Equilibrium Implications of Interest Rate Smoothing PDF Download

Author: Diogo Duarte
Publisher:
ISBN:
Category :
Languages : en
Pages : 48

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Book Description
We introduce a macro-finance model in which monetary authorities adjust the money supply by targeting not only output and inflation but also the slope of the yield curve. We study the impact of McCallum-type rules on capital growth, the volatility of interest rates, the spread between long- and short-term rates, the persistence of monetary shocks and equity volatility. Our model supports the Federal Reserve's choice to incorporate financial data in their policy decisions and expand the monetary base to decrease the nominal interest rate spread at the cost of lower expected long-term growth.

Author:
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ISBN:
Category :
Languages : en
Pages :

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This paper examines the interaction between monetary policy and financial stability and provides an assessment of the implications of banks' risk management practices for monetary policy. By considering the desire of the central bank to stabilize different types of the "basis" risk as a contribution to financial stability, we derive a set of plausible interest-rate rules characterized by either backward or forward interest-rate smoothing. The paper investigates the determinacy conditions of the rational expectations equilibria obtained under such rules. Contrary to what previously found in the literature, we find that the practice of smoothing interest rates backward does not in general alleviate problems of equilibrium indeterminacy. Moreover, basis risk stabilization may lead to policy rules embedding "forward" interest-rate smoothing, where a new kind of indeterminacy may arise following excessive concern for financial stability.

Author: Sergio Rebelo
Publisher:
ISBN:
Category : Economic development
Languages : en
Pages : 44

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This paper studies some continuous-time cash-in-advance models in which interest rate smoothing is optimal. We consider both deterministic and stochastic models. In the stochastic case we obtain two results of independent interest: (i) we study what is, to our knowledge, the only version of the neoclassical model under uncertainty that can be solved in closed form in continuous time; and (ii) we show how to characterize the competitive equilibrium of a stochastic continuous time model that cannot be computed by solving a planning problem. We also discuss the scope for monetary policy to improve welfare in an economy with a suboptimal real competitive equilibrium, focusing on the particular example of an economy with externalities.

Author: Jess Benhabib
Publisher:
ISBN:
Category :
Languages : en
Pages : 0

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The existing literature on the stabilizing properties of interest-rate feedback rules has stressed the perils of linking interest rates to forecasts of future inflation. Such rules have been found to give rise to aggregate fluctuations due to self-fulfilling expectations. In response to this concern, a growing literature has focused on the stabilizing properties of interest-rate rules whereby the central bank responds to a measure of past inflation. The consensus view that has emerged is that backward-looking rules contribute to protecting the economy from embarking on expectations-driven fluctuations. A common characteristic of the existing studies that arrive at this conclusion is their focus on local analysis. The contribution of this paper is to conduct a more global analysis. We find that backward-looking interest-rate feedback rules do not guarantee uniqueness of equilibrium. We present examples in which for plausible parameterizations attracting equilibrium cycles exist. The paper also contributes to the quest for policy rules that guarantee macroeconomic stability globally. Our analysis indicates that policy rules whereby the interest rate is set as a function of the past interest rate and current inflation are likely to ensure global stability provided that the coefficient on lagged interest rates is greater than unity.

Author:
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ISBN:
Category :
Languages : en
Pages :

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Author: Ben S. Bernanke
Publisher: University of Chicago Press
ISBN: 0226044734
Category : Business & Economics
Languages : en
Pages : 469

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Book Description
Over the past fifteen years, a significant number of industrialized and middle-income countries have adopted inflation targeting as a framework for monetary policymaking. As the name suggests, in such inflation-targeting regimes, the central bank is responsible for achieving a publicly announced target for the inflation rate. While the objective of controlling inflation enjoys wide support among both academic experts and policymakers, and while the countries that have followed this model have generally experienced good macroeconomic outcomes, many important questions about inflation targeting remain. In Inflation Targeting, a distinguished group of contributors explores the many underexamined dimensions of inflation targeting—its potential, its successes, and its limitations—from both a theoretical and an empirical standpoint, and for both developed and emerging economies. The volume opens with a discussion of the optimal formulation of inflation-targeting policy and continues with a debate about the desirability of such a model for the United States. The concluding chapters discuss the special problems of inflation targeting in emerging markets, including the Czech Republic, Poland, and Hungary.

Author: Takushi Kurozumi
Publisher:
ISBN:
Category :
Languages : en
Pages : 39

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We investigate implications of search and matching frictions in the labor market for inflation targeting interest rate policy in terms of equilibrium stability. When the interest rate is set in response to past or present inflation, determinacy of equilibrium is ensured similarly to comparable previous studies with frictionless labor markets. In stark contrast to these studies, indeterminacy is very likely if the interest rate is adjusted in response solely to expected future inflation. This is due to a vacancy channel of monetary policy that stems from the labor market frictions and renders inflation expectations self-fulfilling. The indeterminacy can be overcome once the interest rate is adjusted in response also to output or the unemployment rate or if the policy contains interest rate smoothing. When E-stability is adopted as an equilibrium selection criterion, a unique E-stable fundamental rational expectations equilibrium is generated under active, but not too strong, policy responses only to expected future inflation. This suggests that the problem is not critical from the perspective of learnability of the fundamental equilibrium.

Author: Natalya Martynova
Publisher: International Monetary Fund
ISBN: 1513565818
Category : Business & Economics
Languages : en
Pages : 44

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Book Description
Traditional theory suggests that more profitable banks should have lower risk-taking incentives. Then why did many profitable banks choose to invest in untested financial instruments before the crisis, realizing significant losses? We attempt to reconcile theory and evidence. In our setup, banks are endowed with a fixed core business. They take risk by levering up to engage in risky ‘side activities’(such as market-based investments) alongside the core business. A more profitable core business allows a bank to borrow more and take side risks on a larger scale, offsetting lower incentives to take risk of given size. Consequently, more profitable banks may have higher risk-taking incentives. The framework is consistent with cross-sectional patterns of bank risk-taking in the run up to the recent financial crisis.

Author: Mr.Jaromir Benes
Publisher: International Monetary Fund
ISBN: 1475505523
Category : Business & Economics
Languages : en
Pages : 71

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At the height of the Great Depression a number of leading U.S. economists advanced a proposal for monetary reform that became known as the Chicago Plan. It envisaged the separation of the monetary and credit functions of the banking system, by requiring 100% reserve backing for deposits. Irving Fisher (1936) claimed the following advantages for this plan: (1) Much better control of a major source of business cycle fluctuations, sudden increases and contractions of bank credit and of the supply of bank-created money. (2) Complete elimination of bank runs. (3) Dramatic reduction of the (net) public debt. (4) Dramatic reduction of private debt, as money creation no longer requires simultaneous debt creation. We study these claims by embedding a comprehensive and carefully calibrated model of the banking system in a DSGE model of the U.S. economy. We find support for all four of Fisher's claims. Furthermore, output gains approach 10 percent, and steady state inflation can drop to zero without posing problems for the conduct of monetary policy.

Author: Mr.Pau Rabanal
Publisher: International Monetary Fund
ISBN: 1451875657
Category : Business & Economics
Languages : en
Pages : 68

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Our answer: Not so well. We reached that conclusion after reviewing recent research on the role of technology as a source of economic fluctuations. The bulk of the evidence suggests a limited role for aggregate technology shocks, pointing instead to demand factors as the main force behind the strong positive comovement between output and labor input measures.