Monetary Policy and Economic Performance Since the Financial Crisis

Caldara, Dario; Gagnon, Étienne; Martínez‐García, Enrique; Neely, Christopher J.

doi:10.20955/r.103.425-60

Cited by 5 publications

(5 citation statements)

References 57 publications

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“…In any given quarter-at or away from the ZLBnews shocks often contribute up to or slightly more than 1 percentage points to the movements in the unemployment rate. The behavior of news in the decomposition at the ZLB is particularly intriguing, as we find that policy news shocks led to increases in the unemployment rate for much of the period, through 2013, suggesting that the Federal Reserve's forward guidance was not used effectively to lower unemployment during the worst of the 2007-09 Global Financial Crisis and the early part of the recovery until policymakers learned how to better deploy forward guidance to provide monetary accommodation at the ZLB (as noted, for instance, in Caldara et al (2021)).…”

Section: Key Resultsmentioning

confidence: 94%

Monetary Policy Expectations and Economic Fluctuations at the Zero Lower Bound

Doehr¹,

Martínez‐García²

2021

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We propose a recursive VAR model augmented with survey-based measures of future interest rates to identify the effects of forward guidance on the U.S. economy. Our results show that when interest rates are away from the zero lower bound (ZLB), an exogenous shift in the perception toward higher future interest rates leads to an increase in current economic activity. However, when policy rates fall to the ZLB, economic activity decreases following an upward revision to expected future interest rates. These findings are robust to alternative estimation frameworks, identification schemes, and data sources. We also provide a structural interpretation for our findings in the context of the workhorse New Keynesian model with news shocks about future monetary policy (forward guidance). In this setting, the monetary authority cannot accommodate the anticipatory effects from higher future interest rates while at the ZLB, which drags economic activity today. In turn, away from the ZLB, there is policy room to cut rates and revert the negative economic impacts of the anticipated policy. Similarly, announcing future lower interest rates while keeping interest rates at the ZLB today boosts current economic activity while the reverse can happen if, instead, policy rates are lifted above the ZLB to cool down the nascent expansion. Therefore, our empirical results and theoretical insights suggest that managing monetary policy expectations is a useful policy tool for stimulating economic activity, but its transmission mechanism is different at and away from the ZLB.

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Section: Key Resultsmentioning

confidence: 94%

Monetary Policy Expectations and Economic Fluctuations at the Zero Lower Bound

Doehr¹,

Martínez‐García²

2021

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“…This implies that, for such a horizon, the first value in the forecasting sample is in 2008:Q4 and the last one appears in 2016:Q4. Hence, we are putting the light on the forecasting performance of the NOEM-BVAR and the competing models during the period of the 2007-2009 global financial crisis and its aftermath where inflation for many advanced economies tended to fall below target (as noted in Caldara et al, 2021).…”

Section: Forecast Comparisonmentioning

confidence: 99%

Forecasting inflation in open economies: What can a NOEM model do?

Duncan

Martínez‐García

2023

Journal of Forecasting

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This paper evaluates the forecasting ability when inflation is viewed as an inherently global phenomenon through the lens of the workhorse New Open Economy Macro (NOEM) model. The NOEM model emphasizes the importance of cross‐country spillovers arising through trade, and its reduced form solution can be represented by a finite‐order VAR that provides a tractable model of inflation forecasting. We use Bayesian techniques to estimate this VAR specification—we name it NOEM‐BVAR—and pseudo‐out‐of‐sample forecasts to assess its forecasting performance at different horizons in a diverse set of 18 countries. On average, the NOEM‐BVAR specification produces a similar or even lower root mean square prediction error (RMSPE) than its standard competitors, which include both purely statistical models and theoretically‐based forecasting models (e.g., Phillips‐curve‐type alternatives and others with global inflation measures). In a number of cases, the gains in smaller RMSPEs are statistically significant, especially at short horizons. The NOEM‐BVAR model is also accurate in predicting the direction of change for inflation and is often better than its competitors along this dimension as well. Even though purely statistical models can be useful as prediction tools, the NOEM‐BVAR is an attractive tool among those forecasting models motivated by economic theory.

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“…First, the word flexible in FAIT recognizes that monetary policy does not have price stability as its sole goal as it would be expected under a purest form of an inflation targeting regime. In turn, the Federal Reserve is statutorily required to balance price stability with full employment García (2021) since the 2007-09 global financial crisis (or even before) underlies another one of the key concerns raised during the Fed's 2019-20 Monetary Policy Framework Review-that a sustained period of low interest rates increases the likelihood of monetary policy hitting the ZLB even after only modest economic downturns (Caldara et al, 2021). This was an important motivation for the FOMC's subsequent update of the Longer-Run Statement announced by Chairman Powell at the 2020 Jackson Hole Symposium.…”

Section: Monetary Policy Frameworkmentioning

confidence: 99%

Flexible Average Inflation Targeting: How Much Is U.S. Monetary Policy Changing?

2022

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One major outcome of the Federal Reserve’s 2019–20 framework review was the adoption of a Flexible Average Inflation Targeting (FAIT) strategy in August 2020. Using synthetic control methods, we document that U.S. inflation rose post-FAIT considerably more than predicted had the strategy not changed (an average of 1.18 percentage points during 2020:M8–2022:M2). To explore the extent to which targeting average inflation delayed the Fed’s response and contributed to post-FAIT inflation, we adopt a version of the open-economy New Keynesian model in Martínez-García (2021) and document the economic consequences of adopting alternative measures of average inflation as policy objectives. We document three additional major findings using this general equilibrium setup: First, depending on how far back and how much weight is assigned to past inflation misses, the policy outcomes under FAIT are similar to those under the pre-FAIT regime. Secondly, we find that the implementation of FAIT can have large effects over short periods of time as it tends to delay action. However, over longer periods of time—such as the 1984:Q1–2019:Q4 pre-FAIT period—its effects wash out and appear negligible. Finally, we find that di˙erent average inflation measures explain an average of 0.5 percentage points per quarter of the post-FAIT inflation surge, indicating that targeting average inflation by itself can only explain part of the inflation spike since August 2020.

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Monetary Policy and Economic Performance Since the Financial Crisis

Cited by 5 publications

References 57 publications

Monetary Policy Expectations and Economic Fluctuations at the Zero Lower Bound

Monetary Policy Expectations and Economic Fluctuations at the Zero Lower Bound

Forecasting inflation in open economies: What can a NOEM model do?

Flexible Average Inflation Targeting: How Much Is U.S. Monetary Policy Changing?

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