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Working Paper
Should We Be Puzzled by Forward Guidance?
Although a growing literature argues output is too sensitive to future interest rates in standard macroeconomic models, little empirical evidence has been put forth to evaluate this claim. In this paper, we use a range of vector autoregression models to answer the central question of how much output responds to changes in interest rate expectations following a monetary policy shock. Despite distinct identification strategies and sample periods, we find surprising agreement regarding this elasticity across empirical models. We then show that in a standard model of nominal rigidity estimated ...
Working Paper
Maintaining the Anchor: An Evaluation of Inflation Targeting in the Face of COVID-19
This paper provides evidence that inflation targeting delivered well-anchored inflation expectations during the post-2020 inflation surge. Using a macroeconomic model, we first illustrate how long-term nominal interest rates respond to an unexpected burst of inflation under both anchored and unanchored inflation expectations. Then, we evaluate these predictions using high-frequency financial market data from nine advanced economies. Specifically, we examine whether inflation expectations embedded in asset prices remained anchored as inflation climbed in the aftermath of the pandemic. Our ...
Journal Article
Assessing Market Conditions ahead of Quantitative Tightening
Quantitative tightening (QT)—the reduction in the Federal Reserve’s balance sheet—will transfer a significant amount of Treasury and agency mortgage-backed securities to investors. This transfer will be larger than the first endeavor with QT in 2017 and will occur at a time when financial markets are strained, suggesting this round of QT has the potential to be more disruptive compared with the benign start to the 2017 runoff.
Journal Article
A Tight Labor Market Could Keep Rent Inflation Elevated
Rent inflation responds more to labor market conditions compared with other components of inflation. We attribute this link between labor market tightness and rent inflation to greater demand for rental units afforded by job gains and wage growth. Although online measures of asking rents currently suggest official measures of rent inflation will decline, we caution that rent inflation is likely to remain above pre-pandemic levels so long as the labor market remains tight.
Journal Article
Evaluating Quantitative Easing: The Importance of Accounting for Forward Guidance
During the COVID-19 pandemic crisis, policymakers used large-scale asset purchases (LSAPs) along with forward guidance about the future path of the federal funds rate to help stabilize financial markets. However, policymakers and economists have yet to reach a consensus on the efficacy of LSAPs in providing accommodation and improving macroeconomic outcomes. Because announced changes in LSAPs often coincide with changes in forward guidance, the market responses to these two tools can be difficult to disentangle and each tool’s efficacy challenging to evaluate.Brent Bundick and A. Lee Smith ...
Journal Article
How Does a Rise in International Shipping Costs Affect U.S. Inflation?
Trenton Herriford, Elizabeth M. Johnson, Nicholas Sly, and A. Lee Smith find that an increase in ocean shipping costs leads to a modest boost in core inflation after one year.
Working Paper
When does the cost channel pose a challenge to inflation targeting central banks?
In a sticky-price model where firms finance their production inputs, there is both a lower and an upper bound on the central bank's inflation response necessary to rule out the possibility of self-fulfilling inflation expectations. This paper shows that real wage rigidities decrease this upper bound, but coefficients in the range of those on the Taylor rule place the economy well within the determinacy region. However, when there is time-variation in the share of firms who finance their inputs (i.e. Markov-Switching) then inflation targeting interest rate rules are often found to result in ...
Working Paper
The Optimal Monetary Instrument and the (Mis)Use of Causality Tests
This paper uses a New-Keynesian model with multiple monetary assets to show that if the choice of instrument is based solely on its propensity to predict macroeconomic targets, a central bank may choose an inferior policy instrument. We compare a standard interest rate rule to a k-percent rule for three alternative monetary aggregates determined within our model: the monetary base, the simple sum measure of money, and the Divisia measure. Welfare results are striking. While the interest rate dominates the other two monetary aggregate k-percent rules, the Divisia k-percent rule outperforms the ...