ECON 4325 Monetary Policy Lecture 13: Summary. Martin Blomhoff Holm

Transcription

1 ECON 4325 Monetary Policy Lecture 13: Summary Martin Blomhoff Holm

2 Outline 1. A short summary of this course. 2. The bank lending channel and bank capital channel 3. An example problem 4. Interpreting κ 5. Optimal monetary policy - discretion vs. commitment 6. How to write a good case solution 7. Last messages Holm Monetary Policy, Lecture 13 1 / 30

3 Part I: Short summary Holm Monetary Policy, Lecture 13 2 / 30

4 Syllabus All lecture notes. Monetary Policy, Inflation, and the Business Cycle. Chapter 1-XX. Four articles (see syllabus page): Bernanke-Gertler (1995) Clarida-Gali-Gertler (1999) Clarida-Gali-Gertler (2000) Woodford (2012) Norges Bank MPC 1/2018 & Norges Bank Watch 2018 Holm Monetary Policy, Lecture 13 3 / 30

5 This Course in a Nutshell 1. Solve FOCs. 2. Interpret FOCs. 3. Log-linearize. 4. Interpreting κ. 5. Optimal monetary policy. (discretion/optimal simple rule/commitment) 6. Solve impulse responses by method of undetermined coefficients. 7. Solve monetary policy cases. a) The standard model in the course. b) The other transmission channels. c) Unconventional monetary policy. Holm Monetary Policy, Lecture 13 4 / 30

6 Part II: Bank lending and bank capital channels. Holm Monetary Policy, Lecture 13 5 / 30

7 Bank lending and bank capital channels Bank lending channel(s): Old View: (Banks care about reserves relative to deposits) Reserves deposits and reserves increase for banks R/D banks increase lending. New View: (Effect through costs) Reserves more supply of reserves in interbank market i ib cheaper funding for banks and they increase lending. Bank capital channel: (Banks care about equity relative to assets) Reserves and central bank buys some assets that banks hold E banks increase lending. Holm Monetary Policy, Lecture 13 6 / 30

8 Part III: An Example Problem. Holm Monetary Policy, Lecture 13 7 / 30

9 An Example Problem The household problem is: max C t,n t,b t E 0 t=0 β t (log(c t ) N1+φ t 1 + φ ) subject to P t C t + B t W t N t + B t 1 + D t 1 + i t Transversality condition 1. Find the first-order conditions. 2. Interpret the first-order conditions. 3. Log-linearize the first-order conditions. NB: two other functional forms: Standard non-separable, See problem set II. Greenwood-Hercowitz-Huffman non-separable. Holm Monetary Policy, Lecture 13 8 / 30

10 Part IV: Interpreting κ Holm Monetary Policy, Lecture 13 9 / 30

11 Interpreting κ Part 1: ( κ = σ + φ+α 1 α ( σ + φ + α 1 α ) ) ( 1 θ θ ) ( ) 1 α (1 βθ) 1 α + αɛ Link between output and marginal costs. Intuition: to increase production, firms have to attract labor from households and it affects the marginal product of labor. There are three effects: σ φ 1 α α 1 α Holm Monetary Policy, Lecture / 30

12 Interpreting κ κ = Part 2: ( ) 1 θ θ ( σ + φ + α 1 α ) ( 1 θ θ ) ( ) 1 α (1 βθ) 1 α + αɛ Link between optimal prices and aggregate inflation. If θ is high, fewer firms change prices, thus aggregate inflation is less sensitive to changes in current marginal costs. Holm Monetary Policy, Lecture / 30

13 Interpreting κ κ = Part 3: (1 βθ) ( σ + φ + α 1 α ) ( 1 θ θ ) ( ) 1 α (1 βθ) 1 α + αɛ How long the firm expect the price to last and the cost of it. If βθ is high, the firm is expected to be stuck with the price for a long (θ) costly (β) period, inducing firms to change prices less in response to changes in current marginal costs. Holm Monetary Policy, Lecture / 30

14 Interpreting κ Part 4: ( κ = σ + φ + α 1 α ( ) 1 α 1 α+αɛ ) ( 1 θ θ ) ( ) 1 α (1 βθ) 1 α + αɛ The loss from having the wrong price in the future. If ɛ is high, demand is more sensitive to price differences, making firms more reluctant to change prices. If α is high, having different price than the rest has a greater impact on marginal costs, making firms more reluctant to change prices. Holm Monetary Policy, Lecture / 30

15 Part V: Optimal MP. Discretion vs. Commitment. Holm Monetary Policy, Lecture / 30

16 Optimal Monetary Policy The standard model (CGG, 1999) x t = η[i t E t π t+1 ] + E t x t+1 π t = κx t + βe t π t+1 + u t u t = ρu t 1 + û t L t = 1 2 E t β k [λxt+k 2 + π2 t+k ] 1. Solve under discretion. 2. Solve under commitment. 3. What s the difference? 4. Why is it different? k=0 Holm Monetary Policy, Lecture / 30

17 Part VI: How to write a good case solution. Holm Monetary Policy, Lecture / 30

18 A QE/CE Case Imagine you are one of the senior advisors at the central bank in Country A. The central bank follows a flexible inflation regime targeting 2 % inflation rate and 0 % output gap. Currently, the economy is in a recession with - 2% output gap and a 1 % inflation rate. Moreover, the interest rate is currently at 0 %, something the governor considers to be the lower bound on the interest rate. The governor wants to consider government balance sheet expansions to achieve the monetary policy targets. Write a note describing the balance sheet options available, how they operate, and a recommendation on future action. Holm Monetary Policy, Lecture / 30

19 A QE/CE Case - The Facts Imagine you are one of the senior advisors at the central bank in Country A. The central bank follows a flexible inflation regime targeting 2 % inflation rate and 0 % output gap. Currently, the economy is in a recession with - 2% output gap and a 1 % inflation rate. Moreover, the interest rate is currently at 0 %, something the governor considers to be the lower bound on the interest rate. The governor has asked you to describe how government balance sheet policies might help to achieve the monetary policy targets. Write a note describing the balance sheet options available, how they operate, and a recommendation on future action. Holm Monetary Policy, Lecture / 30

20 A QE/CE Case - The Question Imagine you are one of the senior advisors at the central bank in Country A. The central bank follows a flexible inflation regime targeting 2 % inflation rate and 0 % output gap. Currently, the economy is in a recession with - 2% output gap and a 1 % inflation rate. Moreover, the interest rate is currently at 0 %, something the governor considers to be the lower bound on the interest rate. The governor has asked you to describe how government balance sheet policies might help to achieve the monetary policy targets. Write a note describing the balance sheet options available, how they operate, and a recommendation on future action. Holm Monetary Policy, Lecture / 30

21 A QE/CE Case - What you need to provide Imagine you are one of the senior advisors at the central bank in Country A. The central bank follows a flexible inflation regime targeting 2 % inflation rate and 0 % output gap. Currently, the economy is in a recession with - 2% output gap and a 1 % inflation rate. Moreover, the interest rate is currently at 0 %, something the governor considers to be the lower bound on the interest rate. The governor has asked you to describe how government balance sheet policies might help to achieve the monetary policy targets. Write a note describing the balance sheet options available, how they operate, and a recommendation on future action. Holm Monetary Policy, Lecture / 30

22 Structuring the case solution 1. Intro. One paragraph. Just provide a brief intro + road map. 2. The body. Explain the options. What are they? How do they work? 3. The conclusion. A recommendation. Holm Monetary Policy, Lecture / 30

23 The Intro Make a plan before you write the intro. To the point. No more than 4-5 sentences. Example: We are currently in a recession with low inflation rate and negative output gap. The interest rate is at zero, limiting the options available for conventional monetary policy. This note presents two balance sheet options available for the central bank: quantitative easing and credit easing. I will first describe how the two policies work before I provide recommendations on future policy. Holm Monetary Policy, Lecture / 30

24 The Body Describe the options available. Structure each presentation in the same way (e.g. description, theory, empirics). A wordy text is in most cases a sign of confusion. Don t worry about writing a short answer as long as you answer the question. A for example is a good way of explaining things. Holm Monetary Policy, Lecture / 30

25 The Body Quantitative Easing One policy available to the central bank at the zero lower bound is to acquire bonds from the market using new reserves. This policy is called quantitative easing and is similar to standard open market operations in the sense that we expand the balance sheet. However, in contrast to open market operations, the goal is no longer to affect the short-term interest rate, but to expand the monetary base and through that expansion affect the economy. In theory, quantitative easing works through the bank lending channel. [...] Empirical evidence suggests that quantitative easing has had limited impact on output and prices. [...] Holm Monetary Policy, Lecture / 30

26 The Conclusion 1-2 paragraphs. Answer the question. There is no right answer. But there are well-argued and not-so-well-argued answers. Remember that policy making is decision under uncertainty. Explain what information is needed to implement the policy. Holm Monetary Policy, Lecture / 30

27 The Conclusion Of the two balance sheet policies discussed above, credit easing seems to be the most promising. It is not clear how quantitative easing should have effect. Further, empirical evidence [...]. Credit easing, on the other hand, has some promise. The empirical evidence suggests that it has had positive impact on employment in the US. Further [...]. However, a weakness of credit easing is that although it might have positive impact on employment, the costs are uncertain. [...] I recommend [...]. Holm Monetary Policy, Lecture / 30

28 Part VII: Last messages. Holm Monetary Policy, Lecture / 30

29 Structure of the exam Exactly same structure as previous exams: 4 short problems. 2 long questions. Compared to previous versions of the course, we ve had... less focus on monetary policy at different central banks.... no Barro-Gordon model.... more about unconventional monetary policy. Holm Monetary Policy, Lecture / 30

30 The Feynman Technique 1. Pick a topic you want to understand and start studying it. Write down everything you know about the topic on a notebook page, and add to that page every time you learn something new about it. 2. Pretend to teach your topic to a classroom. Make sure you re able to explain the topic in simple terms. 3. Go back to the books when you get stuck. The gaps in your knowledge should be obvious. Revisit problem areas until you can explain the topic fully. 4. Simplify and use analogies. Repeat the process while simplifying your language and connecting facts with analogies to help strengthen your understanding. Holm Monetary Policy, Lecture / 30

31 Last messages If you have any questions, just send me an . You can also visit me at my office at BI, but you should send me an first to check if I m there. Good luck on the exam! Holm Monetary Policy, Lecture / 30