Quantitative easing in the US after the financial crisis led to a substantial increase in the Fed's balance sheet and the monetary base. The velocity of circulation of money decreased dramatically, inflation and interest rates remained low, and the real recovery from the Great Recession was slow. This paper demonstrates that this is precisely what a standard New Keynesian model predicts in response to an increase in the money supply that is expected to be temporary. The predictions of the model are a corollary of Friedman's (1998) dictum that short-term nominal interest rates are a poor indicator of the stance of monetary policy, and that low rates can be a sign that money has been tight. As shown here, low interest rates can also be a sign that money is expected to be tight in the future.
Nine years after the beginning of the Great Recession in 2008 and at least seven years since the recovery from the Great Recession began, industrialized economies are experiencing sluggish growth and inflation that is persistently under targeted rates. The unconventional monetary policies that have been tried by different central banks have not generally been successful in achieving their goals. We suggest here that quantitative easing could be made much more effective by making expansions of the monetary base permanent. In turn, a commitment to permanent monetary expansion would be more credible if central banks adopted targets for nominal aggregates such as the price level or nominal GDP. A level target would also allay fears of runaway inflation.
with Jean-Paul Lam
We compare inflation targeting and price-level targeting in the canonical New Keynesian model, with particular attention to multiple steady-states, indeterminacy, and global stability. Under price-level targeting we show the following: 1) the well-known problem of multiple steady-state equilibria under inflation targeting is absent; 2) the model's dynamics close to the steady state are determinate for a much wider range of parameter values; 3) the model is globally saddlepoint stable. These results provide additional arguments in favour of price-level targeting as a monetary policy framework.
We evaluate inflation targeting and price-level targeting in a simulation model that explicitly takes into account the central bank's zero lower bound constraint on its policy rate. We find that the economy is much less likely to hit the zero bound under price-level targeting for a given rate of inflation. Trend inflation is optimally positive under both regimes because of the zero lower bound, but is lower under price-level targeting, which delivers an enhanced level of economic welfare. Monetary policy is modeled using simple rules. We model the lower bound constraint with a smooth function that can approximate a kink.
The paper uses a simple model of monopolistic competition in the labor market to show that nominal wage rigidity can be endogenized with modest costs of adjusting wages and without the types of real rigidities introduced in recent New Keynesian models. In contrast, models of nominal price rigidity require strong real rigidities or implausibly high adjustment costs to endogenize nominal price rigidity. The minimum size of the cost of adjusting wages remains modest even if labor supply is inelastic, different labor types are highly substitutable, or there are decreasing returns to labor in production.
This paper reexamines the case for fixed exchange rates using a microfounded model of a small open economy with nominal wage rigidities and subject to both terms of trade shocks and money demand shocks. If monetary instability is sufficiently important compared to real shocks, a fixed rate regime improves welfare over a flexible rate regime with an exogenous money supply. The relative importance of the two types of shocks can be calibrated to reproduce the observed increase in real exchange rate variability in industrialized countries under flexible rates.
The title says it all. I include this here since it's still getting steady downloads.
Last changed – Dernière mise à jour: 22/01/2025
Fremd bin ich eingezogen, Fremd zieh' ich wieder aus. (Wilhelm Müller/Franz Schubert, Die Winterreise)