The Global acor in Neural Policy Raes Some Implicaions for Exchange Raes Moneary Policy and Policy Coordinaion Richard Clarida Lowell Harriss Professor of Economics Columbia Universiy Global Sraegic Advisor PIMCO Research Associae NBER Prepared for he BIS Research Conference Lucerne Swizerland June 23 207
Moivaion Moneary Policy wih an r* anchor Wicksell riedman Taylor Woodford wih a ime varying and low r * - Yellen Haldane Williams wih a globally correlaed and ime varying r* - Clarida Gerler Gali Empirical Evidence on ime varying r* US - Laubach Williams; Hamilon e. al Global Holson Laubach Williams King and Low Lucasz Smih Naional Moneary Policies Inernaional Spillovers in world wih r* shocks Beggar hy neighbor depreciaions? Currency War races o he boom on raes? Aainable gains o Moneary Policy cooperaion or coordinaion? Challenges in communicaion and credibiliy wih policy cooperaion?
This Paper Review some exising evidence of global facor in ime varying counry r*s Sudy and assess inernaional implicaions of r* shocks in a sandard model r* sar shocks driven by shock o expeced produciviy growh r* shocks are sum of global facor and counry specific facor Moneary policy is se opimally aking foreign policy as given Resuls in model (Gali Monacelli; Clarida) wih no policy exernaliies Exchange rae adjusmen required o counry specific r* shocks -This is no beggar hy neighbor depreciaion o fall in r* No exchange rae adjusmen required for global r* shocks -This is no a race o boom on raes currency war Exchange rae is presen value of expeced pah of r* differenials -plus PPP and business cycle facors 2
This paper - Policy Exernaliies More general model (based on CGG) wih inernaional spillovers and inrinsic r* correlaion Nash equilibrium looks like firs model Exchange rae adjusmen sill required o counry specific r* shocks No exchange rae adjusmen required for global r* shocks Exchange rae is sill presen value of expeced pah of r* differenials Bu r* in each counry is now a funcion of home and foreign produciviy and b cycle This is rue even if home and foreign fundamenals are independen Creaes poenial for maerial gains o policy coordinaion r* gains -nowcasing reacion funcion parameers my r* depends on your pracice And in heory gains o binding policy cooperaion BUT I argue -Policy Cooperaion could be hard o communicae/defend in 3
Quick Review of Empirical r* Esimaes igure : HLW Esimaes of r* 4 HLW Esimaes of r* 3 2 0 US r* UK r* CAN r* EUR r* - 4
igure 2: HLW r* and TIPS Implied orwards 5 4 3 2 0 US r* US TIPS y4y wd - -2 5
igure 3: HLW r* and Implied Linker orward 5 4 3 2 0 UK r* - UK Linker y5y wd -2 6
igure 4:Equilbrium Error in he HLW VECM Represenaion 4.00 3.50 HW_r*_US 3.00 Equilibiurm Error in HLW VECM 2.50 2.00 HLW_r*_index_UKEZCA.50.00 0.50 0.00 7
Opimal Moneary Policy and Exchange Raes wih r* Shocks Two counry model based on Gali Monacelli (2005) as exended in Clarida (204) Global common facor in produciviy as well as home-counry specific facor This sole source of r * shocks Home counry business cycle wih nominal rigidiy and mark up shocks Parameers chosen so no gains o policy cooperaion if naional policies are se opimally Key equaions r * = E Δ a E Δ a x = E x {R E (p -p ) r * } p β p ) λx u p = E ( p s = a x e = s p 8
Equilibrium Exchange Rae wih r* Shocks Log nominal exchange rae (home price of foreign currency) can be decomposed ino he sum of a PPP componen Business cycle componen orward looking r* componen. The nominal exchange rae oday will reflec he enire expeced fuure ime pah of he counry specific componen in he neural real ineres rae bu ceeris paribus does no adjus o he global componen in he neural policy rae. In paricular if oday he neural real rae a home is expeced in he fuure o lie below he neural real rae abroad he nominal exchange rae oday mus weaken (home currency price of foreign currency goes up) relaive o domesic prices given he sae of he business cycle x. 9
Empirical Relaionship HLW VECM Error and Trade Weighed $ 0
Closing he Model wih Opimal Moneary Policy Rule R * ( ) = r E π λ ρ αρ (4) R = r * e = p α λ ( ) ψu α E i = 0 ( r * i r * i ) r * = E Δ a E Δ a r * = E Δ a and E π = ρψu and p - = Σ i= ψu -i. Thus opimal policy in he open economy a forward looking Taylor rule The opimal policy rule feaures a ime varying r* Only he counry specific componen of (presen and fuure) r* impacs e Global r* shocks pass hough one for one o policy raes no impac on exchange rae Also noe he bad news=good news possibiliy for u inflaion shocks
Implicaions - If counries are adjusing policy in response o common global neural real rae shocks his will obviously impar a posiive correlaion in policy even in he absence policy coordinaion or cooperaion. -Wih he parameer assumpion we have made here is no gain o policy cooperaion in his model so ha he Nash bes response policy rules which here ake he form of Taylor ype rules - lead o he maximum level global welfare ha can be obained under discreion. -Exchange rae depreciaion in he face of a persisen counry specific r* shock is no a beggar hy neighbor policy in eiher moive or realizaion. In his simple model rade is balanced period by period and so he exchange rae adjusmen ha occurs is required o mainain goods marke equilibrium wih balanced rade and no o generae a rade surplus. 2
Implicaions (con d) - By conras a leas under opimal policy exchange raes do no need o adjus o he global componen in neural policy raes realized or expeced. In response o a global shock a common global decline in real policy raes can do all he work o generae global aggregae demand in line wih aggregae supply; -This may look like bu is no a globally inefficien currency war defined as a race o he boom in policy raes as counries seek o avoid home currency appreciaion as oher counries cu ineres raes. 3
Allowing for Inernaional Spillovers Can modify he analysis (as in CGG 2002) o allow for inernaional spillovers so ha here may be heoreical gains o moneary policy coordinaion and even formal cooperaion. In his more general se up and regardless of how he model is closed we can sill wrie he nominal exchange rae σ ) * e = p p ( x x ) E ( r i r 2 ( * i i = 0 as a funcion of a PPP erm a business cycle erm and a forward looking neural real rae erm where /σ < is ineremporal elasiciy of subsiuion. The nominal exchange rae will sill reflec he enire expeced fuure ime pah of he counry specific componen in he neural real ineres rae bu ceeris paribus does no adjus o he global componen in he neural policy rae. ) Again Exchange rae depreciaion in he face of a persisen counry specific r* shock is no a beggar hy neighbor policy in eiher moive or realizaion. 4
) ( 2 ) ( ) ( 2 ) ( * x x a a y E x x a a y E r = σ σ In he more general case each counry r* is a funcion of home and foreign produciviies as well as home and foreign business cycle facors even if he facors hemselves are uncorrelaed he r* s will be. The bes non cooperaive moneary policy is sill a forward looking Taylor ype rule Each counry s r* is deermined in global general equilibrium ) ( 2 ) ( ) ( 2 ) ( * x x a a y E x x a a y E r = σ σ * 2 ) ( = E r R π σ αρ ρ λ * 2 ) ( = E r R π σ αρ ρ λ r* in he more general model 5
Poenial Gains o Moneary Policy Coordinaion The bes Nash policy in his wo counry model is a Taylor-ype rule - Depends on r* which in urn is funcion of a a x x -and r * is a funcion of a a x x To he exen he foreign cenral bank has some comparaive advanage in nowcasing or forecasing a and x.. Sharing his informaion or even pooling hese nowcass/forecass wih he home cenral bank could improve is esimae of he r* and hus he effeciveness of is policy rule in meeing is domesic objecives. In pracice r* is no observable and coordinaion in such signal exracion effors could be very valuable. 6
Theoreical Gains o Moneary Policy Cooperaion When here are spillovers Nash policy rules ha feedback solely on domesic variables don maximize world welfare The CGG model is simple enough ha he policy rule under binding cooperaion can be solved in closed form and for he home counry is given by R λ( ρ) σ αρ 2 σ λ( ρ) σ σ 2ϕ αρ 2 * = r E π E π So he opimal cooperaive policy is a Taylor ype rule ha is a funcion of a weighed average of home and foreign inflaion Imporanly under cooperaion r* shocks are sill fully passed hrough o he policy rae And he prior resuls on exchange raes and r* shocks coninues o hold 7
Bu Also Pracical Problems wih Moneary Policy Cooperaion R λ( ρ) σ αρ 2 σ λ( ρ) σ σ 2ϕ αρ 2 * = r E π E π Threa o he credibiliy of he cenral bank communicaion and loss of public suppor from his we are he world reacion funcion If home inflaion is above arge bu foreign inflaion is below arge he opimal policy rule under cooperaion calls for he home (real) policy rae o be lower more accommodaive han i would be in he absence of cooperaion In pracice credibiliy appears o be a funcion of cenral bank communicaion and as well he policies acually implemened In pracice cenral banks could have a hard ime mainaining credibiliy as well as communicaing a policy ha reacs o foreign inflaion especially if subsanial divergence Imagine he case wih home inflaion below arge when foreign inflaion is above arge. In his case he opimal policy rule calls for he home (real) policy rae o be higher less accommodaive han i would be in he absence of cooperaion no because home inflaion is oo high bu because foreign inflaion is! 8
In Sum We have reviewed some simple examples based on rigorous models which can i) generae moneary policy correlaion via he global facor presen in each counry s equilibrium real ineres rae and wha migh appear o be bu are no beggar hy neighbor exchange rae policies or currency wars ii) raionalize he benefis o moneary policy coordinaion ; bu iii) provide some inuiion for why binding moneary policy cooperaion may be rare in pracice In general r* shocks will require adjusmens in policy raes as well as in equilibrium exchange raes unless he shocks are common and equal More elaborae models may inroduce addiional drivers of r* - asse marke fricions household desire and insiuional requiremens o hold safe asses bu he framework here is rich enough o shed ligh on he imporance of global general equilibrium consideraions in accouning for and inferring shifs in counry neural policy raes. 9