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72
Monetary Policy under Uncertainty
 IN MICROFOUNDED MACROECONOMETRIC MODELS,Â NBER MACROECONOMICS ANNUAL
, 2005
"... We use a microfounded macroeconometric modeling framework to investigate the design of monetary policy when the central bank faces uncertainty about the true structure of the economy. We apply Bayesian methods to estimate the parameters of the baseline specification using postwar U.S. data and then ..."
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Cited by 242 (13 self)
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We use a microfounded macroeconometric modeling framework to investigate the design of monetary policy when the central bank faces uncertainty about the true structure of the economy. We apply Bayesian methods to estimate the parameters of the baseline specification using postwar U.S. data and then determine the policy under commitment that maximizes household welfare. We find that the performance of the optimal policy is closely matched by a simple operational rule that focuses solely on stabilizing nominal wage inflation. Furthermore, this simple wage stabilization rule is remarkably robust to uncertainty about the model parameters and to various assumptions regarding the nature and incidence of the innovations. However, the characteristics of optimal policy are very sensitive to the specification of the wage contracting mechanism, thereby highlighting the importance of additional research regarding the structure of labor markets and wage determination.
Credit Frictions and Optimal Monetary Policy
, 2008
"... We extend the basic (representativehousehold) New Keynesian [NK] model of the monetary transmission mechanism to allow for a spread between the interest rate available to savers and borrowers, that can vary for either exogenous or endogenous reasons. We find that the mere existence of a positive av ..."
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Cited by 136 (15 self)
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We extend the basic (representativehousehold) New Keynesian [NK] model of the monetary transmission mechanism to allow for a spread between the interest rate available to savers and borrowers, that can vary for either exogenous or endogenous reasons. We find that the mere existence of a positive average spread makes little quantitative difference for the predicted effects of particular policies. Variation in spreads over time is of greater significance, with consequences both for the equilibrium relation between the policy rate and aggregate expenditure and for the relation between real activity and inflation. Nonetheless, we find that the target criterion – a linear relation that should be maintained between the inflation rate and changes in the output gap — that characterizes optimal policy in the basic NK model continues to provide a good approximation to optimal policy, even in the presence of variations in credit spreads. We also consider a “spreadadjusted Taylor rule, ” in which the intercept of the Taylor rule is adjusted in proportion to changes in credit spreads.
Inflation Stabilization and Welfare: The Case of a Distorted Steady State
, 2004
"... This paper considers the appropriate stabilization objectives for monetary policy in a microfounded model with staggered pricesetting. Rotemberg and Woodford (1997) and Woodford (2002) have shown that under certain conditions, a local approximation to the expected utility of the representative hous ..."
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Cited by 121 (21 self)
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This paper considers the appropriate stabilization objectives for monetary policy in a microfounded model with staggered pricesetting. Rotemberg and Woodford (1997) and Woodford (2002) have shown that under certain conditions, a local approximation to the expected utility of the representative household in a model of this kind is related inversely to the expected discounted value of a conventional quadratic loss function, in which each period’s loss is a weighted average of squared deviations of inflation and an output gap measure from their optimal values (zero). However, those derivations rely on an assumption of the existence of an output or employment subsidy that offsets the distortion due to the market power of monopolisticallycompetitive pricesetters, so that the steady state under a zeroinflation policy involves an efficient level of output. Here we show how to dispense with this unappealing assumption, so that a valid linearquadratic approximation to the optimal policy problem is possible even when the steady state is distorted to an arbitrary
Realtime model uncertainty in the United States: the Fed from 19962003
, 2005
"... We study 30 vintages of FRB/US, the principal macro model used by the Federal Reserve Board staff for forecasting and policy analysis. To do this, we exploit archives of the model code, coefficients, baseline databases and stochastic shock sets stored after each FOMC meeting from the model’s incepti ..."
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Cited by 35 (0 self)
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We study 30 vintages of FRB/US, the principal macro model used by the Federal Reserve Board staff for forecasting and policy analysis. To do this, we exploit archives of the model code, coefficients, baseline databases and stochastic shock sets stored after each FOMC meeting from the model’s inception in July 1996 until November 2003. The period of study was one of important changes in the U.S. economy with a productivity boom, a stock market boom and bust, a recession, the Asia crisis, the Russian debt default, and an abrupt change in fiscal policy. We document the surprisingly large and consequential changes in model properties that occurred during this period and compute optimal Taylortype rules for each vintage. We compare these optimal rules against plausible alternatives. Model uncertainty is shown to be a substantial problem; the efficacy of purportedly optimal policy rules should not be taken on faith.
Computing DSGE Models with Recursive Preferences
, 2009
"... This paper compares different solution methods for computing the equilibrium of dynamic stochastic general equilibrium (DSGE) models with recursive preferences such as those in Epstein and Zin (1989 and 1991). Models with these preferences have recently become popular, but we know little about the b ..."
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Cited by 31 (1 self)
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This paper compares different solution methods for computing the equilibrium of dynamic stochastic general equilibrium (DSGE) models with recursive preferences such as those in Epstein and Zin (1989 and 1991). Models with these preferences have recently become popular, but we know little about the best ways to implement them numerically. To fill this gap, we solve the stochastic neoclassical growth model with recursive preferences using four different approaches: second and thirdorder perturbation, Chebyshev polynomials, and value function iteration. We document the performance of the methods in terms of computing time, implementation complexity, and accuracy. Our main finding is that a thirdorder perturbation is competitive in terms of accuracy with Chebyshev polynomials and value function iteration, while being an order of magnitude faster to run. Therefore, we conclude that perturbation methods are an attractive approach for computing this class of problems.
The Term Structure of Interest Rates in a DSGE Model with Recursive Preferences
, 2010
"... We solve a dynamic stochastic general equilibrium (DSGE) model in which the representative household has Epstein and Zin recursive preferences. The parameters governing preferences and technology are estimated by means of maximum likelihood using macroeconomic data and asset prices, with a particul ..."
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Cited by 31 (2 self)
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We solve a dynamic stochastic general equilibrium (DSGE) model in which the representative household has Epstein and Zin recursive preferences. The parameters governing preferences and technology are estimated by means of maximum likelihood using macroeconomic data and asset prices, with a particular focus on the term structure of interest rates. We estimate a large risk aversion, an elasticity of intertemporal substitution higher than one, and substantial adjustment costs. Furthermore, we identify the tensions within the model by estimating it on subsets of these data. We conclude by pointing out potential extensions that might improve the model’s fit.
Optimal taxation in an RBC model: A linearquadratic approach
 Journal of Economic Dynamics and
, 2006
"... We reconsider the optimal taxation of income from labor and capital in the stochastic growth model analyzed by Chari et al. (1994, 1995), but using a linearquadratic (LQ) approximation to derive a loglinear approximation to the optimal policy rules. The example illustrates how inaccurate “naive ” ..."
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Cited by 30 (1 self)
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We reconsider the optimal taxation of income from labor and capital in the stochastic growth model analyzed by Chari et al. (1994, 1995), but using a linearquadratic (LQ) approximation to derive a loglinear approximation to the optimal policy rules. The example illustrates how inaccurate “naive ” LQ approximation — in which the quadratic objective is obtained from a simple Taylor expansion of the utility function of the representative household — can be, but also shows how a correct LQ approximation can be obtained, which will provide a correct local approximation to the optimal policy rules in the case of small enough shocks. We also consider the numerical accuracy of the LQ approximation in the case of shocks of the size assumed in the calibration of Chari et al. We find that the correct LQ approximation yields results that are quite accurate, and similar in most respects to the results obtained by Chari et al. using a more computationally intensive numerical method.