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2013): Housing Prices and Robustly Optimal Monetary Policy, mimeo
"... PRELIMINARY DRAFT We analytically characterize robustly optimal monetary policy for an augmented New Keynesian model with a housing sector. In our setting, the housing stock delivers a service flow entering households ’ utility, houses are durable goods that depreciate over time, and new houses ca ..."
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PRELIMINARY DRAFT We analytically characterize robustly optimal monetary policy for an augmented New Keynesian model with a housing sector. In our setting, the housing stock delivers a service flow entering households ’ utility, houses are durable goods that depreciate over time, and new houses can be produced using a concave production technology. We show that shocks to housing demand and to housing productivity have “costpush ” implications, which warrant temporary fluctuations in the inflation rate under optimal policy, even under an assumption of rational expectations, for reasons familiar from the literature on “flexible inflation targeting”. However, under rational expectations optimal monetary policy can still be characterized by commitment to a “target criterion ” that refers to inflation and the output gap only, just as in the standard model without a housing sector. Instead, if policy is to be robust to potential departures of (house price and inflation) expectations from modelconsistent ones, the target criterion must also depend on housing prices. In the empirically realistic case where the government subsidizes housing, the robustly optimal target criterion requires the central bank to “lean against ” unexpected increases in housing prices, in the sense that it should adopt a policy stance that is projected to undershoot its normal targets for inflation and/or the output gap owing to the increase in housing prices, and similarly aim to overshoot those targets in the case of unexpected declines in housing prices.
Macroeconomic Analysis Without the Rational Expectations Hypothesis,” Annual Review of Economics 5
, 2013
"... This paper reviews a variety of alternative approaches to the specification of the expectations of economic decisionmakers in dynamic models, and reconsiders familiar results in the theory of monetary and fiscal policy when one allows for departures from the hypothesis of rational expectations. The ..."
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Cited by 5 (2 self)
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This paper reviews a variety of alternative approaches to the specification of the expectations of economic decisionmakers in dynamic models, and reconsiders familiar results in the theory of monetary and fiscal policy when one allows for departures from the hypothesis of rational expectations. The various approaches are all illustrated in the context of a common model, a loglinearized New Keynesian model in which both households and firms solve infinitehorizon decision problems; under the hypothesis of rational expectations, the model reduces to the standard “3equation model ” used in studies such as Clarida et al. (1999). The alternative approaches considered include rationalizable equilibrium dynamics (Guesnerie, 2008); restricted perceptions equilibria (Branch, 2004); decreasinggain and constantgain variants of leastsquares learning dynamics (Evans and Honkapohja, 2001); rational belief equilibria (Kurz, 2012); and nearrational expectations equilibria (Woodford, 2010). Issues treated include Ricardian equivalence; the determinacy of equilibrium under alternative interestrate rules; nonfundamental sources of aggregate instability; the tradeoff between inflation stabilization and outputgap stabilization; and the possibility of a “deflation trap.” Prepared for Annual Review of Economics, volume 5. I would like to thank Klaus Adam, Ben Hebert, Mordecai Kurz, David Laibson, and Bruce Preston for helpful discussions, Savitar
Woodford’s Approach to Robust Policy Analysis in a LinearQuadratic Framework ∗
, 2013
"... This paper extends Woodford’s (2010) approach to the robustly monetary policy to a general linear quadratic framework. We provide algorithms to solve for a timeinvariant linear robustly optimal policy from a timeless perspective and for a timeinvariant linear Markov perfect equilibrium under discr ..."
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Cited by 3 (1 self)
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This paper extends Woodford’s (2010) approach to the robustly monetary policy to a general linear quadratic framework. We provide algorithms to solve for a timeinvariant linear robustly optimal policy from a timeless perspective and for a timeinvariant linear Markov perfect equilibrium under discretion. We apply our methods to a New Keynesian model of monetary policy with persistent costpush shocks and inflation inertia. We find that the robustly optimal commitment inflation is less responsive to a costpush shock when the shock is more persistent and that the robustly optimal discretionary policy is more responsive to lagged inflation in the presence inflation inertia.
Three types of ambiguity
, 2012
"... For each of three types of ambiguity, we compute a robust Ramsey plan and an associated worstcase probability model. Ex post, ambiguity of type I implies endogenously distorted homogeneous beliefs, while ambiguities of types II and III imply distorted heterogeneous beliefs. Martingales characterize ..."
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Cited by 2 (0 self)
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For each of three types of ambiguity, we compute a robust Ramsey plan and an associated worstcase probability model. Ex post, ambiguity of type I implies endogenously distorted homogeneous beliefs, while ambiguities of types II and III imply distorted heterogeneous beliefs. Martingales characterize alternative probability specifications and clarify distinctions among the three types of ambiguity. We use recursive formulations of Ramsey problems to impose local predictability of commitment multipliers directly. To reduce the dimension of the state in a recursive formulation, we transform the commitment multiplier to accommodate the heterogeneous beliefs that arise with ambiguity of types II and III. Our formulations facilitate comparisons of the consequences of these alternative types of ambiguity.
2012, Three Types of Robust Ramsey Problem in a LinearQuadratic Framework, work in progress
"... This paper studies robust Ramsey policy problems in a general discretetime linearquadratic framework when the Ramsey planner faces three types of ambiguity. This framework includes both exogenous and endogenous state variables. In addition, the equilibrium system from the private sector contains b ..."
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This paper studies robust Ramsey policy problems in a general discretetime linearquadratic framework when the Ramsey planner faces three types of ambiguity. This framework includes both exogenous and endogenous state variables. In addition, the equilibrium system from the private sector contains both backwardlooking and forwardlooking dynamics. We provide recursive characterizations and algorithms to solve for robust policy. Applying our method to a basic New Keynesian model of optimal monetary policy with persistent costpush shocks, we find that (i) all three types of ambiguity make optimal monetary policy more historydependent but for different reasons for each type; and (ii) they deliver qualitatively different initial responses of inflation and the output gap following a costpush shock.
Federal Reserve Board and
, 2003
"... We argue that peoples ’ concern for fairness may explain an unsolved puzzle in macroeconomics: the persistence of inflation. We extend a wagecontracting model of Bhaskar (1990) in which workers ’ disutility from being paid less than other workers exceeds their utility from being paid more. This mod ..."
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We argue that peoples ’ concern for fairness may explain an unsolved puzzle in macroeconomics: the persistence of inflation. We extend a wagecontracting model of Bhaskar (1990) in which workers ’ disutility from being paid less than other workers exceeds their utility from being paid more. This model generates a continuum of equilibria over a range of wages and unemployment rates. If workers ’ expectations are based on the past behavior of wage growth, these beliefs will be selffulfilling, generating inflation persistence within, but not outside of, this range. Based on quarterly U.S. data over the period 19552000, we find evidence that inflation is more persistent between unemployment rates of 4.7 and 6.5 percent than outside these bounds.
∗Prepared for Annual Review of Economics, volume 5. I would like to thank Klaus Adam,
, 2013
"... Visiting Professorship, Harvard University, for supporting this research. A crucial methodological question in macroeconomic analysis is the way in which the expectations of decisionmakers about future conditions should be modeled. To the extent that behavior is modeled as goaldirected, it will dep ..."
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Visiting Professorship, Harvard University, for supporting this research. A crucial methodological question in macroeconomic analysis is the way in which the expectations of decisionmakers about future conditions should be modeled. To the extent that behavior is modeled as goaldirected, it will depend (except in the most trivial cases) on expectations; and analyses of the effects of alternative governmental policies need to consider how expectations are endogenously influenced by one policy or another. Finding tractable ways to address this issue has been a key challenge for the extension of optimizationbased economic analysis to the kinds of dynamic settings required for most questions of interest in macroeconomics. The dominant approach for the past several decades, of course, has made use of the hypothesis of modelconsistent or “rational expectations ” (RE): the assumption that people have probability beliefs that coincide with the probabilities predicted by one’s model. The RE benchmark is a natural one to consider, and its use has allowed a tremendous increase in the sophistication of the analysis of dynamics in the theoretical literature in macroeconomics. Nonetheless, the assumption is a strong one, and one may wonder if it should be relaxed, especially when considering relatively