Monetary and Fiscal Policy with Flexible Exchange Rates

If price decisions are taken neither continuously nor in perfect synchronization, the process of adjustment of all prices to a new nominal level will imply temporary movements in relative prices. It might then well be that, to avoid these movements in relative prices, each price setter will want to move his own price slowly compared to others. The result will be a slow movement of all prices to their new nominal level, and substantial inertia of the price level. This paper formalizes this intuitive argument and reaches four main conclusions: (1) Even small departures from perfect synchronization can generate substantial price level inertia. (2) If price decisions are desynchronized, even anticipated movements in money will usually have an effect on economic activity. It is however possible to find paths of money deceleration which reduce inflation at no cost in output. (3) Price desynchronization has implications for relative price movements as well as for the price level. Goods early in the chain of production have more price and profit variability than goods further down the chain. (4) Price inertia, if it is due to price desynchronization, may be difficult to remove. It may well be that, given the timing decisions of others, no agent has an incentive to change his own timing decision: the time structure of price desynchronization may be stable.

The Thatcher Experiment: The First Two Years

macroeconomics, Thatcher

Impending U.S. Spending Bust? The Role of Housing Wealth as Borrowing Collateral

Using data from the Panel Study of Income Dynamics, this paper considers the mechanism by which changing house values impact U.S. household spending. The results suggest that house values affect consumption by serving as collateral for households to borrow against to smooth their spending. The results show that the consumption of households who need to borrow against their home equity increases by roughly 11 cents per $1.00 increase in their housing wealth. Changing house values, however, have little effect on the expenditures of households who do not need to borrow to finance their consumption. Based on these results, the paper further finds that declining housing wealth has a relatively small implied negative impact on aggregate consumption expenditures

Financial Crisis, Global Liquidity and Monetary Exit Strategies

We develop a roadmap of how the ECB should further reduce the volume of money (money supply) and roll back credit easing in order to prevent inflation. The exits should be step-by-step rather than one-off. Communicating about the exit strategy must be an integral part of the exit strategy. Price stability should take precedence in all decisions. Due to vagabonding global liquidity, there is a strong case for globally coordinating monetary exit strategies. Given unsurmountable practical problems of coordinating exit with asymmetric country interests, however, the ECB should go ahead - perhaps joint with some Far Eastern economies. Coordination of monetary and fiscal exit would undermine ECB independence and is also technically out of reach within the euro area

The Liquidity Trap, the Real Balance Effect, and the Friedman Rule

This paper studies the behavior of the economy and the efficacy of monetary policy under zero nominal interest rates, using a model with population growth that nests, as a special case, a more conventional specification in which there is a single infinitely lived representative agent. The paper shows that with a growing population, monetary policy has distributional effects that give rise to a real balance effect, thereby eliminating the liquidity trap. These same distributional effects, however, can also work to make many agents much worse off under zero nominal interest rates than they are when the nominal interest rate is positive