Econometric policy evaluation: A critique

Few areas of monetary economics have been studied as extensively as the transmission mechanism. The literature on this topic has evolved substantially over the years, following the waxing and waning of conceptual frameworks and the changing characteristics of the financial system. In this paper, taking as a starting point a brief overview of the extant work on the interaction between capital regulation, the business cycle and the transmission mechanism, we offer some broader reflections on the characteristics of the transmission mechanism in light of the evolution of the financial system. We argue that insufficient attention has so far been paid to the link between monetary policy and the perception and pricing of risk by economic agents - what might be termed the "risk-taking channel" of monetary policy. We develop the concept, compare it with current views of the transmission mechanism, explore its mutually reinforcing link with "liquidity" and analyse its interaction with monetary policy reaction functions. We argue that changes in the financial system and prudential regulation may have increased the importance of the risk-taking channel and that prevailing macroeconomic paradigms and associated models are not well suited to capturing it, thereby also reducing their effectiveness as guides to monetary policy.

/pdf/capital-regulation-risk-taking-and-monetary-policy-a-missing-4virgvq8ix.pdf

Capital Regulation, Risk-Taking and Monetary Policy: A Missing Link in the Transmission Mechanism?

We lay out a small open economy version of the Calvo sticky price model, and show how the equilibrium dynamics can be reduced to a simple representation in domestic inflation and the output gap. We use the resulting framework to analyse the macroeconomic implications of three alternative rulebased policy regimes for the small open economy: domestic inflation and CPI-based Taylor rules, and an exchange rate peg. We show that a key difference among these regimes lies in the relative amount of exchange rate volatility that they entail. We also discuss a special case for which domestic inflation targeting constitutes the optimal policy, and where a simple second order approximation to the utility of the representative consumer can be derived and used to evaluate the welfare losses associated with the suboptimal rules.

/pdf/monetary-policy-and-exchange-rate-volatility-in-a-small-open-3ywsgemy2r.pdf

Monetary policy and exchange rate volatility in a small open economy

Recently, a number of authors have argued that the standard search model cannot generate the observed business-cycle-frequency fluctuations in unemployment and job vacancies, given shocks of a plausible magnitude. We use data on the cost of vacancy creation and cyclicality of wages to identify the two key parameters of the model - the value of non-market activity and the bargaining weights. Our calibration implies that the model is, in fact, consistent with the data.

The Cyclical Behavior of Equilibrium Unemployment and Vacancies Revisited

Capital regulation, risk-taking and monetary policy: A missing link in the transmission mechanism?

A joint econometric model of macroeconomic and term structure

http://fmwww.bc.edu/repec/esNASM04/up.17876.1075485099.pdf

A joint econometric model of macroeconomic and term-structure dynamics

Price-level versus inflation targeting

We show that, when private sector expectations are determined in line with adaptive learning, optimal policy responds persistently to cost-push shocks. The optimal response is stronger and more persistent, the higher is the initial level of perceived inflation persistence by the private sector. Such a sophisticated policy reduces inflation persistence and inflation volatility at little cost in terms of output gap volatility. Persistent responses to cost-push shocks and stability of inflation expectations resemble optimal policy under commitment and rational expectations. Nevertheless, it is clear that the mechanism at play is very different. In the case of commitment it relies on expectations of future policy actions affecting inflation expectations; in the case of sophisticated central banking it relies on the reduction in the estimated inflation persistence parameter based on inflation data generated by shocks and policy responses. (JEL: E52)

/pdf/adaptive-learning-persistence-and-optimal-monetary-policy-2h079v665n.pdf

Adaptive learning, persistence, and optimal monetary policy

This paper examines a price-level target in a model with a forward-looking Calvo-Taylor Phillips curve. Contrary to conventional wisdom, it is found that price-level targeting leads to a better trade-off between inflation and output-gap variability than inflation targeting, when the central bank acts under discretion. In some cases, price-level targeting under dircretion results in the same equilibrium as inflation targeting under commitment.

https://www.econstor.eu/bitstream/10419/82434/1/wp_106.pdf

David Vestin

Papers

A joint econometric model of macroeconomic and term structure

A joint econometric model of macroeconomic and term-structure dynamics

Price-level versus inflation targeting

Adaptive learning, persistence, and optimal monetary policy

Price-level Targeting versus Inflation Targeting in a Forward-looking Model