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To Fed Watch or Not to Fed Watch: Equilibrium Analysis of Bank System Dynamics

Author

Listed:
  • William A. Brock

    (Department of Economics, University of Wisconsin-Madison and Department of Economics, University of Missouri-Columbia)

  • Joseph H. Haslag

    () (Department of Economics, University of Missouri-Columbia
    University of Missouri-Columbia)

Abstract

We build a model economy in which Fed watching occurs. There is a huge number of blogs, financial letters, and news reporting that talks about what the Federal Reserve is likely to do. We model this behavior by allowing for banks to Fed watch, meaning that the bank will apply a costly forecasting technology to predict next period’s price level. Here, the banks accept deposits to insure against idiosyncratic liquidity shocks. Within this model economy, we characterize the price-level dynamics. Our findings have direct implications for the notion of banking crises though related precisely to the role of insurance, not output fluctuations. We derive conditions in which there are endogenous oscillations between price level spikes and price-level falls; in other words, the model economy generates boom-andbusts cycles as real balances fluctuate from high to low values. We extend the model economy to consider how heterogeneity exists with the set of central bankers as they could have heterogeneous forecasts of the next-period price level.

Suggested Citation

  • William A. Brock & Joseph H. Haslag, 2017. "To Fed Watch or Not to Fed Watch: Equilibrium Analysis of Bank System Dynamics," Working Papers 1712, Department of Economics, University of Missouri.
  • Handle: RePEc:umc:wpaper:1712
    as

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    File URL: https://economics.missouri.edu/sites/default/files/wp-files/fed_watching_rel_ver_aug_2017.pdf
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    References listed on IDEAS

    as
    1. Hall, Robert E, 1978. "Stochastic Implications of the Life Cycle-Permanent Income Hypothesis: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 971-987, December.
    2. Canzoneri, Matthew B, 1985. "Monetary Policy Games and the Role of Private Information," American Economic Review, American Economic Association, vol. 75(5), pages 1056-1070, December.
    3. Joseph H. Haslag & Antoine Martin, 2007. "Optimality of the Friedman Rule in an Overlapping Generations Model with Spatial Separation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(7), pages 1741-1758, October.
    4. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
    5. Hommes,Cars, 2015. "Behavioral Rationality and Heterogeneous Expectations in Complex Economic Systems," Cambridge Books, Cambridge University Press, number 9781107564978, October.
    6. Bruce Champ & Bruce D. Smith & Stephen D. Williamson, 1996. "Currency Elasticity and Banking Panics: Theory and Evidence," Canadian Journal of Economics, Canadian Economics Association, vol. 29(4), pages 828-864, November.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    random relocation; heterogeneous forecasts; banks; fed watching;

    JEL classification:

    • C62 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Existence and Stability Conditions of Equilibrium
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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