1 / 31

The New Normative Macroeconomics

The New Normative Macroeconomics. John B. Taylor Stanford University XXI Encontro Brasileiro de Econometria 9 December 1999. Some Historical Background. Rational expectations assumption was introduced to macroeconomics nearly 30 years ago

tiana
Download Presentation

The New Normative Macroeconomics

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. The New NormativeMacroeconomics John B. Taylor Stanford University XXI Encontro Brasileiro de Econometria 9 December 1999

  2. Some Historical Background • Rational expectations assumption was introduced to macroeconomics nearly 30 years ago • now most common expectations assumption in macro • work on improving it ( e.g. learning) continues • The “rational expectations revolution” led to • new classical school • new Keynesian school • real business cycle school • new neoclassical synthesis • new political macroeconomic school • Now as old as the Keynesian revolution was in early 70s

  3. But this raises a question • We know that many interesting schools have evolved from the rational expectations revolution, but has policy research really changed? • The answer: Yes. It took a while, but if you look you will see a whole new normative macroeconomics which has emerged in the 1990s • Interesting, challenging theory and econometrics • Already doing some good • Policy guidelines for decisions at central banks • Helping to implement inflation targeting • Constructive rather than destructive • Look at • policy models, policy rules, and policy tradeoffs

  4. Characteristics of the Policy Models • Similarities • price and wage rigidities • combines forward-looking and backward-looking • frequently through staggered price or wage setting • monetary transmission mechanism through interest rates and/or exchanges rates • all viewed as “structural” by the model builders • Differences • size (3 equations to nearly 100 equations) • degree of openness • degree of formal optimization • all hybrids: some with representative agents (RBC style), other based directly on decision rules

  5. Examples of Policy Models • Taylor (Ed.) Monetary Policy Rules has 9 models • Taylor multicountry model (www.stanford.edu/~johntayl) • Rotemberg-Woodford • McCallum-Nelson • But there are many many more in this class • Svensson • This conference: Hillbrecht, Madalozzo, and Portugal • Central Bank Research (not much different) • Fed: FRB/US • Bank of Canada (QPM) • Riksbank (similar to QPM) • Central Bank of Brazil (Freitas, Muinhos) • Reserve Bank of New Zealand (Hunt, Drew) • Bank of England (Batini, Haldane)

  6. Solving the Models • Solution is a stochastic process for yt • In linear fi case • Blanchard-Kahn, eigenvalues, eigenvectors • In non-linear fi case • Iterative methods • Fair-Taylor • simple, user friendly (can do within Eviews), slow • Ken Judd

  7. Policy Rules • Most noticeable characteristic of the new normative macroeconomics • interest in policy rules has exploded in the 1990s • Normative analysis of policy rules before RE • A.W. Phillips, W. Baumol, P. Howrey • motivated by control engineering concerns (stability) • But extra motivation from RE • need for a policy rule to specify future policy actions in order to estimate the effect of policy • Dealing constructively with the Lucas critique • time inconsistency less important

  8. Interest rate Constant Real Interest Rate Policy Rule Inflation rate Target Example of a Monetary Policy Rule

  9. The Timeless Method for Evaluating Monetary Policy Rules • Stick a policy rule into model fi (.) • Solve the model • Look at the properties of the stochastic steady state distribution of the variables (inflation, real output, unemployment) • Choose the rule that gives the most satisfactory performance (optimal) • a loss function derived from consumer utility might be useful • Check for robustness using other models

  10. Simple model illustrating expectations effects of policy rule:(1) yt = -(rt + Etrt+1) + tPolicy Rule:(2) rt = gt + ht-1Plug in rule (2) into model (1) and find var(y) and var(r). Find policy rule parameters (g and h) to minimize var(yt) + var(rt) Observe that Etrt+1 = htIf h = 0, then by raising h and lowering g one can and get the same variance of yt and a lower variance of rt.

  11. Policy Tradeoffs • Original Phillips curve was viewed as a policy tradeoff: could get lower unemployment with higher inflation • but theory (Phelps-Friedman) and data (1970s) proved that there is no permanent trade off • But there is a short run policy tradeoff • at least in models with price/wage rigidities • even in models with rational expectations • New normative macroeconomics characterizes the tradeoff in terms of the variability of inflation and unemployment

  12. A simple illustration of an output-inflation variability tradeoff

  13. Variance of output Variance of inflation

  14. Inflation Rate AD PA target 0 Real Output (Deviation)

  15. Inflation targeting • Keep inflation rate “close” to target inflation rate • In mathematical terms: minimize, over an “infinite” horizon, the expectation of the sum of the following period loss function, t = 1,2,3… w1(t - *)2 + w2 (yt – yt*)2 Or minimize this period loss function in the steady state Try to have y* equal to the “natural” rate of output

  16. Historical confirmation: in the U.S. the federal funds rate has been close to monetary policy rule I Percent 12 10 8 6 0% 4 3% Federal Funds Rate 2 0 89 90 91 92 93 94 95 96 97 98

  17. 12 10 Smothoed inflation rate (4 quarter average) 8 1968.1: Funds rate was 4.8% 1989.2: Funds rate was 9.7% 6 4 2 0 60 65 70 75 80 85 90

  18. percent 4 2 0 -2 GDP gap with HP trend for potential GDP -4 -6 60 65 70 75 80 85 90 95

  19. percent 20 Real GDP growth rate (Quarterly) 15 10 5 0 -5 -10 60 65 70 75 80 85 90 95

  20. Output Stability Comparisons

  21. Interest rate hitting zero problem • To estimate likelihood of hitting zero and getting stuck, put simple policy rule in policy model and see what happens: • pretty safe for inflation targets of 1 to 2 percent • Modify simple rule: • Interest rate stays near zero after the expected crises (Reifschneider and Williams (1999))

  22. Interest rate Constant Real Interest Rate Policy Rule Inflation rate 0 Target

  23. Inflation Rate AD PA 0 Real Output (Deviation)

  24. The role of the exchange rate Extended policy rule it = gt + gyyt +ge0et + ge1et-1 + it-1 where it is the nominal interest rate, t is the inflation rate (smoothed over four quarters), yt is the deviation of real GDP from potential GDP, etis the exchange rate (higher e is an appreciation).

  25. In conclusion • The “new normative macroeconomics” is currently a huge and exciting research effort • it demonstrates how policy research has changed since the rational expectations revolution • it has probably improved policy decisions already in some countries • With a great amount of macro instability still existing in the world there is still much to do.

More Related