boom-bust cycles and monetary...
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Boom-bust Cycles and Monetary Policy
• It has often been argued that there isIt has often been argued that there is advanced information about technology shocksshocks.– Beaudry-Portier, Michelle Alexopoulos,
Jaimovic-Rebelo Christiano-Ilut-Motto-Jaimovic Rebelo, Christiano Ilut MottoRostagno
• In the presence of such advanceIn the presence of such advance information, standard monetary policy can create an inefficient boom followed by acreate an inefficient boom, followed by a bust.
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ObjectiveE ti t d l i hi h t h l h k• Estimate a model in which technology shocks are partially anticipated
‘Normal’ technology shock:– Normal technology shock:
– Shock considered here (J Davis):at aat−1 t
Shock considered here (J Davis):
‘recent information’
1 2 3 4
‘earlier information’
5 6 7 8at aat−1 t t−11 t−2
2 t−33 t−4
4 t−55 t−6
6 t−77 t−8
8
• Evaluate importance of for business cycles t−ii
• Explore implications of for monetary policy. t−ii
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Outline• Estimation
– Resultsesu s– ‘Excessive optimism’ and 2000 recession
• Implications for monetary policy• Implications for monetary policy– Monetary policy causes economy to over-
react to signals inadvertently creates ‘boomreact to signals....inadvertently creates boom-bust’
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Model• Features (version of CEE)
– Habit persistence in preferences
Investment adjustment costs in change of– Investment adjustment costs in change of investment
– Variable capital utilization
– Calvo sticky (EHL) wages and pricesCalvo sticky (EHL) wages and prices
• Non-optimizers: Pit Pi,t−1, Wj,t zWj,t−1
• Probability of not adjusting prices/wages: p, w
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Observables and Shocks• Six observables:
– output growth, i fl ti– inflation,
– hours worked, i t t th– investment growth,
– consumption growth, – T-bill rate.
• Sample Period: 1984Q1 to 2007Q1
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Etj∑
l0
1
1.03−1/4
lpreference shock
c,tl logCtl − bCtl−1 − L
ltl,j2
2l0
K 1 0 02K 1 Smarginal (in-) efficiency of investment
It IKt1 1 − 0.02Kt 1 − S I,t
ItIt−1
It
Yt 0
1Yjt
1f,t dj
markup shock f,t
, Yj,t zt exptechnology shock
at Lj,t
1−
utKj,t, zt expzt
R R 1 1 1 a ytlog RtR log Rt−1
R 1 − 1R a log t1
ay4 log yt
y tM
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Shock representationsmarkupmarkup
log f,t
f f log
f,t−1
f f ,t
discount ratelogc,t c logc,t−1 c,t
efficiency of investmentlogI t logI t 1 tlogI,t I logI,t−1 I,t
technology
at aat−1 iid
t
iid t−1
1
iid t−2
2
iid t−3
3
iid t−4
4
iid t−5
5
iid t−6
6
iid t−7
7
iid t−8
8
monetary policyt
M Mt−1M u,t.
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Variance Decomposition, Technology Shocks
variable t ∑i18 t−i
i t t ∑i14 t−i
i ∑i58 t−i
i
consumption growth 46.6 7.0 24.1 22.5investment growth 16.1 2.3 8.2 7.9output growth 45.4 6.2 23.1 22.3log hours 45.3 5.5 20.0 25.3inflation 49.0 7.0 23.8 25.2interest rate 52.1 7.1 24.9 27.2
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• Estimated technology shock process:Estimated technology shock process:
log, technology shockat aat−1
‘recent information’
t t−11 t−2
2 t−33 t−4
4
‘earlier information’
t−55 t−6
6 t−77 t−8
8
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Centered 5-quarter moving average of shocks
Signals 5-8 quarters inpastpast
NBER trough
Current shock plus most recentFour quarters’ signals
NBER peak
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Implications for Monetary Policyp y y• Estimated monetary policy rule induces over-
reaction to signal shockg
• Problem: – positive signal induces expectation that consumption
will be high in the future
– Ramsey-efficient (‘natural’) real rate of interest jumps
– Under Taylor rule, real rate not allowed to jump, so monetary policy is expansionary
• Intuition easy to see in Clarida-Gali-Gertler model
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The standard New-Keynesian Model
at at−1 t t−p at log, technologyp
rrt∗ rr − 1 − at t1−p (natural (Ramsey) rate)rrt rr 1 at t1−p (natural (Ramsey) rate)
E 1 x (Calvo pricing equation) t Et t1 xt − t (Calvo pricing equation)
E ∗ E (i t t l ti )xt −rt − Et t1 − rrt∗ Etxt1 (intertemporal equation)
rt Et t1 xxt (policy rule)
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Response to signal that technology will expand 1% in period 1Equilibrium RamseyEquilibrium Ramsey
Period PeriodCase Where Signal is False
0 1 2 3 0 1 2 34 t -1 0 0 0 0 0 0 0
l A 0 0 0 0 0 0 0 0logAt 0 0 0 0 0 0 0 0loght 0.7 0 0 0 0 0 0 0logyt 0.7 0 0 0 0 0 0 0gy
Case Where Signal is True0 1 2 3 0 1 2 3
0.95, 1.5, x 0.5, 0.824 t -1 0 0 0 0
logAt 0 1 .95 .9025 0 1 .95 .9025loght 0 7 -0 04 -0 04 -0 04 0 0 0 0loght 0.7 0.04 0.04 0.04 0 0 0 0logyt 0.7 1.0 0.9 0.9 0 1 .95 .9025
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• Let’s see how a signal that turns out to beLet s see how a signal that turns out to be false works in the full, estimated model.
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• The following slide corrects the hoursThe following slide corrects the hours worked response in the previous slides, which was graphed incorrectlywhich was graphed incorrectly.
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Why is the Boom-Bust So Big?y g
• Most of boom-bust reflects suboptimalityp yof monetary policy.
• What’s the problem?
– Monetary policy ought to respond to the natural (Ramsey) rate of interestnatural (Ramsey) rate of interest.
Relatively sticky wages and inflation– Relatively sticky wages and inflation targeting exacerbate the problem
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Policy solution• Modify the Taylor rule to include:
– Natural rate of interest (probably not feasible)– Credit growthCredit growth– Stock market– Wage inflation instead of price inflation.g p
• Explored consequences of adding credit p q ggrowth and/or stock market by adding Bernanke-Gertler-Gilchrist financial frictions.
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Conclusion• Estimated a model in which agents receive advanceEstimated a model in which agents receive advance
information about technology shocks.
• Advance information seems to play an important role in b i l d i
p y pbusiness cycle dynamics
– Important in variance decompositions
– Boom-bust of late 1990s seems to correspond to a period in which there was a lot of initial optimism about technology, which later came to be seen as excessive
• Monetary policy appears to be overly expansionary in response to signal shocks
– Ramsey-efficient allocations require sharp rise in rate of interest, which `standard monetary policy does not deliver’.
– Problem is most severe when wages are sticky relative to prices.