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Working Paper
Vector rational error correction
Systems of forward-looking linear decision rules can be formulated as vector "rational" error correction models. The closed-form solution of the restricted error corrections is derived, and a full-information estimator is suggested. The error correction format indicates that the assumptions of convex adjustment costs and rational expectations impose different types of a priori restrictions on the dynamic structure of the error corrections. An empirical model of the producer decision rule for capital investment illustrates that the data rejects dynamic restrictions imposed by a standard ...
Working Paper
Estimating equilibrium real interest rates in real time
We use a range of simple models and 22 years of real-time data vintages for the U.S. to assess the difficulties of estimating the equilibrium real interest rate in real time. Model specifications differ according to whether the time-varying equilibrium real rate is linked to trend growth, and whether potential output and growth are defined by the CBO's estimates or treated as unobserved variables. Our results reveal a high degree of specification uncertainty, an important one-sided filtering problem, and considerable imprecision due to data uncertainty. Also, the link between trend growth and ...
Working Paper
Shifting endpoints in the term structure of interest rates
This paper links the term structure to perceptions of monetary policy. Long-horizon forecasts of short rates needed in empirical term structure models are heavily influenced by the endpoints, or limiting conditional forecasts, of the short rate process. Mean-reversion or unit roots are commonly assumed, but do not provide realistic yield predictions. Failures occur because neither accounts for historical shifts in market perceptions of the policy target for inflation. This paper links endpoint shifts to a learning model where agents must detect shifts in long-term policy goals. With ...
Working Paper
Dynamic specifications in optimizing trend-deviation macro models
As noted in surveys by Goodfriend and King (1997) and Walsh (1998) and exemplified by models analyzed in Taylor (1999), there is encouraging progress in developing optimizing trend-deviation macro models that provide useful insights into the transmission and design of monetary policy. Several controversial features of a minimalist trend-deviation model, with optimizing households, firms, and bond traders, are examined. Dynamic specifications are suggested to improve the data-based realism, while preserving the simplicity, of the minimalist model.
Working Paper
Breathing room for beta
This paper argues that a test of beta insignificance, commonly used in empirical studies of the CAPM, predisposes studies toward rejecting the CAPM. Under the null hypothesis of these tests, the CAPM is false. Consequently, insufficient evidence to reject the null is taken as sufficient evidence to reject the CAPM. Simulations suggest that this framework typically leads to false rejection rates of more than 1/2. An alternative test, with a null hypothesis consistent with the CAPM, is proposed. Based on statistics from published studies, the proposed test does not reject the CAPM.
Conference Paper
Estimating forward-looking Euler equations - discussion
Working Paper
Term structure transmission of monetary policy
The sensitivity of bond rates to macro variables appears to vary both over time and over forecast horizons. The latter may be due to differences in forward rate term premiums and in bond trader perceptions of anticipated policy responses at different forecast horizons. Determinacy of policy transmission through bond rates requires a lower bound on the average responsiveness of term premiums and anticipated policy responses to inflation.
Journal Article
Longer-term perspectives on the yield curve and monetary policy
In the spring of 2004, there was widespread expectation in financial markets that the Federal Reserve would shortly begin the process of raising its federal funds rate target back toward a more normal level. At the time, there was considerable concern that removing policy accommodation could lead to a sharp rise in long-term interest rates that might roil financial markets or slow the economic recovery. Much of this concern was based on the sizable increases in long-term rates that occurred when the Federal Reserve tightened policy in 1994-95 and 1999-2000. In contrast to the conventional ...
Working Paper
Implications of rounding and rebasing for empirical analysis using consumer price inflation
Monthly CPI inflation rates can be spuriously choppy when constructed using the official CPI, rebased with 1982-84=100. The problem can be traced to rounding that occurs when only one digit after the decimal place is reported in rebased CPI data. This paper compares three CPI measures to illustrate how rounding and rebasing introduce distortions that affect variance properties, alter lag specification in autoregressive models, and "flip" results of unit root tests. To reduce distortions, the paper recommends using either original release data or the CPI rebased with 1967=100.
Journal Article
Parsing shocks: real-time revisions to gap and growth projections for Canada
The output gap - the deviation of output from potential output - has played an important role in the conduct of monetary policy in Canada. This paper reviews the Bank of Canada's definition of potential output, as well as the use of the output gap in monetary policy. Using a real-time staff economic projection dataset from 1994 through 2005, a period during which the staff used the Quarterly Projection Model to construct economic projections, the authors investigate the relationship between shocks (data revisions or real-time projection errors) and revisions to projections of key ...