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Working Paper
Understanding the Aspects of Federal Reserve Forward Guidance
This paper studies the effects of Federal Open Market Committee (FOMC) forward guidance language. I estimate two policy surprises at FOMC meetings: a change in the current federal funds rate and an orthogonal change in the expected path of the federal funds rate. From February 2000 to June 2003, the FOMC only gave forward guidance about risks to the economic outlook, and a surprise increase in the expected federal funds rate path had expansionary effects. This is consistent with models of central bank information effects, where a positive economic outlook causes private agents to revise up their expectations for the economy. From August 2003 to May 2006, the FOMC also gave forward guidance about policy inclinations, and a surprise increase in the federal funds rate path had contractionary effects. These results are consistent with standard macroeconomic models of forward guidance. Overall, the effects of forward guidance depend on the FOMC?s choice to use one or both of the economic-outlook and policy-inclination aspects of forward guidance.
AUTHORS: Lunsford, Kurt Graden
DATE: 2018-11-07

Working Paper
Some Evidence on Secular Drivers of US Safe Real Rates
We study long-run correlations between safe real interest rates in the United States and over 20 variables that have been hypothesized to influence real rates. The list of variables is motivated by the familiar intertermporal IS equation, by models of aggregate savings and investment, and by reduced form studies. We use annual data, mostly from 1890 to 2016. We find that safe real interest rates are correlated as expected with demographic measures. For example, the long-run correlation with labor force hours growth is positive, which is consistent with overlapping generations models. For another example, the long-run correlation with the proportion of 40- to 64-year-olds in the population is negative. This is consistent with standard theory where middle-aged workers are high-savers who drive down real interest rates. In contrast to standard theory, we do not find productivity to be positively correlated with real rates. Most other variables have a mixed relationship with the real rate, with long-run correlations that are statistically or economically large in some samples and by some measures but not in others.
AUTHORS: Lunsford, Kurt Graden; West, Kenneth D.
DATE: 2017-12-21

Working Paper
The Informational Effect of Monetary Policy and the Case for Policy Commitment
I explore how asymmetric information between the central bank and the private sector changes the optimal conduct of monetary policy. I build a New Keynesian model in which private agents have imperfect information about underlying shocks, while the central bank has perfect information. In this environment, private agents extract information about the underlying shocks from the central bank?s interest-rate decisions. This informational effect weakens the direct effect of monetary policy: When the central bank adjusts the interest rate to offset the effects of underlying shocks, the interest rate also reveals information about the realization of underlying shocks. Because private agents have more precise information about the shocks and consequently react more aggressively to it, the economy becomes harder to stabilize with monetary policy. I show that committing to the optimal state-contingent policy rule alleviates this problem by controlling the information revealed through the interest rate.
AUTHORS: Jia, Chengcheng
DATE: 2019-04-17

Working Paper
Saving Constraints, Debt, and the Credit Market Response to Fiscal Stimulus
We document that the interest rate response to fiscal stimulus (IRRF) is lower in countries with high inequality or high household debt. To interpret this evidence we develop a model in which households take on debt to maintain a consumption threshold (saving constraint). Now debt-burdened, these households use additional income to deleverage. In economies with more debt-burdened households, increases in government spending tighten credit conditions less (relax credit conditions more), leading to smaller increases (larger declines) in the interest rate. Our theoretical framework predicts that the negative relationship between the IRRF and debt only holds when credit is not restricted. It also predicts that the consumption response to fiscal stimulus is falling in debt and inequality (only during periods of relaxed credit). We perform a series of empirical tests and find support for these predictions. In doing so, we provide context to recent evidence on the debt-dependent effects of government spending by highlighting that the relationship between debt and fiscal effects varies with credit conditions.
AUTHORS: Miranda-Pinto, Jorge; Walsh, Kieran; Young, Eric R.; Murphy, Daniel P.
DATE: 2020-02-27

Working Paper
Forecasts of inflation and interest rates in no-arbitrage affine models
In this paper, we examine the forecasting ability of an affine term structure framework that jointly models the markets for Treasuries, inflation-protected securities, inflation derivatives, and oil future prices based on no-arbitrage restrictions across these markets. On the methodological side, we propose a novel way of incorporating information from these markets into an affine model. On the empirical side, two main findings emerge from our analysis. First, incorporating information from inflation options can often produce more accurate inflation forecasts than those based on the Survey of Professional Forecasters. Second, incorporating oil futures tends to improve short-term inflation and longer-term nominal yield forecasts.
AUTHORS: Gospodinov, Nikolay; Wei, Bin
DATE: 2016-02-01

Working Paper
Optimal Time-Consistent Taxation with Default
We study optimal time-consistent distortionary taxation when the repayment of government debt is not enforceable. The government taxes labor income or issues noncontingent debt in order to finance an exogenous stream of stochastic government expenditures. The government can repudiate its debt subject to some default costs, thereby introducing some state-contingency to debt. We are motivated by the fact that domestic sovereign default is an empirically relevant phenomenon, as Reinhart and Rogoff (2011) demonstrated. Optimal policy is characterized by two opposing incentives: an incentive to postpone taxes by issuing more debt for the future and an incentive to tax more currently in order to avoid punishing default premia. A generalized Euler equation (GEE) captures these two effects and determines the optimal back-loading or front-loading of tax distortions.
AUTHORS: Karantounias, Anastasios G.
DATE: 2017-11-01

Working Paper
Forecasts from Reduced-form Models under the Zero-Lower-Bound Constraint
In this paper, I consider forecasting from a reduced-form VAR under the zero lower bound (ZLB) for the short-term nominal interest rate. I develop a method that a) computes the exact moments for the first n + 1 periods when n previous periods are tracked and b) approximates moments for the periods beyond n + 1 period using techniques for truncated normal distributions and approximations a la Kim (1994). I show that the algorithm produces satisfactory results for VAR systems with moderate to high persistence even when only one previous period is tracked. For very persistent VAR systems, however, tracking more periods is needed in order to obtain reliable approximations. I also show that the method is suitable for affine term-structure modeling, where the underlying state vector includes the short-term interest rate as in Taylor rules with inertia.
AUTHORS: Pasaogullari, Mehmet
DATE: 2015-08-05

Report
The equilibrium real policy rate through the lens of standard growth models
The long-run equilibrium real policy rate is a key concept in monetary economics and an important input into monetary policy decision-making. It has gained particular prominence lately as the Federal Reserve continues to normalize monetary policy. In this study, we assess the evolution, current level, and prospective values of this equilibrium rate within the framework of standard growth models. Our analysis considers as a baseline the single-sector Solow model, but it places more emphasis on the multi-sector neoclassical growth model, which better fits the data over the past three decades. We find that the long-run equilibrium policy rate has fallen between 0.3 and more than 1.6 percentage points from the 1973?2007 historical average, depending on the model and parameter values, mainly because of slower growth in total factor productivity (TFP) and the labor force. To the extent that the recent sluggish TFP growth persists, our estimates suggest a range of 0 percent to 1 percent for the equilibrium real rate in the current policy setting. But these estimates are subject to a substantial degree of uncertainty, as has been found in other studies. Policymakers thus need to interpret cautiously the guidance from policy rules that depend on the long-run equilibrium rate. This uncertainty also highlights the importance of the Federal Reserve?s standard practice of constantly monitoring a wide range of indicators of inflation and real activity to gauge as accurately as possible the economy?s reaction to policy.
AUTHORS: Wang, J. Christina; Sichel, Daniel E.
DATE: 2017-11-17

Report
The liquidity effect of the Federal Reserve’s balance sheet reduction on short-term interest rates
I examine the impact of the Federal Reserve?s balance sheet reduction on short-term interest rates emanating from the declining supply of reserve balances. Using an exogenous shift in the supply of reserves, I estimate that by January 2019, when the Fed will have reduced its portfolio by $500 billion, the overnight repurchase agreement (repo) spread (relative to the lower bound of the federal funds target range) will be 10 basis points higher and the fed funds spread will be 2 basis points higher than in October 2017, all else being equal. I also find that a declining supply of reserve balances reduces recourse to the Fed?s overnight reverse repo (RRP) facility, which might initially dampen the tightening effects on short-term rates of the Fed?s balance sheet reduction.
AUTHORS: Brauning, Falk
DATE: 2017-10-01

Report
Predicting Recessions Using the Yield Curve: The Role of the Stance of Monetary Policy
The yield curve is often viewed as a leading indicator of recessions. While the yield curve’s predictive power is not without controversy, its ability to anticipate economic downturns endures across specifications and time periods. This note examines the predictive power of the yield curve after accounting for the current stance of monetary policy—a relevant issue given that monetary policy was unusually accommodative during the most recent yield curve inversion, in the third quarter of 2019. The results show that a yield curve inversion likely overstates the probability of a recession when the stance of monetary policy, judged relative to a time-varying neutral federal funds rate, is accommodative.
AUTHORS: Olivei, Giovanni P.; Fuhrer, Jeffrey C.; Cooper, Daniel H.
DATE: 2020-02-03

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