Th Scinc of Monary Policy. Inroducion o Topics of Sminar. Rviw: IS-LM, AD-AS wih an applicaion o currn monary policy in Japan 3. Monary Policy Sragy: Inrs Ra Ruls and Inflaion Targing (Svnsson EER) 4. Monary Policy Analysis, Microfoundaions and h Lucas Criiqu Prof. Volkr Wiland / Monary Policy Sminar Lcur / S Handou!.) Sminar Papr Topics Prof. Volkr Wiland / Monary Policy Sminar Lcur /
.) Rviw: IS-LM, AD-AS AS and Japan IS-LM: fixd prics (vry shor run) AD-AS: AD rprsns pric and incom combinaions saisfying goods, mony and crdi mark quilibrium, AS: mdium pric adjusmn o dviaions of oupu from ponial Long-run, prics ar complly flxibl (monary nuraliy Prof. Volkr Wiland / Monary Policy Sminar Lcur / 3 IS-LM Modl and Monary Policy LM-Kurv: (i,y) combinaions mony mark quilibrium (dmand for ral balancs = supply of ral balancs M/P), P xognous and fixd Chang M shif of LM curv IS Curv (r,y) combinaions goods mark in quilibrium (CIG = Y) Wha abou i vs r? i=r if P fixd only Prof. Volkr Wiland / Monary Policy Sminar Lcur / 4
IS-LM Modl and Monary Policy Equaions: Shor-Run quilibrium Y = C(Y - T) I(r) G IS M/P = L(r,Y) LM Graphical Analysis Prof. Volkr Wiland / Monary Policy Sminar Lcur / 5 AD-AS AS Modl and Monary Policy AD Curv (P,Y) combinaions s.. IS and LM quilibria, changs in M or G shifs AD curv AS curv: Mdium pric-adjusmn, shorrun ral ffcs of pric-surpriss Y = Y α( P P ) α > 0 Prof. Volkr Wiland / Monary Policy Sminar Lcur / 6
AD-AS AS Modl and Monary Policy Graphical Analysis / Sabilizaion Policy Prof. Volkr Wiland / Monary Policy Sminar Lcur / 7 Exampl Monary Policy and h Rcssion in Japan Prof. Volkr Wiland / Monary Policy Sminar Lcur / 8
Japan: Dflaion and Db Prof. Volkr Wiland / Monary Policy Sminar Lcur / 9 Japan: Mony and Inrs Ras Nominal inrs ra (i) M/(PY) Prof. Volkr Wiland / Monary Policy Sminar Lcur / 0
Expcd Dflaion in h IS-LM Modl Shor-run quilibrium: Y = C(Y - T) I(i- ) G IS M/P = L(i,Y) LM Chang in dflaion xpcaions will chang h ral inrs ra (rcssionary ffc if xpcd dclin in prics) Prof. Volkr Wiland / Monary Policy Sminar Lcur / Japan and h Liquidiy Trap Zro-bound on nominal inrs ras Addiional mony injcions don lowr inrs ras, no simulaiv ffc Graphical analysis using h IS-LM modl Also, rcssionary ffc of dflaion xpcaions Comparison o h Gra Dprssion Prof. Volkr Wiland / Monary Policy Sminar Lcur /
3.) Monary Policy Sragy, Inrs Ra Ruls and Inflaion Targing An xampl: monary policy and inflaion arging (Svnsson, 997, EER) Framwork: Modl wih backward-looking xpcaions / Acclraionis Phillips curv Characrisics of opimal policy and rlaion o Taylor-syl inrs ra ruls Prof. Volkr Wiland / Monary Policy Sminar Lcur / 3 Svnsson,, 997 Th Modl: Acc. Ph.: AD: y ε y = α = y ( i ) η Policy Insrumn: Policy Lags: i i r P. y P. Prof. Volkr Wiland / Monary Policy Sminar Lcur / 4
Prof. Volkr Wiland / Monary Policy Sminar Lcur / 5 Svnsson Svnsson 997 997 Policy Objciv: choos so as o minimiz { } = i τ τ = E L τ τ τ δ ) ( *) ( ) ( τ τ = L Prof. Volkr Wiland / Monary Policy Sminar Lcur / 6 Svnsson Svnsson 997 997 Subsiu! ] [ ) ( = i y y ε η α ε α ( ) 3 = i a y a a ε α η ε 3 ) (, whr α α α = = = a a a
Svnsson,, 997 Soluion can b found by solving simpl priod-by-priod problm Rcall: (*) = a a y a3i Th problm o choos { iτ } so as o τ = minimiz τ E δ ( τ *) whr τ = ach i τ dpnds on informaion availabl in priod τ, can b wrin as a squnc of on-priod problms: Prof. Volkr Wiland / Monary Policy Sminar Lcur / 7 mine i Svnsson,, 997 τ *) E δ mine ( τ τ= iτ δ ( *) Why? s (*) τ can b conrolld by i τ bu is no affcd by i τ, i τ, for illusraion s f.o.c. Prof. Volkr Wiland / Monary Policy Sminar Lcur / 8
E f.o.c τ = which is τ = Svnsson,, 997 τ min E δ ( *) δ i τ ( τ *) i linar modl is consan: i ak xpcaions hrough τ τ τ = τ = δ τ τ ( τ *) = 0 i Prof. Volkr Wiland / Monary Policy Sminar Lcur / 9 Svnsson,, 997 i can b chosn such ha * = 0 similarly i τ,τ =,,, can b chosn such ha τ τ * = 0 Du o h law of irad xpcaions i follows ha τ * = 0 τ = 3, 4, f.o.c. rms =0, Loss funcion =0 xcp for unconrollabl random rms; global Min Prof. Volkr Wiland / Monary Policy Sminar Lcur / 0
min Eδ L( ) i Svnsson,, 997 (*) = a a y a3i Th firs-ordr condiion δ L( ) = E δ ( *) i i or E = = δ a3( *) = 0 * Prof. Volkr Wiland / Monary Policy Sminar Lcur / Svnsson,, 997 Equivaln problm: Minimiz forcas dviaions from arg: *) min ( Inrmdia loss funcion Inflaion forcas is h idal inrmdia arg () by dfiniion highs corrlaion wih ulima arg Prof. Volkr Wiland / Monary Policy Sminar Lcur /
Svnsson,, 997 () is mor conrollabl han (3) is asir o obsrv (4) ransparn: if > * : i < * : i Wha is h opimal policy in rms of h inrs ra? Taylor rul Prof. Volkr Wiland / Monary Policy Sminar Lcur / 3 Svnsson,, 997 Solv for opimal policy rul: i = ( * a a y ) a4 = b ( *) b y b =, b α = Prof. Volkr Wiland / Monary Policy Sminar Lcur / 4
Svnsson,, 997 () inrs rsponsivnss of AD up ( ): policy racion down b, b () oupu mor prsisn ( ): b (3) Phillips curv spr (α ): b Prof. Volkr Wiland / Monary Policy Sminar Lcur / 5 Svnsson,, 997 Acual inflaion in yar will in quilibrium b = ε α η ε = forcas rror: * ε αη ε = ε αη ε Prof. Volkr Wiland / Monary Policy Sminar Lcur / 6
Svnsson,, 997 Policy prscripions: Do wha i aks o g -yar ahad inflaion forcas on arg Publish inflaion forcas, publish arg Public, wach ou for prsisn dviaions from arg Easy monioring!? Prof. Volkr Wiland / Monary Policy Sminar Lcur / 7 Svnsson,, 997 Wha abou mony and monary arging? Mony dmand: m p = y kii ν Mony growh arging: µ ν = y y ki ki ν Prof. Volkr Wiland / Monary Policy Sminar Lcur / 8
Svnsson,, 997 An opimal monary arg: (condiional) * µ such ha = * * µ drivd in papr is im-varying, dpnds on, y, x,c. Prof. Volkr Wiland / Monary Policy Sminar Lcur / 9 Svnsson,, 997 Wha abou a fixd mony growh arg? µ* = * (avrag inflaion = *) *) min ( µ µ bu, subopimal, mor variabiliy in Prof. Volkr Wiland / Monary Policy Sminar Lcur / 30
Svnsson,, 997 So far, on objciv (), on conrol (i) simpl priod-by-priod problm prfc conrol Nx Sp: Mulipl () objcivs, on conrol Mor complicad dynamic opimizaion problm Tradoff bwn objcivs Prof. Volkr Wiland / Monary Policy Sminar Lcur / 3 4.) Monary Policy Analysis and h Lucas Criiqu Svnsson s papr aks backward-looking Phillips curv as srucural Wha if priva scor aks ino accoun policymakr s objcivs in forming inflaion xpcaions Forward-looking Phillips curv Microfoundaions? Prof. Volkr Wiland / Monary Policy Sminar Lcur / 3
Phillips Curv and Aggrga Supply Svnsson ras h following yp of Phillips curv as srucural: = α0 αy ε whr α 0 = Moivaion: i is a sabl mpirical rlaionship No: som simas of α 0 nd o b blow long-run radoff bwn oupu and inflaion Prof. Volkr Wiland / Monary Policy Sminar Lcur / 33 Phillips Curv and Aggrga Supply if α 0 = h pric of kping y > 0 prmannly would b incrasing inflaion L s driv his Phillips curv from mor basic principls: Aggrga Supply Assum oupu producd by compiiv firms Y = F(L) whr F'( L) > 0 F''( L) < 0 Prof. Volkr Wiland / Monary Policy Sminar Lcur / 34
Phillips Curv and Aggrga Supply Exampl: sinc firms ar compiiv hy hir labor up o h poin whr marginal produc of labor quals h ral wag: W ( γ ) W F '( L) = γl = P P ak logs: Y = L γ lnγ ( γ ) γ < F'(L) = γl l d = w p ( γ -) Prof. Volkr Wiland / Monary Policy Sminar Lcur / 35 Phillips Curv and Aggrga Supply Labor dmand: (downward-sloping) d l = k0 k ( w p ) assum labor supply upward-sloping: s l = k k3( w p ) normaliz k 0 = k = 0 assum w is s on priod in advanc o qua xpcd labor dmand and supply Prof. Volkr Wiland / Monary Policy Sminar Lcur / 36
Phillips Curv and Aggrga Supply k ( w p ) = k3( w p ) w = p Aggrga supply s y = k( p p ) = ( p p ) inrpr as Phillips curv: = α y ε whrα = Prof. Volkr Wiland / Monary Policy Sminar Lcur / 37 Phillips Curv and Aggrga Supply How o g o Svnsson s yp of Phillips curv: Exampl : adapiv xpcaions / rul of humb = δ )( ) 0 < δ ( < = ( δ ) δ = ( δ ) ( δ ) δ δ Prof. Volkr Wiland / Monary Policy Sminar Lcur / 38
Phillips Curv and Aggrga Supply = ( δ ) ( δ ) δ ( δ ) δ 3... = ( δ ) j= δ Phillips curv j j j = δ ( ) δ j αy ε j= Prof. Volkr Wiland / Monary Policy Sminar Lcur / 39 Phillips Curv and Aggrga Supply Exampl : δ = 0: Random-walk xpcaions = = α y ε Prof. Volkr Wiland / Monary Policy Sminar Lcur / 40
Lucas Criiqu in considring alrnaiv policis, i is wrong o ra h paramrs α 0 and α in = α0 αy ε as indpndn of policy, rahr if policy changs, hn h paramrs chang Supply curv: s y = ( p p ) µ Prof. Volkr Wiland / Monary Policy Sminar Lcur / 4 Lucas Criiqu Simpl dmand spcificaion d y = m p v wih consan vlociy v = 0 and a policy rul (in rms of mony m) m = p θ and raional xpcaions [ p I ] = E p p = E Prof. Volkr Wiland / Monary Policy Sminar Lcur / 4
Subsiu: p E Lucas Criiqu ( p ) µ = p p θ ( E ) µ = θ θ µ = E θ E = E Prof. Volkr Wiland / Monary Policy Sminar Lcur / 43 Lucas Criiqu ( ) θ E = = θ µ Inflaion Procss: = θ Oupu Procss: y = [ E ] µ µ y = No: y is unaffcd by θ policy inffcivnss, only on ffciv nominal variabls Prof. Volkr Wiland / Monary Policy Sminar Lcur / 44
Lucas Criiqu Back o Lucas criiqu supply curv: y = ) µ ( θ Phillips curv inrpraion: = θ y µ = α0 αy ε whr h prsisnc paramr α 0 is only a funcion of policy m θ = p Prof. Volkr Wiland / Monary Policy Sminar Lcur / 45