the EU is like being ruled by a foreign power immune to the normal processes of political economy

Many British citizens want self-government again, as they had for hundreds of years before the ‘Common Market’ that they joined became a European super-state on the way to ‘ever-closer union’. According to Patrick Minford, this seems to be a reasonable demand. He claims that under the rules of British democracy the citizenry are always able to eject the government, through a general election. However, whatever they do about the elite that governs the EU, they can never get rid of it or change its decisions. He claims it is like being ruled by a foreign power immune to the normal processes of political economy

The Observational Equivalence of Taylor Rule and Taylor-type Rules

In a variety of recent papers, researchers have found that interest rate behaviour approximately follows a Taylor rule. From this they have concluded that the central bank is following a Taylor rule as its monetary policy reaction function. We show that such interest rate behaviour results when the central bank may be following quite different monetary policy rules from the one proposed by Taylor. In other words an interest rate relation with output and inflation does not identify a central bank reaction function.

Testing a DSGE model of the EU using indirect inference

We use the method of indirect inference, using the bootstrap, to test the Smets and Wouters model of the EU against a VAR auxiliary equation describing their data; the test is based on the Wald statistic. We find that their model generates excessive variance compared with the data. If the errors are scaled down, then the original model marginally passes the Wald test. We compare a New Classical version of the model which passes the test but generates a combination of excessive inflation variance and inadequate output variance. If the large consumption and investment errors are removed as possibly due to low frequency events, then the New Classical version passes easily while the original version is strongly rejected.Bootstrap, DSGE Model, VAR model, Model of EU, indirect inference, Wald statistic.

Testing a Simple Structural Model of Endogenous Growth

The efect of taxation on growth is embodied in a model of a small open economy with endogenous growth. The structural model is estimated on post-war panel data for 76 countries and the bootstrap is used to produce the model’s sampling variation. Panel data regressions of growth on taxation do not reject this model but do reject a model with no tax effects.endogenous growth, taxation, business regulation, bootstrap, model validation.

Testing a DSGE model of the EU using indirect inference

We use the method of indirect inference, using the bootstrap, to test the Smets and Wouters model of the EU against a VAR auxiliary equation describing their data; the test is based on the Wald statistic. We find that their model generates excessive variance compared with the data. But their model passes the Wald test easily if the errors have the properties assumed by SW but scaled down. We compare a New Classical version of the model which also passes the test easily if error properties are chosen using New Classical priors (notably excluding shocks to preferences). Both versions have (different) difficulties fitting the data if the actual error properties are used.Bootstrap, DSGE Model, VAR model, Model of EU, indirect inference, Wald statistic.