Housing is the business cycle: commentary

Housing ; Housing - Prices ; Gross domestic product

Monetary Policy under Adaptive Learning

The paper studies the conduct of monetary policy, in a simple new Keynesian model, with adaptive learning on the part of the private sector. A key feature is that even though we start out with a linear “structural†model, the system and hence policy responses inherit the non-linear feature of the updating equations for the estimated parameters. In the paper, we contrast two different monetary policy regimes. In the first the central bank follows a simple rule, which comes from the first order conditions, for optimal policy under discretion in the case of rational expectations. In the second, the central bank has full information about the structure of the economy, including the adaptive learning mechanism. It takes the expectations formation mechanism explicitly into account when deriving optimal policy. This framework allows an explicit discussion of the importance of keeping inflation expectations under control. We illustrate with an application to a regime change, where we assume that the incumbent policymaker did not take the learning into account and allowed the expectation formation process to become unhinged. However, before inflation expectations (and actual inflation) spirals out of control, we assume that a sophisticated central banker, who does take the effect of learning into account, takes charge and study how the economy adjusts after the regime change. Under our assumptions the transition is slow. We claim that some features of the transition match important stylised facts associated with the Volcker disinflation in the US. In the end the fully optimal policy delivers less inflation and output gap volatility. It does so by anchoring inflation expectations thereby contributing to the overall stability of the economy. To achieve this result optimal policy is conditional on the degree of perceived persistence. As perceived persistence increases so does inertia in the policy response in the face of inflation shocks. We compare the contrast between the two policy regimes in the paper with the difference between the rational expectations under discretion and commitment.monetary policy, adaptive learning, regime change

Price Setting and Price Adjustment in Some European Union Countries: Introduction to the Special Issue

This introductory essay briefly summarizes the eleven empirical studies of price setting and price adjustment that are included in this special issue. The studies, which use data from several European countries, were conducted as part of the European Central Bank’s Inflation Persistence Network.Price Rigidity, Price Flexibility, Cost of Price Adjustment, Menu Cost, Managerial and Customer Cost of Price Adjustment, Pricing, Price System, Price Setting, New Keynesian Economics, Store-Level Data, Micro-Level Data, Product-Level Data

An estimated stochastic dynamic general equilibrium model of the euro area

This paper develops and estimates a stochastic dynamic general equilibrium (SDGE) model with sticky prices and wages for the euro area. The model incorporates various other features such as habit formation, costs of adjustment in capital accumulation and variable capacity utilisation. It is estimated with Bayesian techniques using seven key macro-economic variables: GDP, consumption, investment, prices, real wages, employment and the nominal interest rate. The introduction of ten orthogonal structural shocks (including productivity, labour supply, investment, preference, cost-push and monetary policy shocks) allows for an empirical investigation of the effects of such shocks and of their contribution to business cycle fluctuations in the euro area. Using the estimated model, the paper also analyses the output (real interest rate) gap, defined as the difference between the actual and model-based potential output (real interest rate). JEL Classification: E4, E5euro area, monetary policy, SDGE models

Price Setting and Price Adjustment in Some European Union Countries: Introduction to the Special Issue

This introductory essay briefly summarizes the eleven empirical studies of price setting and price adjustment that are included in this special issue. The studies, which use data from several European countries, were conducted as part of the European Central Bank’s Inflation Persistence Network.Price Rigidity; Price Flexibility; Cost of Price Adjustment; Menu Cost; Managerial and Customer Cost of Price Adjustment; Pricing; Price System; Price Setting; New Keynesian Economics; Store-Level Data; Micro-Level Data; Product-Level Data

Uncertain potential output: implications for monetary policy

This paper uses a small, calibrated forward-looking model of the euro-area economy to investigate the implications of incomplete information about potential output for the conduct and the design of monetary policy. Three sets of issues are examined. First, the certainty-equivalent optimal policy under both commitment and discretion is characterised. In both cases, incomplete information about potential output leads to very persistent deviations between the actual and the perceived output gap in response to supply and cost-push shocks. The costs of imperfect information are quite large. Second, the implications for simple policy rules such as Taylor or inflation-forecast rule are examined. In first-difference form, both rules continue to perform relatively well with imperfect information as long as the output gap and the inflation forecast are optimally estimated. Third, the implications of potential output uncertainty for the optimal delegation to an independent central bank are examined. Incomplete information implies that it is optimal to appoint a more 'hawkish' central bank. JEL Classification: E52, E31, E17monetary policy rules, potential output, uncertainty

Shocks and frictions in US business cycles: a Bayesian DSGE approach

Using a Bayesian likelihood approach, we estimate a dynamic stochastic general equilibrium model for the US economy using seven macro-economic time series. The model incorporates many types of real and nominal frictions and seven types of structural shocks. We show that this model is able to compete with Bayesian Vector Autoregression models in out-of-sample prediction. We investigate the relative empirical importance of the various frictions. Finally, using the estimated model we address a number of key issues in business cycle analysis: What are the sources of business cycle fluctuations? Can the model explain the cross-correlation between output and inflation? What are the effects of productivity on hours worked? What are the sources of the “Great Moderation”? JEL Classification: E4, E5DSGE Models, monetary policy

An estimated dynamic stochastic general equilibrium model of the euro area

This paper develops and estimates a dynamic stochastic general equilibrium (DSGE) model with sticky prices and wages for the euro area. The model incorporates various other features such as habit formation, costs of adjustment in capital accumulation and variable capacity utilisation. It is estimated with Bayesian techniques using seven key macro-economic variables: GDP, consumption, investment, prices, real wages, employment and the nominal interest rate. The introduction of ten orthogonal structural shocks (including productivity, labour supply, investment, preference, cost-push and monetary policy shocks) allows for an empirical investigation of the effects of such shocks and of their contribution to business cycle fluctuations in the euro area. Using the estimated model, the paper also analyses the output (real interest rate) gap, defined as the difference between the actual and model-based potential output (real interest rate).DSGE models, monetary policy, euro area

Are the effects of monetary policy in the euro area greater in recessions than in booms?

This paper investigates whether monetary policy impulses have asymmetric effects on output growth in seven countries of the euro area (Germany, France, Italy, Spain, Austria, Belgium and the Netherlands). First, it is shown that these seven countries share the same business cycle. Next, strong evidence is presented that area-wide monetary policy impulses, measured as the contribution of monetary policy shocks to the short-term interest rate in a simple VAR for the euro area economy, have significantly larger effects on output growth in recessions than in booms. These differences are most pronounced in Germany, France, Italy, Spain, and Belgium, while they are much smaller in Austria and the Netherlands JEL Classification: E4, E5monetary policy