An "Inflation Reports" Report

This paper evaluates the Swedish Riksbank's Inflation Reports' and draws comparisons among the Reports issued by the Riksbank, the Bank of England, and the Reserve Bank of New Zealand. This report poses and addresses a common set of questions about each of the three central banks' Inflation Reports'. It assesses the credibility of inflation forecasts, evaluates the Reports' discussions of the current state of the economy, asks if a coherent set of models underlies the Reports, and discusses whether the Reports hold the banks sufficiently accountable for their decisions.

Anchors Away: How Fiscal Policy Can Undermine "Good" Monetary Policy

Slow moving demographics are aging populations around the world and pushing many countries into an extended period of heightened fiscal stress. In some countries, taxes alone cannot or likely will not fully fund projected pension and health care expenditures. If economic agents place sufficient probability on the economy hitting its ”fiscal limit” at some point in the future, after which further tax revenues are not forthcoming, it may no longer be possible for “good” monetary policy—behavior that obeys the Taylor principle—to control inflation or anchor inflation expectations. In the period leading up to the fiscal limit, the more aggressively that monetary policy leans against inflationary winds, the more expected inflation becomes unhinged from the inflation target. Problems confronting monetary policy are exacerbated when policy institutions leave fiscal objectives and targets unspecified and, therefore, fiscal expectations unanchored. In light of this theory, the paper contrasts monetary-fiscal policy frameworks in the United States and Chile.

Anchors Away: How Fiscal Policy Can Undermine “Good” Monetary Policy

Slow moving demographics are aging populations around the world and pushing many countries into an extended period of heightened fiscal stress. In some countries, taxes alone cannot or likely will not fully fund projected pension and health care ex- penditures. If economic agents place sufficient probability on the economy hitting its “fiscal limit” at some point in the future—after which further tax revenues are not forthcoming—it may no longer be possible for “good” monetary policy behavior to control inflation or anchor inflation expectations. In the period leading up to the fiscal limit, the more aggressively that monetary policy leans against inflationary winds, the more expected inflation becomes unhinged from the inflation target. Problems con- frontingmonetary policy are exacerbated when policy institutions leave fiscal objectives and targets unspecified and, therefore, fiscal expectations unanchored.

Fiscal Policy and Inflation: Pondering the Imponderables

An asset-pricing perspective on inflation reveals that it depends on current and expected monetary and fiscal policies. There are three ways to carry $1 today into the future: money, bonds, and real assets. That dollar's purchasing power varies inversely with the price level. Expected money growth, tax rates, and government spending directly impinge on these expected rates of return of these assets, and determine the price level and the inflation rate. The paper considers a tax reduction that is financed by new government debt. It examines how alternative responses of current and future policies to the tax cut can imply very different outcomes for inflation.

An Interpretation of Fluctuating Macro Policies

This paper estimates simple regime-switching rules for monetary policy and tax policy over the post-war period in the United States and imposes the estimated policy process on a standard dynamic stochastic general equilibrium model with nominal rigidities. The estimated joint policy process produces a unique stationary rational expectations equilibrium in a simple New Keynesian model. We characterize policy impacts across regimesPolicy rules, Markov-switching, DSGE models

EXPECTATIONS AND FISCAL STIMULUS

Increases in government spending trigger substitution effects—both inter- and intra-temporal—and a wealth effect. The ultimate impacts on the econ- omy hinge on current and expected monetary and fiscal policy behavior. Studies that impose active monetary policy and passive fiscal policy typically find that government consumption crowds out private consumption: higher future taxes cre- ate a strong negative wealth effect, while the active monetary response increases the real interest rate. This paper estimates Markov-switching policy rules for the United States and finds that monetary and fiscal policies fluctuate between ac- tive and passive behavior. When the estimated joint policy process is imposed on a conventional new Keynesian model, government spending generates positive consumption multipliers in some policy regimes and in simulated data in which all policy regimes are realized. The paper reports the model’s predictions of the macroeconomic impacts of the American Recovery and Reinvestment Act’s implied path for government spending under alternative monetary-fiscal policy combina- tions.

What Has Financed Government Debt?

Equilibrium models imply that the real value of debt in the hands of the public must equal the expected present-value of surpluses. Empirical models of fiscal policy typically do not impose this condition and often do not even include debt. Absence of debt from empirical models can produce non-invertible representations, obscuring the true present-value relation, even if it holds in the data. First, we show that small VAR models of fiscal policy may not be invertible and that expanding the information set to include government debt has quantitatively important implications. Then we impose the present-value condition on an identified VAR and characterize the way in which the present-value support of debt varies across types of fiscal shocks. The role of expected primary surpluses in supporting innovations to debt depends on the nature of the shock. Debt is supported almost entirely by changes in the present-value of surpluses for some fiscal shocks, but for other fiscal shocks surpluses fail to adjust, leaving a large role for expected changes in discount rates. Horizons over which debt innovations are financed are long---on the order of 50 years or more.fiscal policy, present-value restriction, taxes, government spending

Reply to "Generalizing the Taylor principle": a comment

Farmer, Waggoner, and Zha (2009) show that a new Keynesian model with a regime-switching monetary policy rule can support multiple solutions that depend only on the fundamental shocks in the model. Their note appears to find solutions in regions of the parameter space where there should be no bounded solutions, according to conditions in Davig and Leeper (2007). This puzzling finding is straightforward to explain: Farmer, Waggoner, and Zha (FWZ) derive solutions using a model that differs from the one to which the Davig and Leeper (DL) conditions apply. In addition, FWZ impose cross-equation restrictions between behavioral relations and the exogenous driving process. This rather special assumption undermines the traditional sharp distinction in micro-founded general equilibrium models between 'deep' parameters and the parameters governing the exogenous processes.

MONETARY-FISCAL POLICY INTERACTIONS AND FISCAL STIMULUS

Increases in government spending trigger substitution effects—both inter- and intra-temporal—and a wealth effect. The ultimate impacts on the econ- omy hinge on current and expected monetary and fiscal policy behavior. Studies that impose active monetary policy and passive fiscal policy typically find that government consumption crowds out private consumption: higher future taxes cre- ate a strong negative wealth effect, while the active monetary response increases the real interest rate. This paper estimates Markov-switching policy rules for the United States and finds that monetary and fiscal policies fluctuate between ac- tive and passive behavior. When the estimated joint policy process is imposed on a conventional new Keynesian model, government spending generates positive consumption multipliers in some policy regimes and in simulated data in which all policy regimes are realized. The paper reports the model’s predictions of the macroeconomic impacts of the American Recovery and Reinvestment Act’s implied path for government spending under alternative monetary-fiscal policy combina- tions.

Endogenous monetary policy regime change

This paper makes changes in monetary policy rules (or regimes) endogenous. Changes are triggered when certain endogenous variables cross specified thresholds. Rational expectations equilibria are examined in three models of threshold switching to illustrate that (i) expectations formation effects generated by the possibility of regime change can be quantitatively important; (ii) symmetric shocks can have asymmetric effects; (iii) endogenous switching is a natural way to formally model preemptive policy actions. In a conventional calibrated model, preemptive policy shifts agents’ expectations, enhancing the ability of policy to offset demand shocks; this yields a quantitatively significant “preemption dividend.”Monetary policy ; Taylor's rule