The Volatility Costs of Procyclical Lending Standards: An Assessment Using a DSGE Model

The ongoing financial turmoil has triggered a lively debate on ways of containing systemic risk and lessening the likelihood of future boom-and-bust episodes in credit markets. Particularly, it has been argued that banking regulation might attenuate procyclicality in lending standards by affecting the behavior of banks capital buffers. This paper uses a two-country DSGE model with financial frictions to illustrate how procyclicality in borrowing limits reinforces the ”overreaction” of asset prices to shocks described by Aiyagari and Gertler (1999), and to quantify the stabilization gains from policies aimed at smoothing cyclical swings in credit conditions. Results suggest that, in financially constrained economies, the ensuing volatility reduction in equity prices, investment, and external imbalances would be sizable. In the presence of cross-border spillovers, gains would be even higher.Credit Cycles; Collateral Constraints; DSGE Models

Monetary Magic? How the Fed Improved the Supply Side of the Economy

Extending recent theoretical contributions on sources of inflation inertia, we argue that monetary uncertainty accounts for sluggish expectations adjustment to nominal disturbances. Estimating a model in which rational individuals learn over time about shifts in U.S. monetary policy and the Phillips curve, we find strong evidence that this link exists. These results question the standard approach for evaluating monetary rules by assuming unchanged private sector responses, help clarify the role of monetary stability in reducing output variability in the U.S. and elsewhere, and tell a subtle and dynamic story of the interaction between monetary policy and the supply-side of the econoInflation dynamics; Monetary policy; Kalman filter

Monetary Magic? How the Fed Improved the Supply Side of the Economy

Extending recent theoretical contributions on sources of inflation inertia, we argue that monetary uncertainty accounts for sluggish expectations adjustment to nominal disturbances. Estimating a model in which rational individuals learn over time about shifts in U.S. monetary policy and the Phillips curve, we find strong evidence that this link exists. These results question the standard approach for evaluating monetary rules by assuming unchanged private sector responses, help clarify the role of monetary stability in reducing output variability in the U.S. and elsewhere, and tell a subtle and dynamic story of the interaction between monetary policy and the supply-side of the ecoInflation dynamics; Monetary Policy; Kalman filter

Policy evaluation with macroeconometric models

This thesis presents a number of examples where macroeconometric models are employed as useful tools for evaluation of contemporary policy problems. A range of approaches is proposed to shed light on how macromodels can actually contribute to the policy debate. In particular, the thesis emphasises how different models maybe augmented or modified and stresses the need for care in the experimental design of policy simulations. Small stylised models of the UK economy are estimated in the first part of this thesis. They are used to assess the performance of simple monetary policy rules under the current inflation targeting monetary regime. In a monetary policy regime of inflation targeting, the appropriate target band-width can be assessed by calculating the variance of inflation in a macroeconomic model under alternative policy rules. A recent Bank of England study concludes from stochastic simulation of a small semi-structural model that a 'fairly substantial lump of inflation uncertainty' exists in the United Kingdom. In chapter 2 an extended and improved version of that model is developed while their estimates of inflation variability are revised downwards by deploying analytic techniques. In chapter 3 a new small 'semi structural' dynamic model of the UK economy is estimated, with particular attention to the modelling of wages and prices. It is used to assess the performance of simple monetary policy rules, including 'inflation forecast targeting' and 'Taylor' rules, while taking into account different degrees of forward-lookingness in both inflation targeting horizon and wage bargaining. Computation of asymptotic inflation-output standard-error trade-offs is provided under various specifications and parametrisations of the model. Large-scale country models have the convenience to make explicit a complete range of relationships among macroeconomic variables most of which, for obvious reasons, are neglected in smaller dynamic models. As a consequence, such quantitative framework offers an unique opportunity to evaluate not only the aggregate impact of exogenous shocks on the variables of interest, but also to identify the underlying economic mechanisms enabling the transmission of such shocks. In the second part of the thesis, I undertake simulations of the National Institute's Domestic Econometric Model (NIDEM) to analyse the characteristics of the UK monetary transmission mechanism. Chapter 4 emphasises that the impact of interest rate movements on real variables is strictly determined by both the monetary regime at work and the underlying assumptions regarding consumption behaviour. Certainly, the steady integration of the members of the EMU and increasing awareness of the need for closer co-operation in monetary and fiscal policy have stimulated greater interest in modelling interdependencies between European countries and the impact and feedbacks from the rest of the world economy. Many of the key issues have now an international aspect, so it becomes more and more difficult to rely on single-country models to provide necessary analysis. International transmission mechanisms can therefore be better tackled with a multi-country model. The third and last part of this thesis focuses on cross-country asymmetric transmissions in response to a common monetary shock within EMU. In particular, in chapter 5 an empirical analysis of the links between monetary and fiscal policy within EMU is presented. This is done through simulation of a neo-classical highly non-Ricardian multi-country model: the IMF's MULTIMOD Mark III (MM3). Chapter 6 provides further evidence about the effects of embracing a Monetary Union when underlying macroeconomist structures still differ across countries. By use of the same model-based quantitative framework, this chapter examines the role of nominal and real rigidities in European labour markets for the assessment of asymmetries in monetary transmission under various monetary regimes

(Un)naturally low? Sequential Monte Carlo tracking of the US natural interest rate

Following the 2000 stockmarket crash, have US interest rates been held "too low" in relation to their natural level? Most likely, yes. Using a structural neo-Keynesian model, this paper attempts a real-time evaluation of the US monetary policy stance while ensuring consistency between the specification of price adjustments and the evolution of the econ- omy under flexible prices. To do this, the model's likelihood function is evaluated using a Sequential Monte Carlo algorithm providing inference about the time-varying distribution of structural parameters and unobservable, nonstationary state variables. Tracking down the evolution of underlying stochastic processes in real time is found crucial (i) to explain postwar Fed's policy and (ii) to replicate salient features of the data. JEL Classification: E43, C11, C15Bayesian Analysis, DSGE Models, Natural Interest Rate, Particle Filters

Policy evaluation with macroeconometric models

SIGLEAvailable from British Library Document Supply Centre- DSC:DXN064845 / BLDSC - British Library Document Supply CentreGBUnited Kingdo

Explicit and Implicit Targets in Open Economies

Under a flexible inflation targeting regime, should policymakers avoid any reaction to movements in the foreign exchange market? Using data for six advanced open economies explicitly targeting inflation, the paper examines empirically whether real exchange rate disequilibria systematically affect the conduct of monetary policy. Estimates indicate that monetary policy responses in inflation-targeting, open economies have changed significantly, as the institutional framework for the conduct of monetary policy has evolved. In particular, an explicit target for core inflation and a greater use of the expectation channel of monetary policy appear to be key features of the newest policy framework. In this context, central banks are unlikely to react to regular fluctuations in the exchange rate.Inflation targeting;Exchange rates;inflation, monetary policy, central bank, inflation targeting regime, inflation target, monetary authority, foreign exchange, optimal monetary policy, monetary fund, inflation ? targeting, monetary policy rules, monetary authorities, real output, aggregate demand, money market, monetary responses, monetary ? policy, effective exchange rates, inflationary pressures, real interest rate, foreign currency, monetary policy decision, inflationary expectations, monetary ? policy rules, high inflation, monetary regimes, monetary regime, inflation forecasts, inflation dynamics, rational expectations, price inflation, monetary policy objectives, real exchange rates, inflation targeting framework, money market interest rate, monetary policies, monetary framework, real rates, price stability, expectations of inflation, monetary reaction functions, independent monetary policy, inflation rate, nominal rate of interest, monetary policy decisions, monetary reaction function

Long-Run Productivity Shifts and Cyclical Fluctuations

Using unobserved stochastic components and Kalman filter techniques, the paper assesses the relative importance of transitory and permanent shifts in Italian real GDP within a production function framework. Evidence suggests that the increase in hours worked that has accompanied pension and labor market reforms accounts for the bulk of low-frequency variation in growth, but points to factor utilization as the main driver of business cycle fluctuations. In contrast with the predictions of standard Real Business Cycle models, a positive shock to the underlying rate of total factor productivity growth generates a slight decline in hours, whereas the response of output to the same shock is found to be positive.Economic models;business cycle, employment, unemployment, growth accounting, business cycle fluctuations, unemployment rate, nairu, gdp growth, labor participation, business cycles, growth rate, real gdp, real business cycle, employment growth, total factor productivity, growth rates, rate of unemployment, employment rates, employment indicators, private employment, employment rate, gdp growth rate, female labor force, employment fluctuations, real business cycles, male labor force, private employment agencies, labor force participation, self employment, economic growth, labor force population, total employment, aggregate employment, employment agencies, source of business cycles

The Volatility Costs of Procyclical Lending Standards: An Assessment Using a DSGE Model

The ongoing financial turmoil has triggered a lively debate on ways of containing systemic risk and lessening the likelihood of future boom-and-bust episodes in credit markets. Particularly, it has been argued that banking regulation might attenuate procyclicality in lending standards by affecting the behavior of banks capital buffers. This paper uses a two-country DSGE model with financial frictions to illustrate how procyclicality in borrowing limits reinforces the ”overreaction” of asset prices to shocks described by Aiyagari and Gertler (1999), and to quantify the stabilization gains from policies aimed at smoothing cyclical swings in credit conditions. Results suggest that, in financially constrained economies, the ensuing volatility reduction in equity prices, investment, and external imbalances would be sizable. In the presence of cross-border spillovers, gains would be even higher

Euro Area Sovereign Risk During the Crisis

While the use of public resources is critical to cushion the impact of the financial crisis on the euro-area economy, it is key that the entailed fiscal costs not be seen by markets as undermining fiscal sustainability. From this perspective, to what extent do movements in euro area sovereign spreads reflect country-specific solvency concerns? In line with previous studies, the paper suggests that euro area sovereign risk premium differentials tend to comove over time and are mainly driven by a common time-varying factor, mimicking global risk repricing. Since October 2008, however, there is evidence that markets have become progressively more concerned about the potential fiscal implications of national financial sectors'' frailty and future debt dynamics. The liquidity of sovereign bond markets still seems to play a significant (albeit fairly limited) role in explaining changes in euro area spreads.Euro Area;Fiscal policy;European Union;External debt;Financial sector;Fiscal management;Fiscal sector;Public finance;Risk premium;Sovereign debt;bond, sovereign bond, bonds, bond markets, financial markets, bond market, government bond, bond spreads, government bonds, sovereign bond markets, fiscal sustainability, financial system, financial institutions, fiscal implications, financial market, fiscal balance, sovereign bonds, government bond market, fiscal discipline, stock market, fiscal deficits, fiscal stimulus, international financial markets, fiscal costs, financial systems, debt-service, fiscal positions, aggregate demand, bond spread, fiscal vulnerabilities, fiscal expansion, fiscal variables, treasury bonds, bond yield, public finances, national fiscal rules, bond prices, fiscal conditions, fiscal cost, asset markets, tax revenues, debt stock, financial derivative, derivative, corporate bonds, fiscal rules, fiscal adjustments, money market, fiscal policies, future fiscal deficits, fiscal developments, fiscal deficit, bond yields, government bond markets