Monetary Policy. ECON 30020: Intermediate Macroeconomics. Prof. Eric Sims. Fall University of Notre Dame

Transcription

1 Monetary Policy ECON 30020: Intermediate Macroeconomics Pro. Eric Sims University o Notre Dame Fall / 13

2 Ineiciency in the New Keynesian Model Backbone o the New Keynesian model is the neoclassical model Argued earlier that the equilibrium o the New Keynesian model is eicient in the sense that the quantities coincide with what a ictitious social planner would choose The social planner s problem is identical in the New Keynesian and neoclassical models Intuition: no prices in the social planner s problem, and the dierence between New Keynesian and neoclassical models is price/wage rigidity This means that the optimal equilibrium o the New Keynesian model is the hypothetical equilibrium which would occur in the neoclassical model Call the hypothetical neoclassical level o output Y t No guarantee that Y t = Y t, hence equilibrium o New Keynesian model is in general ineicient 2 / 13

3 Optimal Policy in the New Keynesian Model I Y t = Yt, policy can be adjusted to make Y t = Yt In principle, this can be accomplished via endogenous monetary policy Given exogenous shocks, adjust M t (equivalently, interest rates) to make the equilibrium o the New Keynesian model mimic the equilibrium o the neoclsasical model Why not iscal policy? Fiscal policy will aect rt (the hypothetical real interest rate in the neoclassical model), and hence the distribution o output across consumption and investment in the neoclassical model Potentially long implementation lags with iscal policy Consensus view: iscal policy ought to be geared more toward the long run (e.g. inrastructure), with possible exception o extreme periods where monetary policy is ineective 3 / 13

4 Optimal Monetary Policy Responses: IS and Supply Shocks IS shocks: Positive IS shocks cause output to rise, but do not aect Yt I nothing done, will open up a positive output gap, Y t Yt Optimal policy should reduce M t (equivalently, raise r t /i t ) to counteract the IS shock Supply shocks: Supply shocks (changes in A t or θ t ) do not impact output in the NK model, but aect Yt Optimal policy should increase M t (equivalently, lower r t /i t ) to accommodate positive supply shocks (increase in A t or decrease in θ t ) Intuition: M t P t needs to adjust to implement neoclassical equilibrium. I P t can t adjust, adjust M t 4 / 13

5 Counteracting an IS Shock Original, sticky price rr tt LLLL(MM 1,tt, PP 0,tt) LLLL(MM 0,tt, PP 0,tt) Original, hypothetical lexible price Post-shock, sticky price Post-shock, hypothetical lexible price Optimal monetary policy response rr 2,tt rr 1,tt rr 0,tt 0 subscript: original 1 subscript: post-shock IIII ww tt superscript: hypothetical lexible price 2 subscript: post-policy response IIII ww 1,tt NN ss (ww tt, θθ tt) PP tt AAAA ww 0,tt = ww 2,tt PP 0,tt AAAA NN dd (ww tt, AA tt, KK tt) AAAA AAAA = AAAA NN tt AA ttff(kk tt, NN tt) = NN 0,tt NN 1,tt NN tt YY 0,tt YY 1,tt = NN 2,tt = YY 2,tt 5 / 13

6 Accommodating an Increase in A t rr tt LLLL(MM 0,tt, PP 0,tt) Original, sticky price Original, hypothetical lexible price Post-shock, sticky price LLLL(MM 1,tt, PP 0,tt) Post-shock, hypothetical lexible price Optimal monetary policy response rr 0,tt 0 subscript: original rr 2,tt 1 subscript: post-shock superscript: hypothetical lexible IIII price ww tt 2 subscript: post-policy response NN ss (ww tt, θθ tt) PP tt AAAA AAAA ww 2,tt ww 0,tt PP 0,tt AAAA ww 1,tt NN dd (ww tt, AA 1,tt, KK tt) NN dd (ww tt, AA 0,tt, KK tt) AAAA AAAA NN tt AA 1,ttFF(KK tt, NN tt) = AA 0,ttFF(KK tt, NN tt) NN 1,tt NN 0,tt NN 2,tt NN tt YY 0,tt YY 2,tt 6 / 13

7 Accommodating an Increase in θ t Original, sticky price rr tt LLLL(MM 1,tt, PP 0,tt) Original, hypothetical lexible price Post-shock, sticky price Post-shock, hypothetical lexible price Optimal monetary policy response rr 2,tt LLLL(MM 0,tt, PP 0,tt) 0 subscript: original rr 0,tt 1 subscript: post-shock superscript: hypothetical lexible price 2 subscript: post-policy response IIII ww tt NN ss (ww tt, θθ 1,tt) NN ss (ww tt, θθ 0,tt) PP tt AAAA AAAA ww 1,tt ww 2,tt ww 0,tt PP 0,tt AAAA NN dd (ww tt, AA tt, KK tt) AAAA AAAA NN tt = AA ttff(kk tt, NN tt) NN 2,tt NN 0,tt NN tt YY 2,tt YY 0,tt 7 / 13

8 Summary: Optimal Policy Responses to Shocks Table below summarizes how money supply / interest rates ought to react to dierent shocks: Exogenous Shock Variable IS curve A t θ t M t r t i t Monetary policy ought to be countercyclical conditional on demand shocks (IS shocks), in sense o moving money supply opposite o how output would react Monetary policy ought to be procyclical conditional on supply shocks (productivity and labor supply), in sense o moving money supply in same direction o how output would react 8 / 13

9 The Natural Rate o Interest Wicksell (1898), and later Woodord (2003): the natural rate o interest is r t, the real interest rate which would obtain in the absence o nominal rigidities (i.e. the medium run) Instead o adjusting the money supply, can think o monetary policy as trying to set the real interest rate equal to the natural rate, which automatically implements Y t = Y t Mathematically, money market equilibrium requires: M t P t = M d (r t + π e t+1, Y t ) Set M t such that: M t P t = M d (r t + π e t+1, Y t ) 9 / 13

10 Why not Fiscal Policy or Short Run Stabilization? M t aects neither rt nor Yt Thereore a well-deined exercise to pick M t such that the economy is at a point on the IS curve where (r t, Y t ) = (rt, Yt ). Not so with iscal policy, since G t and G t+1 aect rt In other words, could adjust G t to implement Y t = Yt, but since this would aect rt, you wouldn t have C t = Ct and I t = It 10 / 13

11 Monetary Policy In Practice Taylor (1993) argues that a airly simple rule written in terms o inlation and the output gap its data well: i t = r + π + φ π (π t π ) + φ y (Y t Y t ) r and π are long run targets, and φ π and φ y are positive coeicients Not exactly the optimal policy response we discussed above, and phrased in terms o nominal interest rate rather than money supply But embodies some o the eatures o optimal policy: Positive output gap: raise nominal interest rate I inlation above target, likely that output gap is positive (e.g. basic Phillips Curve idea), so responding to inlation kind o makes sense as well Hence, the Taylor rule has some desirable normative properties 11 / 13

12 Taylor Rule versus FFR: Data The Taylor rule provides a pretty good positive description o monetary policy making rom the early 1980s to mid 2000s Federal Funds Rate Monetary Policy Rule 12 / 13

13 The Zero Lower Bound This relationship breaks down ater 2008 when the economy hit the zero lower bound (ZLB) 7 Eective Federal Funds Rate Will next consider implications o the ZLB or policy 13 / 13