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Are Constant Interest Rate Forecasts Modest Interventions? Evidence from an Estimated Open Economy DSGE Model of the Euro Area

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Author Info

  • Adolfson, Malin

    ()
    (Research Department, Central Bank of Sweden)

  • Laséen, Stefan

    ()
    (Monetary Policy Department, Central Bank of Sweden)

  • Lindé, Jesper

    ()
    (Research Department, Central Bank of Sweden)

  • Villani, Mattias

    ()
    (Research Department, Central Bank of Sweden)

Abstract

This paper uses an estimated open economy DSGE model to examine if constant interest forecasts one and two years ahead can be regarded as modest policy interventions during the period 1993Q4-2002Q4. An intervention is here defined to be modest if it does not trigger the agents to revise their expectations about the inflation targeting policy. Using univariate modesty statistics, we show that the modesty of the policy interventions depends on the assumptions about the uncertainty in the future shock realizations. In 1998Q4-2002Q4, the two year constant interest rate projections turn out immodest when assuming uncertainty only about monetary policy shocks during the conditioning period. However, allowing non-policy shocks to influence the forecasts makes the interventions more modest, at least one year ahead. Using a multivariate statistic, however, which takes the joint effects of the policy interventions into consideration, we find that the conditional policy shifts all projections beyond what is plausible in the latter part of the sample (1998Q4-2002Q4), and thereby affects the expectations formation of the agents. Consequently, the constant interest rate assumption has arguably led to conditional forecasts at the two year horizon that cannot be considered economically meaningful during this period.

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Bibliographic Info

Paper provided by Sveriges Riksbank (Central Bank of Sweden) in its series Working Paper Series with number 180.

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Length: 34 pages
Date of creation: 01 Mar 2005
Date of revision:
Publication status: Published in International Finance, 2005, pages 509-535.
Handle: RePEc:hhs:rbnkwp:0180

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Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden
Phone: 08 - 787 00 00
Fax: 08-21 05 31
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Web page: http://www.riksbank.com/
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Keywords: Forecasting; Monetary policy; Open economy DSGE model; Policy interventions; Bayesian inference;

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References

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  1. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, Elsevier, vol. 12(3), pages 383-398, September.
  2. Smets, Frank & Wouters, Raf, 2004. "Forecasting with a Bayesian DSGE model: an application to the euro area," Working Paper Series, European Central Bank 0389, European Central Bank.
  3. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Working Paper Series, Federal Reserve Bank of Chicago WP-01-08, Federal Reserve Bank of Chicago.
  4. Pierpaolo Benigno, 2009. "Price Stability with Imperfect Financial Integration," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 41(s1), pages 121-149, 02.
  5. Eric M. Leeper & Tao Zha, 1999. "Modest policy interventions," Working Paper, Federal Reserve Bank of Atlanta 99-22, Federal Reserve Bank of Atlanta.
  6. Adolfson, Malin & Laséen, Stefan & Lindé, Jesper & Villani, Mattias, 2005. "Bayesian Estimation of an Open Economy DSGE Model with Incomplete Pass-Through," Working Paper Series, Sveriges Riksbank (Central Bank of Sweden) 179, Sveriges Riksbank (Central Bank of Sweden).
  7. Andrew Levin & Christopher J. Erceg & Dale W. Henderson, 1999. "Optimal Monetary Policy with Staggered Wage and Price Contracts," Computing in Economics and Finance 1999, Society for Computational Economics 1151, Society for Computational Economics.
  8. Seppo Honkapohja & Kaushik Mitra, 2004. " Performance of Inflation Targeting Based on Constant Interest Rate Projections," CDMA Conference Paper Series, Centre for Dynamic Macroeconomic Analysis 0406, Centre for Dynamic Macroeconomic Analysis.
  9. Leitemo, Kai, 2003. " Targeting Inflation by Constant-Interest-Rate Forecasts," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 35(4), pages 609-26, August.
  10. Fagan, Gabriel & Henry, Jérôme & Mestre, Ricardo, 2001. "An area-wide model (AWM) for the euro area," Working Paper Series, European Central Bank 0042, European Central Bank.
  11. Smets, Frank & Wouters, Raf, 2002. "An estimated stochastic dynamic general equilibrium model of the euro area," Working Paper Series, European Central Bank 0171, European Central Bank.
  12. Frank Smets & Raf Wouters, 2002. "Openness, imperfect exchange rate pass-through and monetary policy," Working Paper Research, National Bank of Belgium 19, National Bank of Belgium.
  13. Anderson, Gary & Moore, George, 1985. "A linear algebraic procedure for solving linear perfect foresight models," Economics Letters, Elsevier, Elsevier, vol. 17(3), pages 247-252.
  14. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 1(1), pages 19-46, January.
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Cited by:
  1. Troy Davig & Eric M. Leeper, 2005. "Generalizing the Taylor principle," Research Working Paper, Federal Reserve Bank of Kansas City RWP 05-13, Federal Reserve Bank of Kansas City.
  2. Kamal, Mona, 2011. "Bayesian Estimation of Dynamic Stochastic General Equilibrium Model Using UK Data," MPRA Paper 28988, University Library of Munich, Germany.
  3. Jaromír Beneš & Andrew Binning & Kirdan Lees, 2008. "Incorporating judgement with DSGE models," Reserve Bank of New Zealand Discussion Paper Series DP2008/10, Reserve Bank of New Zealand.

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