Monetary policy and the private sector behavior of the US economy are modeled as a time varying structural vector autoregression, where the sources of time variation are both the coefficients and the variance covariance matrix of the innovations. The paper develops a new, simple modeling strategy for the law of motion of the variance covariance matrix and proposes an efficient Markov chain Monte Carlo algorithm for the model likelihood/posterior numerical evaluation. The main empirical conclusions are: 1) both systematic and non-systematic monetary policy have changed during the last forty years. In particular, systematic responses of the interest rate to inflation and unemployment exhibit a trend toward a more aggressive behavior, despite remarkable oscillations; 2) this has had a negligible effect on the rest of the economy. The role played by exogenous non-policy shocks seems more important than interest rate policy in explaining the high inflation and unemployment episodes in recent US economic history.

/pdf/time-varying-structural-vector-autoregressions-and-monetary-3ch9uubw9g.pdf

Time Varying Structural Vector Autoregressions and Monetary Policy

This paper examines old and new evidence on the predictive performance of asset prices for inflation and real output growth. We first review the large literature on this topic, focusing on the past dozen years. We then undertake an empirical analysis of quarterly data on up to 38 candidate indicators (mainly asset prices) for seven OECD countries for a span of up to 41 years (1959 1999). The conclusions from the literature review and the empirical analysis are the same. Some asset prices predict either inflation or output growth in some countries in some periods. Which series predicts what, when and where is, however, itself difficult to predict: good forecasting performance by an indicator in one period seems to be unrelated to whether it is a useful predictor in a later period. Intriguingly, forecasts produced by combining these unstable individual forecasts appear to improve reliably upon univariate benchmarks.

https://papers.ssrn.com/sol3/Delivery.cfm/nber_w8180.pdf?abstractid=264434&mirid=1

Forecasting Output and Inflation: The Role of Asset Prices

The great moderation lulled macro-economists and policymakers alike in the belief that we knew how to conduct macroeconomic policy. The crisis clearly forces to question that assessment. This paper reviews the main elements of the pre-crisis consensus, identify where we were wrong and what tenets of the pre-crisis framework still hold, and take a tentative first pass at the contours of a new macroeconomic policy framework.

https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1555117_code1331894.pdf?abstractid=1555117&type=2

Rethinking Macroeconomic Policy

From 1960 to 1983, the standard deviation of annual growth rates in real GDP in the United States was 2.7%. From 1984 to 2001, the corresponding standard deviation was 1.6%. This paper investigates this large drop in the cyclical volatility of real economic activity. The paper has two objectives. The first is to provide a comprehensive characterization of the decline in volatility using a large number of U.S. economic time series and a variety of methods designed to describe time-varying time-series processes. In so doing, the paper reviews the literature on the moderation and attempts to resolve some of its disagreements and discrepancies. The second objective is to provide new evidence on the quantitative importance of various explanations for this "great moderation." Taken together, we estimate that the moderation in volatility is attributable to a combination of improved policy (20-30%), identifiable good luck in the form of productivity and commodity price shocks (20-30%), and other unknown forms of ...

/pdf/has-the-business-cycle-changed-and-why-9m7a5e3bxy.pdf

Has the Business Cycle Changed and Why

Because asset prices are forward-looking, they constitute a class of potentially useful predictors of inflation and output growth.

/pdf/forecasting-output-and-inflation-the-role-of-asset-prices-3as8q4c9hh.pdf

SINCE THE EARLY 1980S the U.S. economy has gone through two long expansions. The first, from 1982 to 1990, lasted thirty-one quarters. The second started in 1991 and, although showing signs of faltering, has recorded its fortieth quarter as this volume goes to press and is already the longest U.S. expansion on record. One view is that these two long expansions are simply the result of luck, of an absence of major adverse shocks over the last twenty years. We argue that more has been at work, namely, a large underlying decline in output volatility. Furthermore, we contend, this decline is not a recent development--the by-product of a "New Economy" or of Alan Greenspan's talent. Rather it has been a steady decline over several decades, which started in the 1950s (or earlier, but lack of consistent data makes this difficult to establish), was interrupted in the 1970s and early 1980s, and returned to trend in the late 1980s and the 1990s.(1) The magnitude of the decline is substantial: the standard deviation of quarterly output growth has declined by a factor of three over the period. This is more than enough to account for the increased length of expansions. Having established this fact, we reach two other conclusions. First, the decrease in volatility can be traced to a number of proximate causes, from a decrease in the volatility of government spending early on, to a decrease in consumption and investment volatility throughout the period, to a change in the sign of the correlation between inventory investment and sales in the last decade. Second, there is a strong relationship between movements in output volatility and movements in inflation volatility. The interruption of the trend decline in output volatility in the 1970s was associated with a large increase in inflation volatility; the return to trend is associated with the decrease in inflation volatility since then. This paper is organized as follows. We start by documenting our basic fact, namely, the secular decrease in output volatility. We then look at the stochastic process for GDP and show that this decrease in volatility can be traced primarily to a decrease in the standard deviation of output shocks, rather than to a change in the dynamics of output. Finally, we show how this decrease in the standard deviation of shocks accounts for the increased length of expansions. We then take up the question of whether recessions are special, in a way that the formalization used earlier does not do justice to. Put another way, we ask whether what we have seen over the last twenty years is simply the absence of large shocks and nothing more. We show that this is not the case. The measured decrease in output volatility has little to do with the absence of large shocks in the recent past. We then turn to the relationship between output volatility and inflation. We show that there is a strong relationship both between output volatility and the level of inflation, and between output volatility and inflation volatility. Both volatilities went up in the 1970s and have come down since. Correlation does not, however, imply causality. The correlation in both periods may have been due to third factors, such as supply shocks in the 1970s. This leads us to consider evidence from the other members of the Group of Seven (G-7) large industrial countries. Our motivation here is that the different timings of disinflation across these countries can help us separate out the effects of inflation from those of supply shocks. We first show that these other countries have also experienced a decline in output volatility, although with some differences in timing and in magnitude. (An interesting exception is Japan, where a decline in output volatility has been reversed since the late 1980s.) We then show that, even after controlling for common time fixed effects, inflation volatility still appears to be strongly related to output volatility. As a matter of accounting, the decline in output volatility can be traced either to changes in the composition of output or to changes in the variances and covariances of its underlying components. …

The Long and Large Decline in U.S. Output Volatility

This paper analyses the Fisher effect in Australia Initial testing indicates that both interest rates and inflation contain unit roots Furthermore, there are indications that the variables have non-standard error processes To overcome problems associated with this and derive the correct small sample distributions of test statistics we make use of Monte Carlo simulations These tests indicate that while a long-run Fisher effect seems to exist there is no evidence of a short-run Fisher effect This suggests that, while short-run changes in interest rates reflect changes in monetary policy, longer-run levels indicate inflationary expectations Thus, the longer-run level of interest rates should not be used to characterise the stance of monetary policy

An Empirical Examination of the Fisher Effect in Australia

This paper analyzes the Fisher effect in Australia. Initial testing indicates that both interest rates and inflation contain unit roots. Furthermore, there are indications that the variables have non-standard error processes. To overcome problems associated with this and derive the correct small sample distributions of test statistics we make use of Monte Carlo simulations. These tests indicate that while a long-run Fisher effect seems to exist, there is no evidence of a short-run Fisher effect. This suggests that, while short-run changes in interest rates reflect changes in monetary policy, longer run levels indicate inflationary expectations. Thus, the longer run level of interest rates should not be used to characterize the stance of monetary policy.

/pdf/an-empirical-examination-of-the-fisher-effect-in-australia-4ry08o194b.pdf

The last two US expansions have been unusually long One view is that this is the result of luck, of an absence of major adverse shocks over the last twenty years We argue that more is at work, namely a large underlying decline in output volatility This decline is not a recent development, but rather a steady one, visible already in the 1950s and the 1960s, interrupted in the 1970s and early 1980s, with a return to trend in the late 1980s and the 1990s The standard deviation of quarterly output growth has declined by a factor of 3 over the period This is more than enough to account for the increased length of expansions We reach two other conclusions First, the trend decrease can be traced to a number of proximate causes, from a decrease in the volatility in government spending early on, to a decrease in consumption and investment volatility throughout the period, to a change in the sign of the correlation between inventory investment and sales in the last decade Second, there is a strong relation between movements in output volatility and inflation volatility This association accounts for the interruption of the trend decline in output volatility in the 1970s and early 1980s

/pdf/the-long-and-large-decline-in-u-s-output-volatility-24fywxuayx.pdf

Over the past decade, household debt (as a share of household income) has reached historically high levels. This has raised concerns about whether, as a result of the rise in debt, households are now more financially 'fragile'. Using household survey data, a logit model is constructed to examine the relationship between the probability of being financially constrained and the economic and demographic characteristics of households in Australia. We find that the probability of a household being constrained is significantly affected by demographic and economic variables such as age, home ownership, weekly household income, and the share of income going to repayments on mortgage debt. Comparing survey results across time, it appears that the overall proportion of households that are financially constrained has fallen or, at worst, remained unchanged between 1994 and 2001. Much of the rise in debt appears to have been due to unconstrained households taking on more debt. As such, the rise in the aggregate debt to income ratio associated with owner-occupier mortgages appears to be the result of voluntary household choice and not to be associated with an increase in household financial distress.

John Simon

Papers

The Long and Large Decline in U.S. Output Volatility

An Empirical Examination of the Fisher Effect in Australia

An Empirical Examination of the Fisher Effect in Australia

The Long and Large Decline in U.S. Output Volatility

Household Debt and Financial Constraints in Australia