Working
Papers
Policy Rules and Forward Guidance Following the Covid-19 Recession
(with Ruxandra Prodan)
The Federal Open Market Committee’s revised Statement on Longer-Run Goals and Monetary Policy Strategy implements flexible average inflation targeting and mitigates shortfalls, rather than deviations, of employment from its maximum level. We first show how the Taylor, balanced approach, and balanced approach (shortfalls) rules in the Monetary Policy Report could be modified to be consistent with the revised statement. Federal funds rate prescriptions from the consistent rules are both closer to the liftoff from the effective lower bound in December 2015 and provide a closer fit to the actual federal funds rate than the rules currently included in the Report. We then compare prescriptions from the rules with the Committee’s forward guidance. While all of the rules prescribe liftoff from the effective lower bound before the Committee’s 2024:Q1 prescription, the prescribed liftoff with the balanced approach (consistent) rule is closest to the Committee’s. Finally, we consider longer-run scenarios. While the gap between the federal funds rate prescribed by the consistent rules and the Committee’s framework is about 2.5 percent in 2023:Q4, it is eliminated by 2026:Q2.
Estimating the Natural Rate of Interest in Real Time
(with Sergiy Kasyanenko)
We introduce a new data set of quarterly vintages of real-time estimates of the natural rate of interest and evaluate the reliability of these estimates for a range of empirical models commonly used in the literature. This data, going back to the early 1980s, enables a previously unexplored evaluation of policy rules with time-varying natural rates of interest estimated in real-time. In particular, we investigate how real-time estimates of the natural rate of interest are revised in subsequent quarters. We find that ex-post revisions of real-time estimates of the natural rate of interest are smaller than revisions of the output gap because revisions of different components of the natural rate of interest partly offset each other. These revisions, therefore, do not add substantially to real-time policy errors from monetary policy rules that use real-time estimates of the natural rate of interest.
Monetary Policy Rules in Practice: The Case of Israel
(with Sophia Kazinnik)
This paper presents a case study of how communication on monetary policy rules in Israel allows for discretionary deviations within a rule-like policy framework without impairment to central bank credibility. We quantitatively analyze a monetary policy rule that has described Bank of Israel policy formally since 2012 and informally since 2007. We demonstrate the value of a policy rule as a tool of communication and show how policymakers leverage this rule in times of economic uncertainty. We identify periods of discretionary deviation from the policy rule and show how communication on financial stability concerns derived from monthly interest rate announcements explains these deviations. Finally, we show how policymakers in Israel were able to anchor market expectations, even in times of great economic uncertainty. We assess how market expectations about the future path of the short-term interest rate respond both to communication related to the rule and exercised flexibility during the financial crisis. We use futures contracts on short term interest rates from the inter-bank market and find that monetary policy predictability improves in the period following the publication of this rule. We argue that policymakers in Israel were able to conduct monetary policy consistent with their main long-term objectives while maintain a high degree of transparency on assessments behind interest rate decisions.
(Hawks versus Doves) versus (Rules versus Discretion)
(with Klodiana Istrefi, Alex Nikolsko-Rzhevskyy, and Ruxandra Prodan)
The conduct of monetary policy is often characterized by either “hawks versus doves” or “rules versus discretion”. Calculating quadratic loss ratios, better economic performance occurs when members of the Federal Open Market Committee are more concerned about inflation than unemployment (hawkish) and/or the Fed closely follows a policy rule (rules-based). The results provide support for the hypotheses that economic performance is better in rules-based than in discretionary periods, hawkish than in dovish periods, and either strong hawkish or dovish periods than in weak hawkish or dovish periods.
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