It is argued that inflation targeting is best understood as a commitment to a targeting rule rather than an instrument rule ,e ither ageneral targeting rule (explicit objectives for monetary policy) or a specific targeting rule (a criterion for (the forecasts of) the target variables to be fulfilled), essentially the equality of the marginal rates of transformation and substitution between the target variables. Targeting rules allow the use of judgment and extramodel information, are more robust and easier to verify than optimal instrument rules, and they can nevertheless bring the economy close to the socially optimal equilibrium.

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What is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules

The global financial crisis has led to a renewed interest in discretionary fiscal stimulus. Advocates of discretionary measures emphasize that government spending can stimulate additional private spending – the Keynesian multiplier effect. Thus, we investigate whether the spending package announced by euro area governments for 2009 and 2010 is likely to boost GDP by more than one for one. Because of modelling uncertainty, it is essential that such policy evaluations be robust to alternative modelling assumptions and parameterizations. We use five different empirical macroeconomic models with Keynesian features such as price and wage rigidities to evaluate the impact of the fiscal stimulus. Four of them suggest that the planned increase in government spending will reduce private consumption and investment significantly. Only a model that largely ignores the forward-looking behavioural response of consumers and firms implies crowding-in of private spending. We review a range of issues that may play a role in the recession of 2008–2009. Implementation lags are found to reinforce crowding-out and may even cause an initial contraction. Zero-bound effects may lead the central bank to abstain from interest rate hikes and increase the GDP impact of government spending. Crowding-in, however, requires an immediate anticipation of at least two years at the zero bound. Using a multi-country model, we find that spillovers between euro area countries are negligible or even negative, because direct demand effects are offset by the indirect effect of a euro appreciation. New-Keynesian dynamic stochastic general equilibrium (DSGE) models provide a strong case for government savings packages. Announced with sufficient lead time, spending cuts induce a significant short-run stimulus and crowding-in of private spending.

— Tobias Cwik and Volker Wieland

/pdf/keynesian-government-spending-multipliers-and-spillovers-in-2thc4wpckq.pdf

Keynesian government spending multipliers and spillovers in the euro area

In the aftermath of the global financial crisis, the state of m acroeconomic modeling and the use of macroeconomic models in policy analysis has come under heavy criticism. Macroeconomists in academia and policy institutions are blamed for relying too much on a particular class of macroeconomic models that did not sufficiently. This paper propose s a comparative approach to macroeconomic policy analysis that is open to competing modeling paradigms. Macroeconomic model comparison projects have helped produce some very influenti al insights such as the Taylor rule. However, they have been infrequent and costly, because they require the input of many teams of researchers and multiple meetings to obtain a limited set of comparative findings. This paper provides a new comparative approach to model-based research and policy analysis that enables individual researchers to conduct model comparisons easily, frequently, at low cost and on a large scale. Using this approach a model archive is built that incl udes many well-known empirically estimated models that may be used for quantitative analysis of monetary and fiscal stabilization policies. A computational platform is created that allows straightforward comparisons of models’ implications. Its application is illustrated by compa ring different monetary and fiscal policies across selected models. Researchers can easily include new models in the data base and compare the effects of novel extensions to established benchmarks thereby fostering a comparative instead of insular approach to model development.

/pdf/a-new-comparative-approach-to-macroeconomic-modeling-and-2q3xg4cdqb.pdf

A New Comparative Approach to Macroeconomic Modeling and Policy Analysis

Estimated general equilibrium models for the evaluation of monetary policy in the US and Europe

http://people.bu.edu/rking/EC741stuff/LMPecb.pdf

Quantifying and sustaining welfare gains from monetary commitment

In this article, we analyse the conduct of optimal monetary policy for the new euro area. The aggregate euro area economy is modelled to have relatively sluggish adjustment properties and a private sector with mainly backward-looking expectations. In this economy, we assume that the central bank searches for its best-performing monetary policy rule, e.g. for the optimal weight to give to inflation stabilization compared to that of output and for the optimal degree of forward-looking in the planning horizon. We first find that the optimal degree of gradualism in interest rate-setting needs only be relatively mild and that the central bank should incorporate new information quickly into policy-making. Second, there is substantial gain from implementing and communicating quite forward-looking policies. The optimal forecast horizon for inflation ranges around six quarters. In contrast to deliberately simple rule-based policy recommendations, fully optimal policy is a complicated response to many different economic indicators. With regard to this we find, third, that optimal policy should be based on a broad information set, even if the resulting policy framework is hard to communicate to the outside world. Thus, the article contributes to the debate on optimal monetary policy for the euro area, as well as to the conduct of monetary policy in face of substantial persistence in the transmission mechanism.

/pdf/optimal-monetary-policy-rules-for-the-euro-area-an-analysis-72dyz6zms0.pdf

Keith Küster

Papers

Optimal Monetary Policy Rules for the Euro Area: An Analysis Using the Area Wide Model*