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The psychology of inflation, monetary policy and macroeconomic instability

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Abstract

This paper extends a stylized AD/AS macroeconomic model to a setting in which inflation dynamics impinges on the sentiment of the public toward the future course of the economy. As individuals are allowed to exchange information on their personal mood and to persuade each other through repeated interactions, waves of optimism and pessimism emerge endogenously. The model is then used to analyze the stabilizing effect of alternative monetary policy rules.

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... We saw above that Dixon et al. ( 2014 ) showed (in their analysis of expectations of economic change) that lay predictions of inflation and unemployment conform to the GBG heuristic, and are at variance with the Phillips curve. Gaffeo and Canzian ( 2011 ) further showed that the GBG heuristic has real world economic consequences, and in particular that it complicates the task of the central banks. The Taylor rule is a monetary-policy rule that stipulates how much the central bank should change the nominal interest rate in response to changes in inflation, output, or other economic conditions. ...
... The field of economics should be expanded to include serious quantitative study of changing popular narratives. (Shiller, 2017 , p. 4) If people believe that the current rate of inflation signals that the economy is going through a bad phase and predict that unemployment will rise in the future, this belief has economic consequences, and complicates the task of the central bank (Gaffeo & Canzian, 2011 ). The good-begets-good heuristic (Leiser & Aroch, 2009 ) explains how the public makes such predictions, by showing that the "sentiment" held by the public about the economy is deeply rooted in the globalizing way it perceives economic functioning ( Chapter 5 ). ...
... Sargent and Wallace (1975) 15 . Gordon (1977) 16 . Roberts (1997) 17 . ...
... ﻈﺎرات‬ ‫اﻓﺰاﯾﺶ‬ ‫ﮐﺎﻫﺶ‬ ‫ﺑﺎﻋﺚ‬ ‫ﻧﻘﺪﯾﻨﺪﮔﯽ‬ ‫اﻓﺰاﯾﺶ‬ ‫ﻃﺮﯾﻖ‬ ‫از‬ ‫دﯾﮕﺮي‬ ‫و‬ ‫ﮔﺬاران‬ ‫ﺳﺮﻣﺎﯾﻪ‬ ‫ﺑﺮاي‬ ‫ﺗﻘﺎﺿﺎ‬ ‫ﻣﯽ‬ ‫اﻗﺘﺼﺎد‬ ‫در‬ ‫رﮐﻮد‬ ‫ﺑﺮوز‬ ‫و‬ ‫ﮔﺬاري‬ ‫ﮔﺮدد‬ . ‫ﺑﻪ‬ ‫ﻣﻨﺠﺮ‬ ‫ﻧﺘﻮاﻧﺪ‬ ‫ﻣﺼﺮف‬ ‫ﺑﺮاي‬ ‫ﺗﻘﺎﺿﺎ‬ ‫اﮔﺮ‬ ________________________ 1 . Modigliani and Shiller (1972) 2 . Pyle (1972) 3 . Gibson (1972)4.Cargill and Mayer (1980) 5 . Ricketts (1996)6.Gaffeo & Canzian (2011)140 ‫ﻧﺸﺮﯾﻪ‬ ‫ﺳﯿﺎﺳﺖ‬ ‫اﻗﺘﺼﺎدي‬ ‫ﮔﺬاري‬ ، ‫ﺳﺎل‬ ‫دﻫﻢ‬ ، ‫ﺷﻤﺎره‬ ‫ﺑﯿﺴﺘﻢ‬ ، ‫ﭘﺎﯾﯿﺰ‬ ‫و‬ ‫زﻣﺴﺘﺎن‬ 1397 ‫ﺳﺮﻣﺎﯾﻪ‬ ‫ﺗﻘﺎﺿﺎي‬ ‫ﮐﺎﻫﺶ‬ ‫ﺟﺒﺮان‬ ‫رﮐﻮ‬ ‫ﺑﻪ‬ ‫ﻣﻨﺠﺮ‬ ‫ﺷﺪه‬ ‫اﯾﺠﺎد‬ ‫رﮐﻮد‬ ،‫ﺷﻮد‬ ‫ﮔﺬاري‬ ‫ﻣﯽ‬ ‫ﺗﻮرﻣﯽ‬‫د‬ ‫ﺷﻮد‬ ) ‫وﯾﻦ‬ ‫و‬ ‫اﺳﻨﻮدان‬ 1 ، 2005 : 64 .( ‫ﮐﯿﮕﺎن‬ 2 ) 1956 ( ‫وﯾﮋه‬ ‫ﺗﻮﺟﻪ‬ ‫اﻧﺘﻈﺎرات‬ ‫ﻣﺴﺎﻟﻪ‬ ‫ﺑﻪ‬ ،‫ﭘﻮل‬ ‫ﺗﻘﺎﺿﺎي‬ ‫ﺗﺎﺑﻊ‬ ‫ﺑﺮآورد‬ ‫در‬ ...
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Title :Analysis of the factors affecting the formation of inflation expectations due to political developments and changes in liquidity Abstract Started a new round of UN sanctions against Iran to the Lausanne Declaration , containing the political developments ( changes in government and interactive approach to foreign policy ), the impact on inflation expectations . Based on the experience and global studies , market rate of exchange ( the dollar ) , the stock price index and consumer price index (CPI), all on a monthly basis , as inflation expectations are considered to be approximations. In this study, we extract concession function of the economic planner in the context of conflict economy , based on conflict expectations of Drezner (1999 ) , that is a theory of dynamic games . We then, speicy this function, based on the object of decreasing expected inflation. Three regression models on the basis of the Autoregressive Integerated Moving Average with explanationary variable (ARIMAX) and rolling regressions were estimated. The results show that, one lagged expeted inflation and liquidity have positive effects on the expected inflation. Political developments , including changes in government and negotiating strategies , with different lags , have been effective in reducing inflation expectations. But the longer the negotiation process , would have been unknown changes in inflation expectations. Key Words: Expected Inflation,Conflict Expectations,Political development,Liquidity,Game Theory. Jelcod:C220,C78,E00.
... We saw above that Dixon et al. ( 2014 ) showed (in their analysis of expectations of economic change) that lay predictions of inflation and unemployment conform to the GBG heuristic, and are at variance with the Philips curve. Gaffeo and Canzian ( 2011 ) further showed that the GBG heuristic has real world economic consequences, and in particular that it complicates the task of the central banks. The Taylor rule is a monetary-policy rule that stipulates how much the central bank should change the nominal interest rate in response to changes in inflation, output, or other economic conditions. ...
... The field of economics should be expanded to include serious quantitative study of changing popular narratives. (Shiller, 2017 , p. 4) If people believe that the current rate of inflation signals that the economy is going through a bad phase and predict that unemployment will rise in the future, this belief has economic consequences, and complicates the task of the central bank (Gaffeo & Canzian, 2011 ). The good-begets-good heuristic (Leiser & Aroch, 2009 ) explains how the public makes such predictions, by showing that the "sentiment" held by the public about the economy is deeply rooted in the globalizing way it perceives economic functioning ( Chapter 5 ). ...
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This is the first book to explain why people usually misunderstand economic phenomena (as opposed to economic misbehavior). It explains the mismatch between the limits of our cognitive endowment and the specific way economics analyzes economic phenomena (both micro and macro). It documents numerous examples of misunderstanding and bias, and present the tools laypeople use to make sense of what is largely not understandable to them: metaphors, heuristics, ideology, reliance on psychological traits and more. The book lays out what all this means for policy makers, and makes recommendations based on the (glum) picture it documents.
... As we saw above, Dixon et al. (2014) showed in their analysis of expectations of economic change that lay predictions of inflation and unemployment conform to the GBG heuristic, and is at variance with the Philips Curve. Gaffeo & Canzian (2011) further showed that the GBG heuristic has real world economic consequences, and in particular that it complicates the task of the Central Banks. The Taylor rule is a monetary-policy rule that stipulates how much the central bank should change the nominal interest rate in response to changes in inflation, output, or other economic conditions. ...
... The Taylor rule is a monetary-policy rule that stipulates how much the central bank should change the nominal interest rate in response to changes in inflation, output, or other economic conditions. The GBG heuristic means that the public perceives the economic situation in a simplistic manner, as improving or deteriorating, and this generates waves of optimism or pessimism (Gaffeo and Canzian 2011). A wave of sentiment among the public can trigger a corresponding change in aggregate demand. ...
... Following the turn of the millennium, much emphasis has been placed on the concept of price stability as the core mandate of monetary policy practice by a vast majority of Central banks worldwide. Since then, there has been a multitude of empirical literature which has considered whether monetary policy has been effective at controlling inflation rates or not (Amano, 2007;Gaffeo & Canzian, 2011;Cioran, 2014;Moore, 2014;Colucci & Valori, 2015;Cukierman, 2017 amongst others). From an academic perspective, the centre of this debate primarily revolves around the issue of whether an observed series of inflation rates behaves as a persistent process over time or exhibits mean-reverting tendencies. ...
... Following the turn of the millennium, much emphasis has been placed on the concept of price stability as the core mandate of monetary policy practice by a vast majority of Central banks worldwide. Since then, there has been a multitude of empirical literature which has considered whether monetary policy has been effective at controlling inflation rates or not (Amano, 2007;Gaffeo & Canzian, 2011;Cioran, 2014;Moore, 2014;Colucci & Valori, 2015;Cukierman, 2017 amongst others). From an academic perspective, the centre of this debate primarily revolves around the issue of whether an observed series of inflation rates behaves as a persistent process over time or exhibits mean-reverting tendencies. ...
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Using the quantile autoregression methodology (QAR), this study contributes to the ever-expanding empirical literature by investigating the persistence in inflation for BRICS countries using quarterly time series data collected between 1996 to 2016. Our empirical analysis reveals two crucial findings. Firstly, for all estimated regressions, inflation persistence in the higher percentiles of the QAR regression exhibits unit root tendencies. Secondly, we note that the global financial crisis did alter the levels of inflation persistence at all quantiles for all BRICS countries. Collectively, we advise monetary authorities in BRICS countries to focus on keeping inflation at low and stable rates. JEL Classifications: C21; C31
... Forecaster herding has been extensively studied using theoretical models (see for example, Scharfstein and Stein, 1990;Bikhchandani and Hirshleifer, 1992;Ehrbeck and Waldmann, 1996;Teraji, 2003 , among others; for related research on preferences for conformism, see, e.g., Klick and Parisi, 2008 ), in experimental research ( Anderson and Holt, 1997;Drehmann and Oechssler, 2005;Morone and Sandri, 2009 ), and also in empirical research ( Chang and Cheng, 20 0 0;Clement and Tse, 2005;Bernhardt and Campello, 2006 among others; for related research on biases in how experts update beliefs, see Sinkey, 2015 , among others). 2 While theories of herding behavior have been extensively used in the field of financial economics to study forecasts of stock prices ( Chang and Cheng, 20 0 0;, metal prices ( Pierdzioch and Stadtmann, 2013 ), and exchange rates ( Pierdzioch and Stadtmann, 2012;Fritsche et al., 2015 ), herding behavior has also been studied in a variety of other fields including, for example, macroeconomic modeling ( Gaffeo and Canzian, 2011 ) and the modeling of the foreign direct investment decisions of firms ( Pinheiro-Alves, 2011 ). Forecaster herding arises if, for example, weak forecasters and forecasters in an early stage of their career remain close to the consensus forecast ( Lamont, 2002 ;see, however, Ashiya and Doi, 2001 ). ...
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We examine global economic dynamics under learning in a New Keynesian model in which the interest-rate rule is subject to the zero lower bound. Under normal monetary and fiscal policy, the intended steady state is locally but not globally stable. Large pessimistic shocks to expectations can lead to deflationary spirals with falling prices and falling output. To avoid this outcome we recommend augmenting normal policies with aggressive monetary and fiscal policy that guarantee a lower bound on inflation. In contrast, policies geared toward ensuring an output lower bound are insufficient for avoiding deflationary spirals.
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This paper characterizes the optimal monetary policy reaction function in the presence of a zero lower bound on the nominal interest rate. We analytically prove and numerically show that the function is highly non-linear, more expansionary, and more aggressive than the Taylor rule. We then test its empirical validity taking the case of Japan in the 1990s. Qualitatively, we find some evidence of non-linear monetary policy. Quantitatively, we find the actual monetary policy to be too contractionary during the first half of the decade, while the low interest policy during the latter half turns out to be fairly consistent with the simulated path.
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This paper uses a VAR to investigate four possible explanations of the extended slump in Japanese economic activity over the 1990s: the absence of bold and consistent fiscal stimulus; the limited room for expansionary monetary policy due to a liquidity trap; overinvestment and debt overhang; and disruption of financial intermediation. The results indicate that all of these factors played a role, but that the major explanation is disruption in financial intermediation, largely operating through the impact of changes in domestic asset prices on bank lending.
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Fair (2002) argues that New Keynesian models are wrong in predicting that an inflation shock has contractionary effects only if it raises the real interest rate, and that a coefficient on inflation higher than one in the Taylor rule is a necessary condition for stability. While Fair uses his macroeconometric model as a benchmark to evaluate the predictions of the standard New Keynesian framework, we adopt a VAR supported by models in that framework, and the model of Rudebusch and Svensson (1999). The findings are broadly in line with Fair's.
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In this paper we analyze a credit economy � la Kiyotaki and Moore [1997. Credit cycles. Journal of Political Economy 105, 211-248] enriched with learning dynamics, where both borrowers and lenders need to form expectations about the future price of the collateral. We find that under homogeneous learning, the MSV REE for this economy is E-stable and can be learned by agents, but when heterogeneous learning is allowed and uncertainty in terms of a stochastic productivity is added, expectations of lenders and borrowers can diverge and lead to bankruptcy (default) on the part of the borrowers.
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The General Theory of Employment, Interest, and Money / John Maynard Keynes Note: The University of Adelaide Library eBooks @ Adelaide.
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Under general conditions, a monetary policy of pegging the nominal rate of interest will make it possible for any adaptive learning mechanism that satisfies a weak and plausible condition to converge to rational expectations. Instead, under such a policy an economy will undergo a cumulative process of the sort described.by Milton Friedman. This is shown in a micro-based finance constraint model as well as an IS-LM model. The same result applies also to more flexible policies of interest control and suggests a severe limitation to rational expectations analyses that ignore the issue of expectational stability. Copyright 1992 by University of Chicago Press.
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This paper offers an explanation of behavior that puzzled entomologists and economists. Ants, faced with two identical food sources, were observed to concentrate more on one of these but, after a period, they would turn their attention to the other. The same phenomenon has been observed in humans choosing between restaurants. After discussing the nature of foraging and recruitment behavior in ants, a simple model of stochastic recruitment is suggested. This explains the "herding" and "epidemics" described in the literature on financial markets as corresponding to the equilibrium distributio n of a stochastic process rather than to switching between multiple equilibria. Copyright 1993, the President and Fellows of Harvard College and the Massachusetts Institute of Technology.
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The household data underlying the Michigan Index of Consumer Sentiment are used to test the rationality of consumer expectations and their usefulness in forecasting expenditure. The results can be interpreted as characterizing the shocks that hit different types of households over time. Expectations are found to be biased and inefficient, at least ex post. People underestimated the disinflation of the early 1980s and the severity of recent business cycles. People's forecast errors are also systematically correlated with their demographic characteristics, in part because of time-varying, group-level shocks. Further, sentiment helps forecast consumption growth. Some of this rejection of the permanent income hypothesis is due to the systematic demographic components in forecast errors.
Article
The zero lower bound on nominal interest rates constrains the central bank's ability to stimulate the economy during downturns. We use the FRB/US model to quantify the effects of the zero bound on macroeconomic stabilization and to explore how policy can be designed to minimize these effects. During particularly severe contractions, open-market operations alone may be insufficient to restore equilibrium: some other stimulus is needed. Abstracting from such rare events, if policy follows the Taylor rule and targets a zero-inflation rate, there is a significant increase in the variability of output but not inflation. However, a simple modification to the Taylor rule yields a dramatic reduction in the detrimental effects of the zero bound.
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This paper examines whether indicators of consumer and business confidence can predict movements in GDP over the business cycle for four European economies. The empirical methodology used to investigate the properties of the data comprises cross-correlation statistics, implementing an approach developed by den Haan ["Journal of Monetary Economics" (2000) , Vol. 46, pp. 3-30]. The predictive power of confidence indicators is also examined, investigating whether they can predict discrete events, namely economic downturns, and whether they can quantitatively forecast point estimates of economic activity. The results indicate that both consumer and business confidence indicators are procyclical and generally play a significant role in predicting downturns. Copyright Blackwell Publishing Ltd and the Department of Economics, University of Oxford 2007.
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This study investigates public knowledge of basic economics and public opinion on economic issues. The primary data sources are five national surveys, administered from 1992 to 1999, which contain a rich set of questions to conduct multiple tests and comparisons of the factors that affect economic knowledge and public opinion. As a whole, the results offer significantly stronger evidence of factors that influence knowledge and opinion than is possible from a study of a particular sample of adults using a single set of survey questions.The analysis proceeds in two ways following methods that were originally used with one of the five data sets, a 1992 survey of adults (Walstad, 1997). First, a regression model is specified and estimated with each data set to identify how personal characteristics, general education, course work in economics, income, and political party affect economic knowledge. Second, probit analysis is used to evaluate the effect of economic knowledge on public opinion on selected economic issues after controlling for the above variables. The results from the 1992 data serve as the baseline for comparing the findings across the other surveys.
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Differences between the general public"s "positive" economic views and economists" resemble other judgemental anomalies: Laypeople and experts "systematically" disagree. I analyse this puzzle using data from the Survey of Americans and Economists on the Economy. The paper first tests and decisively rejects the hypothesis that the differences solely reflect economists" self-serving bias. Then it examines whether economists" political ideology and party loyalties explain the disagreement; if anything, this slightly increases their magnitude. The effect of economic training clearly falls but remains large after adding education to the set of control variables. Apparent biases" robustness suggests that the anomaly is real. Copyright 2002 Royal Economic Society
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Using U.K. data, the rational expectations permanent income hypothesis is rejected due to the predictive content of consumer confidence and not labor income or any other macroeconomic variable. The authors provide evidence suggesting that this cannot be explained by liquidity constraints and account for this finding in terms of precautionary saving. Extending the consumption capital asset pricing model to allow a time varying conditional variance, they find a high level of confidence is associated with greater optimism about the level of consumption but also a higher forecast variance. Allowing for time aggregation, the overidentifying restrictions implied by this model are accepted. The authors estimate a small but statistically significant intertemporal elasticity of substitution. Copyright 1994 by Royal Economic Society.
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This paper examines how recent econometric policy evaluation research on monetary policy rules can be applied in a practical policymaking environment. According to this research, good policy rules typically call for changes in the federal funds rate in response to changes in the price level or changes in real income. An objective of the paper is to preserve the concept of such a policy rule in a policy environment where it is practically impossible to follow mechanically any particular algebraic formula that describes the policy rule. The discussion centers around a hypothetical but representative policy rule much like that advocated in recent research. This rule closely approximates Federal Reserve policy during the past several years. Two case studies—German unification and the 1990 oil-price shock—that had a bearing on the operation of monetary policy in recent years are used to illustrate how such a policy rule might work in practice.
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A popular model in the literature postulates an interest rate rule, a NAIRU price equation, and an aggregate demand equation in which aggregate demand depends on the real interest rate. In this model a positive inflation shock with the nominal interest rate held constant is explosive because it increases aggregate demand (because the real interest rate is lower), which increases inflation through the price equation, which further increases aggregate demand, and so on. In order for the model to be stable, the nominal interest rate must rise more than inflation, which means that the coefficient on inflation in the interest rate rule must be greater than one. The results in this paper suggest, however, that an inflation shock with the nominal interest rate held constant has a negative effect on real output. There are three reasons. First, the data support the use of nominal rather than real interest rates in aggregate expenditure equations. Second, the evidence suggests that the percentage increase in nominal household wealth from a positive inflation shock is less than the percentage increase in the price level, which is contractionary because of the fall in real wealth. Third, there is evidence that wages lag prices, and so a positive inflation shock results in an initial fall in real wage rates and thus real labor income, which is contractionary. If these three features are true, they imply that a positive inflation shock has a negative effect on aggregate demand even if the nominal interest rate is held constant. Not only does the Fed not have to increase the nominal interest rate more than the increase in inflation for there to be a contraction, it does not have to increase the nominal rate at all!
Article
The Predictive Power of the Index of Consumer Sentiment THE MONTHLY RELEASE of the Index of Consumer Sentiment (ICS) by the Survey Research Center of the University of Michigan is featured in the financial press with much fanfare, especially during periods of economic uncertainty. Yet the conventional wisdom appears to be that although the index by itself has considerable predictive power, when used in conjunction with other readily available economic variables its marginal value is quite small. For example, Christopher Carroll, Jeffrey Fuhrer, and David Wilcox conclude that “consumer sentiment does indeed forecast future changes in household spending. . . . Further, sentiment likely has some (though probably not a great deal) of incremental predictive power relative to at least some other indicators for the growth of spending.”1 On the other hand, John Matsusaka and Argia Sbordone find evidence of a qualitatively significant causal relationship between the ICS and GDP: they estimate that between 13 and 26 percent of variations in GDP can be attributed to variations in consumer sentiment.2 This paper assesses the predictive power of the ICS, addressing two questions in particular. First, does the index, either alone or in conjunction with other indicator variables, sharpen predictions of recession and recovery? Second, does the index, either alone or in conjunction with other economic indicators, help to predict personal consumption expenditure? 175 E. PHILIP HOWREY University of Michigan The author is grateful to Saul Hymans for comments and suggestions on an earlier draft of this paper and to Joan Crary for help in assembling the data. 1. Carroll, Fuhrer, and Wilcox (1994, p. 1401). 2. Matsusaka and Sbordone (1995). 0099—04 BPEA /Howrey 7/3/01 15:51 Page 175 The first question is especially timely in view of the plunge in the ICS in recent months. To answer this question, it is necessary first to define precisely and in quantitative terms what is meant by recession and what is meant by recovery, next to translate the ICS and other indicator variables into a recession signal, and finally to evaluate the accuracy of that signal as a predictor of recession. The next section summarizes the procedure used to carry out these three steps. This procedure is then applied to quarterly values of a set of indicator variables that includes the ICS as well as the spread between long- and short-term interest rates, a composite stock market index, and an index of leading indicators. This procedure is also applied to a model that generates current-quarter estimates of these indicator variables from data for the first, or first two, months of the quarter, to assess the accuracy of high-frequency predictions of recession and recovery. Finally, the value of monthly indicator data for forecasting personal consumption expenditure is investigated. This question is motivated by the fact that monthly values of the ICS as well as of other indicator variables are available before the corresponding monthly values of personal consumption expenditure are released. An accurate and timely forecast of personal consumption expenditure and its components would be helpful in predicting periods of recession and recovery. Predicting the Probability of Recession Definition of Recession A popular definition of recession is the occurrence of two or more successive quarters of decline in real GDP.3 This definition, however, corresponds only approximately to the standard reference cycle chronology maintained by the National Bureau of Economic Research (NBER). Recession quarters as identified by the NBER coincide roughly with quarters in which real GDP declines, but the correspondence is not perfect. A slightly more technical definition of recession that corresponds more closely with the NBER chronology is two or more successive quarters in which a weighted average of the current and immediately preceding and 176 Brookings Papers on Economic Activity, 1:2001 3. Other definitions of recessionary events have been proposed by Fair (1993) and Stock and Watson (1993). 0099—04 BPEA /Howrey 7/3/01 15:51 Page 176 following quarterly GDP growth rates is negative. In particular, let yt denote the rate of growth of real GDP from quarter t – 1 to t, and let4 According to the average growth rate criterion, a recession is said to begin in quarter t if that quarter...
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A questionnaire survey was conducted to explore how people think about inflation, and what real problems they see it as causing. With results from 677 people, comparisons were made among people in the U.S., Germany, and Brazil, between young and old, and between economists and non-economists. Among noneconomists in all countries, the largest concern with inflation appears to be that it lowers people's standard of living. Non-economists appear often to believe in a sort of sticky-wage model, by which wages do not respond to inflationary shocks, shocks which are themselves perceived as caused by certain people or institutions acting badly. This standard of living effect is not the only perceived cost of inflation among non-economists: other perceived costs are tied up with issues of exploitation, political instability, loss of morale, and damage to national prestige. The most striking differences between groups studied were between economists and non-economists. There were al...
Article
This paper examines various interest rate rules, including rules derived by solving optimal control problems, for their ability to dampen economic fluctuations caused by random shocks. A tax rate rule is also considered. A multicountry econometric model is used for the experiments. The results differ sharply from those obtained using recent models in which the coefficient on inflation in the nominal interest rate rule must be greater than one in order for the economy to be stable. 1
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Introduction John Taylor (1993) has proposed that U.S. monetary policy in recent years can be described by an interest-rate feedback rule of the form i t = .04 + 1.5(# t - .02) + .5(y t - y t ), (1.1) where i t denotes the Fed's operating target for the federal funds rate, # t is the inflation rate (measured by the GDP deflator), y t is the log of real GDP, and y t is the log of "potential output" (identified empirically with a linear trend). ). The rule has since been subject to considerable attention, both as an account of actual policy in the U.S. and elsewhere, and as a prescription for desirable policy. Taylor argues for the rule's normative significance both on the basis of simulations and on the
Article
The zero lower bound on nominal interest rates constrains the central bank's ability to stimulate the economy during downturns. We use the FRB/US model to quantify the effects of the bound on macroeconomic stabilization and to explore how policy can be designed to minimize these effects. During particularly severe contractions, open-market operations alone may be insufficient to restore equilibrium; some other stimulus is needed. Abstracting from such rare events, if policy follows the Taylor rule and targets a zero inflation rate, there is a significant increase in the variability of output but not inflation. However, a simple modification to the Taylor rule yields a dramatic reduction in the detrimental effects of the zero bound. Keywords: monetary policy, macroeconometric models, liquidity trap 1 We would like to thank Marvin Goodfriend, Donald Kohn, David Lebow, Brian Madigan, Athanasios Orphanides, Michael Prell, David Small, David Stockton, Peter Tinsley, Volker Wiela...
Monetary policy and the limitations of economic knowledge Post Walrasian Macroeconomics The predictive power of the Index of Consumer Sentiment
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Policymaking Insights from Behavioral Economics. Federal Reserve Bank of Boston Rule-of-thumb consumers and the design of interest rate rules
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