'Wait and See' Monetary Policy

Lei, X.; Tseng, Michael

doi:10.2139/ssrn.2675600

Cited by 3 publications

(4 citation statements)

References 27 publications

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“…The innovation in our paper is to suppose that the Central Bank confronts a cost to changing either the interest rate or exchange rate. Lei and Tseng (2019) show that a fixed cost can explain observed infrequent interest rate changes at both the Fed and the Bank of Canada. Here, we adopt a similar assumption, although to be consistent with the absence of jumps in the RMB exchange rate, we instead suppose the intervention cost is linear, as in Miller and Zhang (1996).…”

Section: The Modelmentioning

confidence: 89%

“…Recently, real options theory has been successfully applied to a variety of macroeconomic questions where discrete actions and inertia are present. For example, Alvarez and Dixit (2014) examine the optimal timing of a potential eurozone breakdown; Stokey (2016) studies investment options under policy uncertainties; Lei and Tseng (2019) study the optimal timing and size of discrete interest rate adjustments. Recent advances in bringing stochastic volatility into the discussion of option exercise also shed lights on our analysis.…”

Section: Literature Reviewmentioning

confidence: 99%

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“Wait and See” or “Fear of Floating”?

Lei

Kasa

2020

Macroecon. Dynam.

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This paper studies the evolution of China’s exchange rate policy using real options theory. With intervention costs and ongoing uncertainty, intervention involves the exercise of an option. Increased uncertainty increases the value of this option. This “wait and see” effect leads the Central Bank to widen its intervention band. However, increased volatility also produces larger fluctuations in welfare, which creates a “fear of floating.” This induces the Central Bank to set a tighter band. To study this trade-off, our paper incorporates stochastic volatility into a new Keynesian target zone model and then calibrates it to data from China. We find that increased uncertainty leads to a tighter intervention band, both in the data and in the model. Hence, in China, “fear of floating” appears to dominate the “wait and see” effect.

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Section: The Modelmentioning

confidence: 89%

Section: Literature Reviewmentioning

confidence: 99%

“Wait and See” or “Fear of Floating”?

Lei

Kasa

2020

Macroecon. Dynam.

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“…Sill (2014) attributes disagreement of macroeconomic forecasts to two main channels: (i) differences in forecasters' models and (ii) differences in forecasters' information sets and how they digest this data. Thus, forecaster disagreement may capture aggregate economic uncertainty as suggested by Zarnowitz and Lambros (1987), Bomberger (1996), Giordani and Söderlind (2003), and Baetje and Friedrici (2016), implying the Fed may switch its policy response due to heightened uncertainty about macroeconomic conditions as suggested by Lei and Tseng (2019). However, other studies such as Rich and Tracy (2010) do not find a significant relationship between forecaster disagreement and measures of macroeconomic uncertainty, thus calling into question whether disagreement is a proper proxy for uncertainty.…”

Section: Datamentioning

confidence: 99%

Timing and Signals of Monetary Regime Switching

Soques

2020

Macroecon. Dynam.

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This study investigates if the reaction function of the Federal Reserve switches between two distinct policy rules. Using a time-varying transition probability framework, we also determine if forward-looking macroeconomic or financial covariates signal an impending monetary regime switch. We find that US monetary policy is best described by a Markov-switching model with two regime processes, one of which controls for heteroskedasticity in the shocks to the policy rule. We find that the Fed switches between an aggressive regime with a relatively high weight on inflation and a dovish regime that is less responsive to inflationary pressures. We find that an increase in private forecasters’ expectations of an impending recession signals a switch from the more aggressive policy regime to the less aggressive regime. A recovery in equity returns signals a return back to the more aggressive regime.

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“…The fact that large and frequent changes in the policy rate may be a disturbance to central banks is witnessed by the literature on the practice of "interest-rate smoothing" (e.g. Sack and Wieland, 2000;Lei and Tseng, 2019). The main negative by-product of the policy-rate volatility induced by point inflation targeting arises in the context of "flexible" inflation targeting, i.e.…”

Section: Taxonomy Of Inflation Target Zonesmentioning

confidence: 99%