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Systematic monetary policy and persistence

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  • Luca Bindelli
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    Abstract

    Woodford (1999 and 2003) has raised the theoretical possibility that in a standard, forward looking sticky price model, an independent channel of inertia might arise as a result of policy behavior. We analyze this assertion empirically, and estimate a standard model, in which the monetary authority is assumed to commit to an optimal rule. We contribute to the existing literature by identifying the purely policy induced persistence present in the model. We also analyze the role of the structural parameters reflecting policy preferences and price flexibility in altering the policy induced, as well as the overall persistence properties of the model. We find that such a model is able to replicate most of the data's moments. In constrast to previous empirical literature, lagged terms in both modelled Phillips and IS curves are found to be either insignificant or very small. Commitment policy alone can explain a substantial part of output persistence. While the pricing mechanism at the heart of this model helps transfer output persistence into inflation persistence, commitment policy manages to undo this link by undershooting the inflation target following a positive 'cost push' shock so that inflation persistence is slightly reduced compared to the discretionary policy case.

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    Bibliographic Info

    Paper provided by Université de Lausanne, Faculté des HEC, DEEP in its series Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) with number 05.07.

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    Length: 49 pages
    Date of creation: May 2005
    Date of revision:
    Handle: RePEc:lau:crdeep:05.07

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    Postal: Université de Lausanne, Faculté des HEC, DEEP, Internef, CH-1015 Lausanne
    Phone: ++41 21 692.33.64
    Fax: ++41 21 692.33.05
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    Web page: http://www.hec.unil.ch/deep/publications/cahiers/series
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    Keywords: persistence; optimal monetary policy; supply shock; Kalman filter;

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    References

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    1. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," NBER Working Papers 7147, National Bureau of Economic Research, Inc.
    2. Christopher J. Erceg and Andrew T. Levin, 2001. "Imperfect Credibility and Inflation Persistence," Computing in Economics and Finance 2001 19, Society for Computational Economics.
    3. Steinsson, Jon, 2003. "Optimal monetary policy in an economy with inflation persistence," Journal of Monetary Economics, Elsevier, vol. 50(7), pages 1425-1456, October.
    4. Bennett T. McCallum & Edward Nelson, 2004. "Timeless perspective vs. discretionary monetary policy in forward-looking models," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 43-56.
    5. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
    6. Peter N. Ireland, 2002. "Technology Shocks in the New Keynesian Model," Boston College Working Papers in Economics 536, Boston College Department of Economics.
    7. Ehrmann, Michael & Smets, Frank, 2003. "Uncertain potential output: implications for monetary policy," Journal of Economic Dynamics and Control, Elsevier, vol. 27(9), pages 1611-1638, July.
    8. Michael Woodford, 1999. "Optimal Monetary Policy Inertia," NBER Working Papers 7261, National Bureau of Economic Research, Inc.
    9. Woodford, Michael, 1999. "Optimal monetary policy inertia," CFS Working Paper Series 1999/09, Center for Financial Studies (CFS).
    10. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 345-370, April.
    11. Jeff Fuhrer & George Moore, 1993. "Inflation persistence," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
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    13. Sbordone, Argia M., 2002. "Prices and unit labor costs: a new test of price stickiness," Journal of Monetary Economics, Elsevier, vol. 49(2), pages 265-292, March.
    14. Robert D. Dittmar & William T. Gavin & Finn E. Kydland, 2005. "Inflation Persistence And Flexible Prices," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(1), pages 245-261, 02.
    15. Bennett T. McCallum, 1999. "Analysis of the Monetary Transmission Mechanism: Methodological Issues," NBER Working Papers 7395, National Bureau of Economic Research, Inc.
    16. Tommy Sveen & Lutz Weinke, 2004. "Pitfalls in the modeling of forward-looking price setting and investment decisions," Economics Working Papers 773, Department of Economics and Business, Universitat Pompeu Fabra.
    17. Howard J. Wall & Gylfi Zoega, 2003. "U. S. regional business cycles and the natural rate of unemployment," Working Papers 2003-030, Federal Reserve Bank of St. Louis.
    18. Michael Dotsey, 1999. "The importance of systematic monetary policy for economic activity," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 41-60.
    19. Michael Dotsey, 2002. "Pitfalls in interpreting tests of backward-looking pricing in New Keynesian models," Economic Quarterly, Federal Reserve Bank of Richmond, issue Win, pages 37-50.
    20. Mark Bils & Peter J. Klenow & Oleksiy Kryvtsov, 2003. "Sticky prices and monetary policy shocks," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 2-9.
    21. Luca Bindelli, 2005. "Testing the New Keynesian Phillips curve: a frequency domain approach," Money Macro and Finance (MMF) Research Group Conference 2005 69, Money Macro and Finance Research Group.
    22. Söderström, Ulf & Söderlind, Paul & Vredin, Anders, 2002. "New-Keynesian Models and Monetary Policy: A Reexamination of the Stylized Facts," Working Paper Series in Economics and Finance 511, Stockholm School of Economics, revised 15 Aug 2003.
    23. Söderlind, Paul, 1998. "Solution and Estimation of RE Macromodels with Optimal Policy," Working Paper Series in Economics and Finance 256, Stockholm School of Economics.
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