Lawrence Christiano Objective Boom-bust Cycles and Estimate a - PowerPoint PPT Presentation

M A -L L I , O I P R D E W O M O - S , O P D W P AC CR RO IN NK KA AG GE ES IL L RI IC CE ES S A AN ND D EF FL LA AT TI IO ON N OR RK KS SH HO OP J A 6– –9 9, , 20 00 09 9 J 6 2 AN NU UA AR RY Y Boom-bust Cycles and Monetary Policy Lawrence Christiano

Objective Boom-bust Cycles and • Estimate a model in which technology shocks E ti t d l i hi h t h l h k Monetary Policy are partially anticipated • It has often been argued that there is It has often been argued that there is – Normal technology shock: ‘Normal’ technology shock: a t � � a a t � 1 � � t advanced information about technology – Shock considered here (J Davis): Shock considered here (J Davis): shocks. shocks – Beaudry-Portier, Michelle Alexopoulos, ‘recent information’ ‘earlier information’ Jaimovic-Rebelo Christiano-Ilut-Motto- Jaimovic Rebelo, Christiano Ilut Motto a t � � a a t � 1 � � t � � t � 1 � 1 � � t � 2 � 2 � � t � 3 � 3 � � t � 4 � 4 � � t � 5 � 5 � � t � 6 � 6 � � t � 7 � 7 � � t � 8 � 8 1 2 3 4 5 6 7 8 Rostagno • In the presence of such advance In the presence of such advance � t � i i • Evaluate importance of for business cycles information, standard monetary policy can create an inefficient boom followed by a create an inefficient boom, followed by a � t � i i • Explore implications of for monetary policy. bust. Model Outline • Features (version of CEE) • Estimation – Results esu s – Habit persistence in preferences – ‘Excessive optimism’ and 2000 recession – Investment adjustment costs in change of Investment adjustment costs in change of investment • Implications for monetary policy • Implications for monetary policy – Variable capital utilization – Monetary policy causes economy to over- – Calvo sticky (EHL) wages and prices Calvo sticky (EHL) wages and prices react to signals....inadvertently creates boom- react to signals inadvertently creates ‘boom bust’ P it � P i , t � 1 , W j , t � � z W j , t � 1 • Non-optimizers: • Probability of not adjusting prices/wages: � p , � w

Observables and Shocks • Six observables: preference shock j � � � 2 l l t � l , j 1 � c , t � l log � C t � l � bC t � l � 1 � � � L E t 1.03 � 1/4 2 l � 0 l � 0 – output growth, marginal (in-) efficiency of investment � I t I t – inflation, i fl ti K t � 1 � � 1 � 0.02 � K t � � 1 � S � 1 0 02 � K � 1 � I , t � � I t � I K S I t � 1 – hours worked, – investment growth, i t t th markup shock 1 � � � technology shock � f , t � Y t � � 1 1 � u t K j , t � � , z t � exp � � z t � � f , t dj Y j , t � – consumption growth, Y jt , z t exp a t L j , t 0 – T-bill rate. � � t � 1 � � a y a R t R R R t � 1 y t y t � � 1 1 � � � log � � 1 � � a � � � log � � t 1 1 M log 4 log • Sample Period: 1984Q1 to 2007Q1 � � y R R R Shock representations markup markup � f , t � f , t � 1 � � � f log � � � f , t log � f � f Variance Decomposition, Technology Shocks 8 � t � i 4 � t � i 8 � t � i � t � � i � 1 � t � � i � 1 � i � 5 � t i i i variable discount rate log � � c , t � � � � c log � � c , t � 1 � � � � c , t consumption growth 46.6 7.0 24.1 22.5 investment growth 16.1 2.3 8.2 7.9 efficiency of investment output growth 45.4 6.2 23.1 22.3 log � � I t � � � � log � � I t 1 � � � � t log � � I , t � � � � I log � � I , t � 1 � � � � I , t log hours 45.3 5.5 20.0 25.3 technology inflation 49.0 7.0 23.8 25.2 iid iid iid iid iid iid iid iid iid � � � � � � � � interest rate 52.1 7.1 24.9 27.2 � a t � � a a t � 1 � � t � � t � 1 � � t � 2 � � t � 3 � � t � 4 � � t � 5 � � t � 6 � � t � 7 � � t � 8 1 2 3 4 5 6 7 8 monetary policy M � � M � t � 1 M � � u , t . � t

Centered 5-quarter moving average of shocks Signals 5-8 quarters in • Estimated technology shock process: Estimated technology shock process: past past ‘recent information’ ‘earlier information’ log, technology shock � � � a a t � 1 � � t � � t � 1 � � t � 2 � � t � 3 � � t � 4 � � t � 5 � � t � 6 � � t � 7 � � t � 8 1 2 3 4 5 6 7 8 a t NBER trough NBER peak Current shock plus most recent Four quarters’ signals Implications for Monetary Policy p y y The standard New-Keynesian Model • Estimated monetary policy rule induces over- a t � � a t � 1 � � t � � t � p � a t � log, technology � reaction to signal shock g p � � rr � � 1 � � � a t � � t � 1 � p (natural (Ramsey) rate) • Problem: � 1 � � a t � � t � 1 � p (natural (Ramsey) rate) rr t rr t rr – positive signal induces expectation that consumption will be high in the future � t � � E t � t � 1 � � x t � � t (Calvo pricing equation) � � � E � 1 � � x � (Calvo pricing equation) – Ramsey-efficient (‘natural’) real rate of interest jumps � � � E t x t � 1 (intertemporal equation) � � x t � � � r t � E t � t � 1 � rr t � E E (i t t l ti ) – Under Taylor rule, real rate not allowed to jump, so monetary policy is expansionary r t � � � E t � t � 1 � � x x t (policy rule) • Intuition easy to see in Clarida-Gali-Gertler model

Response to signal that technology will expand 1% in period 1 Equilibrium Equilibrium Ramsey Ramsey Period Period Case Where Signal is False • Let’s see how a signal that turns out to be Let s see how a signal that turns out to be 0 1 2 3 0 1 2 3 false works in the full, estimated model. 4 � t -1 0 0 0 0 0 0 0 log A t l A 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 log h t 0.7 0 0 0 0 0 0 0 log y t g y 0.7 0 0 0 0 0 0 0 Case Where Signal is True 0 1 2 3 0 1 2 3 4 � t -1 0 0 0 0 � � 0.95, � � � 1.5, � x � 0.5, � � 0.82 log A t 0 1 .95 .9025 0 1 .95 .9025 log h t log h t 0 7 -0 04 -0 04 -0 04 0 0 0.7 0.04 0.04 0.04 0 0 0 0 0 0 log y t 0.7 1.0 0.9 0.9 0 1 .95 .9025 • The following slide corrects the hours The following slide corrects the hours worked response in the previous slides, which was graphed incorrectly which was graphed incorrectly.

Why is the Boom-Bust So Big? y g • Most of boom-bust reflects suboptimality p y of monetary policy. • What’s the problem? –Monetary policy ought to respond to the natural (Ramsey) rate of interest natural (Ramsey) rate of interest. –Relatively sticky wages and inflation Relatively sticky wages and inflation targeting exacerbate the problem Conclusion Policy solution • Estimated a model in which agents receive advance Estimated a model in which agents receive advance information about technology shocks. • Modify the Taylor rule to include: • Advance information seems to play an important role in p y p business cycle dynamics b i l d i – Natural rate of interest (probably not feasible) – Important in variance decompositions – Credit growth Credit growth – Stock market – Boom-bust of late 1990s seems to correspond to a period in which there was a lot of initial optimism about technology, which – Wage inflation instead of price inflation. g p later came to be seen as excessive • Monetary policy appears to be overly expansionary in response to signal shocks • Explored consequences of adding credit p q g growth and/or stock market by adding – Ramsey-efficient allocations require sharp rise in rate of interest, which `standard monetary policy does not deliver’. Bernanke-Gertler-Gilchrist financial frictions. – Problem is most severe when wages are sticky relative to prices.