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47
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 83 (14 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 77 (15 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 23 (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.
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 16 (1 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.
2010): “Optimal Target Criteria for Stabilization Policy,”NBER Working Paper no
"... This paper considers a general class of nonlinear rationalexpectations models in which policymakers seek to maximize an objective function that may be household expected utility. We show how to derive a target criterion that is: (i) consistent with the model’s structural equations, (ii) strong enou ..."
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Cited by 14 (4 self)
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This paper considers a general class of nonlinear rationalexpectations models in which policymakers seek to maximize an objective function that may be household expected utility. We show how to derive a target criterion that is: (i) consistent with the model’s structural equations, (ii) strong enough to imply a unique equilibrium, and (iii) optimal, in the sense that a commitment to adjust the policy instrument at all dates so as to satisfy the target criterion maximizes the objective function. The proposed optimal target criterion is a linear equation that must be satis…ed by the projected paths of certain economically relevant “target variables. ” It takes the same form at all times and generally involves only a small number of target variables, regardless of the size and complexity of the model. While the projected path of the economy requires information about the current state, the target criterion itself can be stated without reference to a complete description of the state of the world. We illustrate the application of the method to a nonlinear DSGE model with staggered pricesetting, in which the objective of policy is to maximize household expected utility.
Optimal Monetary Policy Under Sudden Stop
, 2008
"... Emerging market economies often face sudden stops in capital inflows or reduced access to the international capital market. This paper analyzes what should monetary policy do in such an event. Optimal monetary policy induces a hike in interest rate and exchange rate depreciation. The latter mitigate ..."
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Cited by 14 (2 self)
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Emerging market economies often face sudden stops in capital inflows or reduced access to the international capital market. This paper analyzes what should monetary policy do in such an event. Optimal monetary policy induces a hike in interest rate and exchange rate depreciation. The latter mitigates the impact of the sudden stop in the domestic economy by boosting export revenues. In spite of that, a recession is not avoided. It is shown in the paper that the arrival of the sudden stop further increases the problem of time inconsistency of policy. Optimal policy is fairly well approximated by a flexible targeting rule, in which a combination of domestic prices, exchange rate and output is stabilized. We show that whether a fixed exchange rate regime is a good policy strategy, from a welfare perspective, depends on the economic environment. For the benchmark parameterization, the peg is the worst of simple rules considered. For alternative parameterizations, featuring low nominal rigidities or high elasticity of foreign demand, the fixed exchange rate regime performs relatively better.
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 14 (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.