Confidence, credibility, and macroeconomic policy: past, present, future


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Looking forward to , when most analysts, including the UN, predict that China will have a population of 1. It anticipated an average life expectancy of It predicted that the population would have on average 14 years of education, where they currently have eight. Beijing and Shanghai would be metropolises even bigger than they are now and a second tier of Chinese cities would dominate regional economies.

The Future of Central Bank Independence

Three things are striking about this analysis. The first is the confidence that underwrites it, even accounting for its official status. If anything, this is an even bolder statement. The second is the implications of this dramatic rise for international politics, which is only just beginning to adapt to the need to factor China into the three dimensional chess of global politics.

Our growing understanding and cooperation. China's future. Finding happiness by being different. There will be no Copenhagen climate change agreement without China. There will be no credible system of global financial governance. There will be no credible regional security strategy for Asia without Chinese leadership and cooperation. Without China, the Doha round of trade talks will not be completed.

With its confident and constructive performance in the G20, its four trillion yuan fiscal stimulus package, there is no doubt that whatever form the eventual governance of the global economy takes, it will have to include China and the other emerging economies in its first rank. But changes are felt only with a long lag we estimate a weight on the preceding year's currency share around. The advent of the euro interrupts the continuity of the historical data set. So we estimate parameters on pre data, and then use them to forecast the EMU era.

The equation correctly predicts a small narrowing in the gap between the dollar and euro over the period Whether the euro might in the future rival or surpass the dollar as the world's leading international reserve currency appears to depend on two things: 1 do the United Kingdom and enough other EU members join euroland so that it becomes larger than the US economy, and 2 does US macroeconomic policy eventually undermine confidence in the value of the dollar, in the form of inflation and depreciation.

Monetary Policy: How It Works, and What It Takes

What we learn about functional form and parameter values helps us forecast, contingent on these two developments, how quickly the euro might rise to challenge the dollar. Under two important scenarios the remaining EU members, including the UK, join EMU by or else the recent depreciation trend of the dollar persists into the future the euro may surpass the dollar as leading international reserve currency by Development of the American Economy.

These conclusions are not very far from those reached in a much more elaborate way by Federal Reserve Board economists Michael T. Kiley and John M. Roberts Kiley and Roberts conclude that that 30 or 40 percent of the time we will be at the zero lower bound. If anything, the Kiley-Roberts assumption of a 1 percent neutral real rate is way too high as a certainty-equivalent estimate of what the neutral real rate actually is, recognizing that the likelihood of the ZLB is very nonlinear in the neutral rate.

Within the Kiley-Roberts framework, the expected output losses are large as a result of binding constraints on the ability to reduce interest rates. They estimate an output loss above 1 percent of GDP on average. I would offer more of a back-of-the-envelope approach. Suppose we get into a ZLB episode once every decade, and that when this happens, monetary policy is constrained for three years. This is about 40 percent as long as it was constrained after the crisis. The calculation would be an underestimate if recessions were more frequent than I have suggested, if they were more severe or if they had substantial hysteresis effects.

The main challenge to this line of argument is that alternative forms of stimulus can be provided so the zero lower bound is not an important constraint. I am far from convinced. First, starting at a 2. If nobody does anything else, the ten-year rate will find its way down to the neighborhood of 1. It is questionable how much extra stimulus would be developed by any further reduction in long-term rates below 1. And that applies with respect to any monetary tool that might be developed. The evidence now is much less clear than it once appeared that it works in practice Greenlaw, Hamilton, Harris and West —especially in light of the awkward fact that the quantity of U.

There is a further awkwardness in the arguments around QE. Supposedly it creates a shortage of outstanding Treasury debt and therefore drives up its price. If this were in fact the case, one would expect to see it trade at a premium to substitutes that the private sector could manufacture. In fact negative swap spreads during much of the QE period suggest if anything that markets were pricing an abundance of Treasury securities.

So, I am completely unconvinced that QE can be our salvation next time round. What about forward guidance? The Fed is moving with some vigor towards tightening while inflation is, at this moment, well short of 2 percent. The fact that the Fed is not willing to predict inflation above 2 percent at any moment, even a hypothetical moment, of the tenth year of recovery with an unemployment rate of 4 percent, must be undercutting whatever credibility might previously have attached to the idea that the Fed would be willing to live with substantially super 2 percent inflation rates.


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Finally, there is the possibility of fiscal policy. I note that growing levels of the debt-to-GDP ratio, coupled with readings of the political process and the way the political process responded to the aftermath of the American Recovery and Reinvestment Act of , suggests little basis for serenity that substantial fiscal policy will be quickly entered into the next time the economy goes into recession.

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I have lived this in helping to design the Recovery Act. It just turns out to be very difficult to turn spending on and off rapidly. It is sometimes suggested that this could be mitigated by requiring units of government to maintain lists of shovel-ready projects available for funding when a countercyclical moment comes. But experience suggests that this may lead to the most promising projects being delayed as the economy turns down in the hope of receiving outside funding when a countercyclical program is introduced.

I recall at the NEC spending the better part of an afternoon trying to figure out how to give money to the National Institutes of Health as a temporary burst in way that would ensure efficient spending. It turned out to be almost impossible. Measures on the tax side are another possibility but there is a real question about the efficacy of temporary measures and the ability of the Congress to keep them temporary.

My conclusion, therefore, is that in our current framework the economy is singularly brittle.

VTLS Chameleon iPortal Communication Error Occurred.

We do not have a basis for assuming that monetary policy will be able, as rapidly as necessary, to lift us out of the next recession. This suggests the suboptimality of our current monetary policy framework. I would suggest a criterion for choosing a monetary framework, when we next choose one, should be that it is a framework that contemplates enough room to respond to a recession.

In other words, it should foresee nominal interest rates in the range of 5 percent in normal times. How that is achieved seems to me to be a question of second-order importance. If we do that and I am wrong in my judgements about the neutral rate of interest or the consequences of extraordinary monetary measures, we will live with marginally, perhaps slightly more than marginally, higher inflation. I have never seen a calculation of the costs of running say 3 rather than 2 percent inflation that are terribly large.

But if I am right, or if the trend towards a declining neutral real rate continues and we ignore it, we will put ourselves at risk of very substantially exacerbating the next recession with grave consequences for lost output and employment and quite possibly matters of political economy as well. These consequences would dwarf those of marginally higher inflation.

So, I would hope that all consideration of monetary frameworks emphasized centrally the need to provide for adequate response to the next recession.

Communication Error Occurred.

And I would make that choice for two reasons. First, it would attenuate the issues around explicitly announcing a higher inflation target, which I think are a little bit problematic on political economy grounds. Second, a nominal GDP target has an additional advantage in its implicit response to changing conditions.

Arithmetically a nominal GDP target has the property that the expected rate of inflation rises as the expected real growth in GDP declines. This is desirable.

Confidence, credibility, and macroeconomic policy: past, present, future Confidence, credibility, and macroeconomic policy: past, present, future
Confidence, credibility, and macroeconomic policy: past, present, future Confidence, credibility, and macroeconomic policy: past, present, future
Confidence, credibility, and macroeconomic policy: past, present, future Confidence, credibility, and macroeconomic policy: past, present, future
Confidence, credibility, and macroeconomic policy: past, present, future Confidence, credibility, and macroeconomic policy: past, present, future
Confidence, credibility, and macroeconomic policy: past, present, future Confidence, credibility, and macroeconomic policy: past, present, future
Confidence, credibility, and macroeconomic policy: past, present, future Confidence, credibility, and macroeconomic policy: past, present, future
Confidence, credibility, and macroeconomic policy: past, present, future Confidence, credibility, and macroeconomic policy: past, present, future
Confidence, credibility, and macroeconomic policy: past, present, future Confidence, credibility, and macroeconomic policy: past, present, future
Confidence, credibility, and macroeconomic policy: past, present, future Confidence, credibility, and macroeconomic policy: past, present, future

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