Search Results
Working Paper
Can structural small open economy models account for the influence of foreign disturbances?
This paper demonstrates that an estimated, structural, small open-economy model of the Canadian economy cannot account for the substantial influence of foreign-sourced disturbances identified in numerous reduced-form studies. The benchmark model assumes uncorrelated shocks across countries and implies that U.S. shocks account for less than 3 percent of the variability observed in several Canadian series, at all forecast horizons. Accordingly, model-implied cross-correlation functions between Canada and U.S. are essentially zero. Both findings are at odds with the data. A specification that ...
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Stabilizing expectations under monetary and fiscal policy coordination
This paper analyzes how the formation of expectations constrains monetary and fiscal policy design. Economic agents have imperfect knowledge about the economic environment and the policy regime in place. Households and firms learn about the policy regime using historical data. Regime uncertainty substantially narrows, relative to a rational expectations analysis of the model, the menu of policies consistent with expectations stabilization. When agents are learning about the policy regime, there is greater need for policy coordination: the specific choice of monetary policy limits the set of ...
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The science of monetary policy: an imperfect knowledge perspective
New Keynesian theory identifies a set of principles central to the design and implementation of monetary policy. These principles rely on the ability of a central bank to manage expectations precisely, with policy prescriptions typically derived under the assumption of perfect information and full rationality. However, the challenging macroeconomic environment bequeathed by the financial crisis has led many to question the efficacy of monetary policy, and, particularly, to question whether central banks can influence expectations with as much control as previously thought. In this paper, we ...
Working Paper
Monetary policy and uncertainty in an empirical small open economy model
This paper explores optimal policy design in an estimated model of three small open economies: Australia, Canada and New Zealand. Within a class of generalized Taylor rules, we show that to stabilize a weighted objective of output, consumer price inflation and nominal interest variation optimal policy does not respond to the nominal exchange. This is despite the presence of local currency pricing and due, in large part, to observed exchange rate disconnect in these economies. Optimal policies that account for the uncertainty of model estimates, as captured by the parameters' posterior ...
Working Paper
Learning about monetary policy rules when long-horizon expectations matter
This paper considers the implications of an important source of model misspecification for the design of monetary policy rules: the assumed manner of expectations formation. Following a considerable literature on learning, it is assumed that private agents seek to maximize their objectives subject to standard constraints and the restriction of using an econometric model to make inferences about future uncertainty. Agents do not know other agents' tastes or beliefs and therefore do not have a complete economic model with which to derive true probability laws. Because agents solve a ...
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How Do We Learn About the Long Run?
Using a novel and unique panel dataset of individual-level professional forecasts at short, medium, and very-long horizons, we provide new stylized facts about survey forecasts. We present direct evidence that forecasters use multivariate models in an environment with imperfect information about the current state, leading to heterogenous non-stationary expectations about the long run. We show forecast revisions are consistent with the predictions of a multivariate unobserved trend and cycle model. Our results suggest models of expectations formation which are either univariate, stationary, or ...
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Long-term debt pricing and monetary policy transmission under imperfect knowledge
Under rational expectations, monetary policy is generally highly effective in stabilizing the economy. Aggregate demand management operates through the expectations hypothesis of the term structure: Anticipated movements in future short-term interest rates control current demand. This paper explores the effects of monetary policy under imperfect knowledge and incomplete markets. In this environment, the expectations hypothesis of the yield curve need not hold, a situation called unanchored financial market expectations. Whether or not financial market expectations are anchored, the private ...
Conference Paper
Central bank communication and expectations stabilization
This paper analyzes the value of communication in the implementation of monetary policy. The central bank is uncertain about the current state of the economy. Households and firms do not have a complete economic model of the determination of aggregate variables, including nominal interest rates, and must learn about their dynamics using historical data. When the central bank implements optimal policy, the Taylor principle is not sufficient for macroeconomic stability: for all reasonable parameterizations self-fulfilling expectations are possible. To mitigate this instability, three ...
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Learning the fiscal theory of the price level: some consequences of debt management policy
This paper examines how the scale and composition of public debt can affect economies that implement a combination of ?passive? monetary policy and ?active? fiscal policy. This policy configuration is argued to be of both historical and contemporary interest in the cases of the U.S. and Japanese economies. It is shown that higher average levels and moderate average maturities of debt can induce macroeconomic instability under a range of policies specified as simple rules. However, interest rate pegs in combination with active fiscal policies almost always ensure macroeconomic stability. This ...
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The Term Structure of Expectations
Economic theory predicts that intertemporal decisions depend critically on expectations about future outcomes. Using the universe of professional survey forecasts for the United States, we document the behavior of the entire term structure of expectations for output growth, inflation, and the policy rate. We show that a simple unobserved components model of the trend and cycle explains the joint behavior of both consensus measures of expectations and the observed disagreement among individual forecasters. Importantly, univariate models of each variable are outperformed by a multivariate model ...