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 Recent Developments in Monetary Economics Lawrence Christiano
Overview Recent�Developments�in�Monetary� p y • • A�new�consensus�has�emerged�about�the�rough�outlines�of�a�model� A new consensus has emerged about the rough outlines of a model Economics for�the�analysis�of�monetary�policy. – Consensus�influenced�heavily�by�estimated�impulse�response� functions�from�Structural�Vector�Autoregression (SVARs) • Describe�empirical�SVAR�results. Lawrence�Christiano Northwestern�University Northwestern University • Construction�of�the�consensus�models�based�on�results�from�SVARs. – Christiano,�Eichenbaum�and�Evans�JPE�(2005) – Smets and�Wouters,�AER�(2007) • Further�developments�of�the�consensus�model – Labor�market – Financial�frictions – Open�economy • Policy�analysis:�how�monetary�policy�may�inadvertedly contribute�to� P li l i h t li i d t dl t ib t t excess�asset�market�volatility. Vector�Autoregressions Outline�of�SVAR�discussion • Proposed�by�Chris�Sims�in�1970s,�1980s d b h i i i • What�is�a�VAR? • Major�subsequent�contributions�by�others�(Bernanke,�Blanchard�Watson,� Blanchard�Quah) Blanchard Quah) • The�Identification�Problem • Useful�Way�to�Organize�Data – VARs�serve�as�a�‘Battleground’�between�alternative�economic�theories – VARs�can�be�used�to�quantitatively�construct�a�particular�model • Question�that�can�(in�principle)�be�addressed�by�VAR: • Identification�restrictions – ‘How does the economy respond to a particular shock?’ How�does�the�economy�respond�to�a�particular�shock? – Current�consensus�model�heavily�guided�by�answers�to�this�question • VARs�can’t� actually address�such�a�question y q • Results • Results – Identification�problem – Need�extra�assumptions….Structural�VAR�(SVAR). • Historical�Decompositions�of�Data
Shocks and Identification Assumptions Shocks�and�Identification�Assumptions • Monetary�Policy�Shock • Neutral�Technology�Shock • Capital�Embodied Shock to Technology Capital Embodied�Shock�to�Technology
Identifying�Monetary�Policy�Shocks Identification�of�Technology�Shocks�(Blanchard� Q Quah,�Fisher,�JPE�2007) h Fi h JPE 2007) • One�strategy:�estimate�parameters�of�Fed’s�feedback� rule • There�are�two�types�of�technology�shocks:�neutral� – Rule�that�relates�Fed s�actions�to�state�of�the�economy: Rule that relates Fed’s actions to state of the economy: and�capital�embodied and capital embodied Fed information set Policy shock X t � Z t F � K t , L t � R R t =� f ( � t )�+�e t K t � 1 � � 1 � � � K t � V t I t • These are only shocks that can affect labor These�are�only�shocks�that�can�affect�labor� – f linear f linear productivity�in�the�long�run. R orthogonal�to�Fed�information,� � t – e t – � t contains�current�prices�and�wages,�aggregate�quantities,� p g , gg g q , t� lagged�stuff • The�only�shock�which�also�has�a�long�run�effect�on� R estimated�by�OLS�regression – e t the�relative�price�of�capital�is�a�capital�embodied� Regress X on e R e R e R ,… – Regress� X t on�e t R ,��e t�1 R ,��e t�2 R t technology�shock�( V t ). h l h k ( V ) VAR estimation with the following data: The data have been transformed to ensure stationarity Sample period: 1959Q1-2007Q1
• Results Results….. Interesting�Properties�of�Monetary�Policy�Shocks • Plenty�of�endogenous�persistence: – money�growth�and�interest�rate�over�in�1�year,�but�other�variables�keep� going…. i • Inflation�slow�to�get�off�the�ground:�peaks�in�roughly�two�years – It�has�been�conjectured�that�explaining�this�is�a�major�challenge�for�economics – Chari�Kehoe�McGrattan ( Econometrica ),�Mankiw. – Kills�models�in�which�movements�in� P are�key�to�monetary�transmission� mechanism�(Lucas�misperception�model,�pure�sticky�wage�model) h i (L i ti d l ti k d l) – Has�been�at�the�heart�of�the�recent�emphasis�on�sticky�prices. • Output, consumption, investment, hours worked and capacity utilization Output,�consumption,�investment,�hours�worked�and�capacity�utilization� hump�shaped • Velocity�comoves with�the�interest�rate
Observations on Neutral Shock Observations�on�Neutral�Shock • Generally,�results�are�‘noisy’,�as�one�expects. – Interest,�money�growth,�velocity�responses�not�pinned�down. • Interestingly,�inflation�response�is�immediate�and� precisely estimated. • Does�this�raise�a�question�about�the�conventional� interpretation�of�the�response�of�inflation�to�a�monetary� shock? • Alternative possibility: information confusion stories. Alternative�possibility:�information�confusion�stories. – A�variant�of�recent�work�by�Rhys�Mendes�that�builds�on�Guido� Lorenzoni’s work. Historical�Decomposition�of�Data�into� Shocks h k Dark line: detrended actual GDP • We can ask: We�can�ask: – What�would�have�happened�if�only�monetary� policy shocks had driven the data? policy�shocks�had�driven�the�data? – We can ask this about other identified shocks or – We�can�ask�this�about�other�identified�shocks,�or� about�combinations�of�shocks Thin line: what GDP would have been if there had only Thin line: what GDP would have been if there had only been one type of technology shock, the type that – We�find�that�the�three�shocks�together�account� affects only the capital goods industry for a large part of fluctuations for�a�large�part�of�fluctuations Th These shocks have some effect, but not terribly important h k h ff t b t t t ibl i t t
Type of technology shock that affects Type of technology shock that affects all industries Monetary policy shocks have a This has very large impact on broad trends in the big impact on 1980 Volcker big impact on 1980 ‘Volcker data, and a smaller impact on business cycles. d t d ll i t b i l recession’ Has big impact on trend in data, and 2000 boom-bust Variance�Decomposition Variable BP(8,32) Output Output 86 86 � 18 � Money Growth 23 � 11 � Inflation 33 � 17 � Fed Funds 52 � 16 � Capacity Util. 51 � 16 � � � Avg. Hours 76 � 17 � Real Wage 44 � 16 � Consumption 89 � 21 � Investment 69 � 16 � Velocity Velocity 29 29 � 16 � All three shocks together account for Price of investment goods 11 � 16 � large part of business cycle
Objectives • Constructing�a�standard�(‘consensus’)�DSGE�Model d d (‘ ’) d l – Model�features.� – Estimation�of�model�using�impulse�responses�from�SVAR’s. • Now to the construction of a monetary Now,��to�the�construction�of�a�monetary� equilibrium�model,�based�on�the�previous� impulse response functions impulse�response�functions…. • Determine�if�there�is�a�conflict�regarding�price�behavior� between�micro�and�macro�data. • Based�on� B d – Macro�Evidence: – Christiano�Eichenbaum�Evans�JPE(2005) • Inflation�appears�sluggish pp gg – Altig�Christiano�Eichenbaum�Linde • Inflation�responds�slowly�to�monetary�shock – Micro�Evidence: • Bils�Klenow,�Nakamura�Steinsson�report�evidence�on�frequency�of�price� Bil Kl N k St i t id f f i change�at�micro�level:�5�11�months.�
Timing Description of Model Description�of�Model • Technology�Shocks�Realized. • Timing�Assumptions g p • Agents�Make�Price/Wage�Setting,�Consumption,� A t M k P i /W S tti C ti Investment,�Capital�Utilization�Decisions. • Firms • Monetary�Policy�Shock�Realized. • Households • Household�Money�Demand�Decision�Made. • Monetary�Authority • Production Employment Purchases Occur and • Production,�Employment,�Purchases�Occur,�and� Markets�Clear.� • Goods�Market�Clearing�and�Equilibrium • Note:�Wages,�Prices�and�Output�Predetermined�Relative�to�Policy�Shock . • Firm Sector Final Good, Competitive Fims Intermediate Intermediate Intermediate Good Good Good … … … … .. Producer Producer 1 Producer 2 infinity Competitive M arket for Competitive M arket Homogeneous Labor Homogeneous Labor For Homogeneous Input Capital Household 1 Househo ld 2 Househo ld infinity
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