Trend inflation and inflation persistence in the New Keynesian Phillips curve
The New Keynesian Phillips curve (NKPC) asserts that inflation depends on expectations of real marginal costs, but empirical research has shown that purely forward-looking versions of the model generate too little inflation persistence. In this paper, we offer a resolution of the persistence problem. We hypothesize that inflation is highly persistent because of drift in trend inflation, a feature that many versions of the NKPC neglect. We derive a version of the NKPC as a log-linear approximation around a time-varying inflation trend and examine whether it explains deviations of inflation ...
A search for a structural Phillips curve
The foundation of the New Keynesian Phillips curve (NKPC) is a model of price setting with nominal rigidities that implies that the dynamics of inflation are well explained by the evolution of real marginal costs. In this paper, we analyze whether this is a structurally invariant relationship. We first estimate an unrestricted time-series model for inflation, unit labor costs, and other variables, and present evidence that their joint dynamics are well represented by a vector autoregression (VAR) with drifting coefficients and volatilities. We then apply a two-step minimum distance estimator ...
Optimized Taylor Rules for Disinflation When Agents are Learning
Highly volatile transition dynamics can emerge when a central bank disinflates while operating without full transparency. In our model, a central bank commits to a Taylor rule whose form is known but whose coefficient are not. Private agents learn about policy parameters via Bayesian updating. Under McCallum's (1999) timing protocol, temporarily explosive dynamics can arise, making the transition highly volatile. Locally-unstable dynamics emerge when there is substantial disagreement between actual and perceived feedback parameters. The central bank can achieve low average inflation, but its ...
Inflation uncertainty and excess returns on stocks and banks
This paper investigates the relation between inflation uncertainty and excess returns on stocks and bonds. It quantifies the effect of inflation uncertainty by comparing actual excess returns with those expected by a hypothetical naive investor who treats inflation forecasts as if they were known with certainty. The evidence suggests that ignoring inflation uncertainty results in only small pricing errors, on average.
Evaluating non-structural measures of the business cycle
This paper evaluates a number of non-structural measures of the business cycle. It adopts a structural definition of the cycle, interprets non-structural measures as noisy approximations, and seeks a proxy that is reliable across a variety of plausible trend-cycle structures. The results favor a consumption-based measure proposed by Cochrane (1994). Across a variety of structures, it has the highest correlation and coherence with structural cycles, and best matches their dynamic properties. When applied to U.S. data, consumption-based measures conform closely to the dates of NBER ...
Adapting to instability in money demand: forecasting money growth with a time-varying parameter model
Conventional money demand models appear to be unstable, and this complicates the problem of conducting monetary policy. One way to deal with parameter instability is to learn how to adapt quickly when parameters shift. This paper applies a time-varying-parameter estimator to conventional money demand models and evaluates its usefulness as a forecasting tool. In relative terms, the time-varying-parameter estimator improves significantly on ordinary least squares. In absolute terms, we continue to have difficulty tracking money demand through turbulent periods.
Should the Fed take deliberate steps to deflate asset price bubbles?
On several occasions over the last few years, various economists and policymakers have expressed the opinion that the stock market was overvalued. They often compared the situation with the 1920s and warned that the U.S. economy was headed for a similar collapse. Some analysts also suggested that the Fed raise interest rates to slow the rate of "asset inflation," on the grounds that it would be better to burst a speculative bubble in its early stages than to let it develop and suffer the inevitable crash. This paper takes up the other side of the debate and argues that deliberate ...
Effects of the Hodrick-Prescott filter on integrated time series