Regime Shifts and the Stability of Backward Looking Phillips Curves in Open Economies

In this paper we assess the stability of open economy backward-looking Phillips curves estimated over two different exchange rate regimes. The pseudo-data employed in our econometric exercise come from the simulation of a New-Keynesian hybrid model suited for performing monetary policy analysis. Two main results arise: i) in most of the simulated scenarios the estimated reduced-form Phillips curves turn out to be unstable. However, if the structural new-keynesian model is predominantly - even if not fully - backward-looking, the estimated reduced-form parameters are stable; ii) the Chow-breakpoint test tends to underestimate the importance of regime-shifts in small samples.Lucas Critique, forwardness, backward looking Phillips curves, exchange rates, Chow test.

Monetary Policy Switch, the Taylor Curve, and the Great Moderation

This paper employs a standard new Keynesian model to compute the inflation/output volatility frontier, i.e. the "Taylor curve". The computation is performed both under equilibrium uniqueness and under indeterminacy. While under uniqueness the Taylor curve looks like expected - i.e. a monotonically decreasing curve in the ($\sigma x$, $\sigma \Pi$) diagram -, under indeterminacy a new result arises. We find that the tighter is the monetary policy, the higher is the inflation/output gap volatility. This is due to impact of systematic monetary policy on inflation and output persistence. In fact, under indeterminacy a more aggressive monetary policy causes an increase in inflation persistence, and augments its volatility. The effects on output tend to be of opposite sign. This finding is robust to different parameterization of the DSGE new-Keynesian monetary model employed. This result i) offers support the move from "passive" to "active" monetary policy as one of the possible rationales for the Great Moderation, ii) underlines the need of a deeper understanding of the link between systematic monetary policy and macroeconomic persistence, and iii) warns against sub-samples pooling when performing macroeconometric analysis.Taylor principle, Taylor curve, new Keynesian model, indeterminacy, persistence

Regime Shifts and the Stability of Backward Looking Phillips Curves in Open Economies

In this paper we assess the stability of open economy backward looking Phillips curves estimated across two different exchange rate regimes. The time series we deal with come from the simulation of a New-Keynesian hybrid model suited for performing monetary policy analysis. The statistical assessment we undertake is based on a standard Chow (1960) test. Our results confirm Lindè (2001)'s finding on the low power of the Chow test in small samples. However, we do not find strong statistical support for the quantitative relevance of the Lucas critique when the 'true' model of the economy is featured by low/intermediate degrees of forwardness.Lucas Critique, forwardness, backward looking Phillips curves, exchange rates, Chow test

Taylor rules, omitted variables, and interest rate smoothing in the US

We test for the presence of interest rate smoothing in forward looking Taylor rules in first differences. We also consider financial and asymmetric preferences indicators. We find that interest rate smoothing is not induced by an omitted variable bias.Taylor rules; Interest rate smoothing; Serial correlation; Observational equivalence; Omitted variables

Testing the structural interpretation of the price puzzle with a cost channel model

We estimate a new-Keynesian DSGE model with the cost channel to assess its ability to replicate the price puzzle ie the inflationary impact of a monetary policy shock typically arising in VAR analysis. In order to correctly identify the monetary policy shock, we distinguish between a standard policy rate shifter and a shock to trend inflation ie the time-varying inflation target set by the Fed. While offering some statistical support to the cost channel, our estimated model clearly implies a negative inflation reaction to a tightening of monetary policy. We offer a discussion of the possible sources of mismatch between the VAR evidence and our own.cost channel; inflation dynamics; price puzzle; trend inflation

Taylor Rules and Interest Rate Smoothing in the US and EMU

In this paper we estimate simple Taylor rules paying a particular attention to interest rate smoothing. Following English, Nelson, and Sack (2002), we employ a model in first differences to gain some insights on the presence and significance of the degree of partial ad- justment. Moreover, we estimate a nested model to take both interest rate smoothing and serially correlated deviations from various Taylor rate prescriptions into account. Our findings suggest that the lagged interest rate enters the Taylor rule in its own right, and may very well coexist with a serially correlated policy shock. Asymmetric preferences on the output gap level and financial indicators turn out to be impor- tant factors to understand Greenspan’s policy conduct. By contrast, our findings support standard regressors for the ’European’ Taylor rule.Taylor rules omitted variables serial correlation interest rate smoothing

Monetary policy indeterminacy in the U.S.: results from a classical test

We work with a newly developed method to empirically assess whether a specified new-Keynesian business cycle monetary model estimated with U.S. quarterly data is consistent with a unique equilibrium or multiple equilibria under rational expectations. We conduct classical tests to verify if the structural model is correctly specified. Conditional on a positive answer, we formally assess if such model is either consistent with a unique equilibrium or with indeterminacy. Importantly, our full-system approach requires neither the use of prior distributions nor that of nonstandard inference. The case of an indeterminate equilibrium in the pre-1984 sample and of a determinate equilibrium in the post-1984 sample is favored by the data. The long-run coefficients on inflation and the output gap in the monetary policy rule are found to be weakly identified. However, our results are further supported by a proposed identification-robust indicator of indeterminacyGMM, Indeterminatezza, Massima Verosimiglianza, Errata specificazione, modello neo-Keynesiano per il ciclo economico, VAR, Identificazione debole GMM, Indeterminacy, Maximum Likelihood, Misspecification, new-Keynesian business cycle model, VAR, Weak identification.

The Price Puzzle and Indeterminacy

This paper re-examines the empirical evidence on the price puzzle and proposes a new theoretical interpretation. Using structural VARs and two different identification strategies based on zero restrictions and sign restrictions, we find that the positive response of price to a monetary policy shock is historically limited to the sub-samples associated with a weak central bank response to inflation. These sub-samples correspond to the pre-Volcker period for the US and the pre-inflation targeting regime for the UK. Using a micro-founded DSGE sticky price model of the US economy, we then show that the structural VARs are capable of reproducing the price puzzle on artificial data only when monetary policy is passive and hence multiple equilibria arise. In contrast, the DSGE model never generates on impact a positive inflation response to a policy shock. The omission in the VARs of a variable capturing the high persistence of expected inflation under indeterminacy is found to account for the price puzzle observed on actual data.Price puzzle, DSGE model, Taylor principle, Indeterminacy, SVARs

Long Memory and Non-Linearities in International Inflation

This paper investigates inflation dynamics in a panel of 20 OECD economies using an approach based on the sample autocorrelation function (ACF). We find that inflation is characterized by long-lasting fluctuations, which are similar across countries and that eventually revert to a potentially time-varying mean. The cyclical and persistent behavior of inflation does not belong to the class of linear autoregressive processes but rather to a more general class of nonlinear and long memory models. Recent theoretical contributions on heterogeneity in price setting and aggregation offer a rationale to our results. Finally, we draw the monetary policy implications of our findings.AutoCorrelation Function, long-memory, inflation persistence, inflation targeting, heavy tails.

Monetary policy, inflation expectations and the price puzzle

This paper re-examines the VAR evidence on the price puzzle and proposes a new theoretical interpretation. Using actual data and two identification strategies based on zero restrictions and model-consistent sign restrictions, we find that the positive response of prices to a monetary policy shock is historically limited to the sub-samples that are typically associated with a weak interest rate response to inflation. Using pseudo data generated by a sticky price model of the US economy, we then show that the structural VARs are capable of reproducing the price puzzle only when monetary policy is passive. The omission in the VARs of a variable capturing expected inflation is found to account for the price puzzle observed in simulated and actual data.SVARs; price puzzle; sticky price model; Taylor principle; passive policy