L ECTURE 10 Monetary Policy at the Zero Lower Bound: Expectations - - PowerPoint PPT Presentation

LECTURE 10

Monetary Policy at the Zero Lower Bound: Expectations Effects October 26, 2016

Economics 210c/236a Christina Romer Fall 2016 David Romer

• I. OVERVIEW

Cases of Countries Hitting the Zero Lower Bound

• US and UK in the 1930s.
• Japan starting in the late 1990s.
• US, Europe, and Japan starting in 2008.

Papers for Today

• Temin and Wigmore (U.S. in the 1930s)
• With a brief discussion of Eggertsson and

Pugsley

• Wieland (Japan, mainly in the 1990s and 2000s)
• Hausman and Weiland (Japan after 2012)

How can monetary policy matter at the zero lower bound?

• Expectations effects.
• Expectations of prices, growth, future interest

rates.

• Quantitative easing and portfolio balance effects.
• Others?
• Special case of the exchange rate.

• II. TEMIN AND WIGMORE, “THE END OF ONE BIG

DEFLATION”

From: Romer, “What Ended the Great Depression?”

Nominal Interest Rate (3-6 mo. Treasury Notes)

1 2 3 4 5 6 Jan-29 Jul-29 Jan-30 Jul-30 Jan-31 Jul-31 Jan-32 Jul-32 Jan-33 Jul-33 Jan-34 Jul-34 Jan-35 Jul-35 Percent

Industrial Production

1929-01 1929-06 1929-11 1930-04 1930-09 1931-02 1931-07 1931-12 1932-05 1932-10 1933-03 1933-08 1934-01 1934-06 1934-11 1935-04 1935-09 1936-02 1936-07 1936-12 1937-05 1937-10

1 1.2 1.4 1.6 1.8 2 2.2 2.4 Industrial Production (Logarithms)

What is a regime shift?

• A dramatic change in the policy framework.
• Leads agents to expect long-lasting changes in policy.

Roosevelt’s Regime Shift

• Hoover was committed to the gold standard,

monetary inaction, and fiscal orthodoxy.

• Roosevelt devalued in April 1933. Temin and

Wigmore believe devaluation was the key sign of the regime shift.

• Followed up with fiscal and monetary expansion.

Roosevelt’s Communications Policy

• Second Fireside Chat, May 7, 1933:

“The Administration has the definite objective of raising commodity prices to such an extent that those who have borrowed money will, on the average, be able to repay that money in the same kind of dollar which they borrowed. … That is why powers are being given to the Administration to provide, if necessary, for an enlargement of credit …”

Inflation Video

DepressionVideo.mp4

Stock Prices

1.5 6.5 11.5 16.5 21.5 26.5 31.5 36.5 Jan-27 Aug-27 Mar-28 Oct-28 May-29 Dec-29 Jul-30 Feb-31 Sep-31 Apr-32 Nov-32 Jun-33 Jan-34 Aug-34 Mar-35 Oct-35 May-36 Dec-36 Monthly S&P Stock Price Index

Producer Price Index, All Commodities

2.3 2.4 2.5 2.6 2.7 2.8 2.9 Jan-29 Aug-29 Mar-30 Oct-30 May-31 Dec-31 Jul-32 Feb-33 Sep-33 Apr-34 Nov-34 Jun-35 Jan-36 Aug-36 Mar-37 Oct-37 Producer Price Index, Logarithms

Expected Inflation as Measured Using Commodity Futures Prices

• 12.00
• 9.00
• 6.00
• 3.00

0.00 3.00 6.00 9.00 1928:1 1929:1 1930:1 1931:1 1932:1 1933:1 1934:1 1935:1 1936:1 1937:1 Percent

From: Hamilton, “Was the Deflation During the Great Depression Anticipated?”

• Fig. 3. Daily Average Frequency Over the Month of the Terms “Inflation” and “Deflation”

Note: The figure displays the daily average frequency over the month of the following terms: “inflation” or “inflationary” and “deflation” or “deflationary.” For each term, one series considers only the article's title while the other series considers the entire

• article. The figure presents the aggregate results across five national daily news sources: the New York Times, the Wall Street Journal,

the Los Angeles Times, the Chicago Tribune, and the Washington Post. These newspapers are available electronically via ProQuest.

From: Jalil and Rua, “Inflation Expectations and Recovery in Spring 1933”

Devaluation in April 1933

Price of Cotton ($) Exchange Rate ($ / ₤)

Price of Cotton, in cents Exchange Rate

From: Temin and Wigmore, “The End of One Big Deflation”

Truck Production, 1927-1936

10 20 30 40 50 60 70 80 90 100 Jan-27 Jul-27 Jan-28 Jul-28 Jan-29 Jul-29 Jan-30 Jul-30 Jan-31 Jul-31 Jan-32 Jul-32 Jan-33 Jul-33 Jan-34 Jul-34 Jan-35 Jul-35 Jan-36 Jul-36 Thousands of Trucks

From: FRED, Federal Reserve Bank of St. Louis

Temin and Wigmore’s Auto Sales Regression

From: Temin and Wigmore, “The End of One Big Deflation”

Steel Production and Industrial Production

Consumption Investment

Industrial Production Steel

Index, 1935-39=100

From: Temin and Wigmore, “The End of One Big Deflation”

Investment and Consumption Spending, 1932-33

Nondurables Consumption Investment

From: Temin and Wigmore, “The End of One Big Deflation”

Evaluation

• III. EGGERTSSON AND PUGSLEY, “THE MISTAKE OF 1937”

How Eggertsson and Pugsley Fit Into the Lecture

• Temin and Wigmore say a switch to an inflationary

regime can be helpful at the ZLB

• Use April 1933 as an example.
• Eggertsson and Pugsley say a change in expectations
• f future policy away from reflation and expansion

can be very damaging at the ZLB.

• Use 1937–38 recession as an example.

Industrial Production, 1926–1941

Alternative Explanations for the 1937–38 Recession

• Increase in reserve requirements (Friedman and

Schwartz, Calomiris, Mason, and Wheelock)

• Sterilization of gold inflows (Irwin)
• Fiscal contraction
• Supply shocks (Hausman)

Eggertsson and Pugsley’s Explanation

• Policymakers started expressing concern about

inflation and deficits.

• Caused a negative change in expectations of future

policy.

• This had contractionary effects on real activity.

Eggertsson and Pugsley’s Model

• DSGE model with binding zero lower bound due to

real shocks.

• Calibrate model and find that inflation and output

are extremely sensitive to changes in beliefs about future policy at ZLB. (Sensitivity is asymmetric.)

• Source of sensitivity is “contractionary spiral”—

change in expectations in one instance affects expectations in other situations, and those expectations feed on each other (vicious feedback loop).

Eggertsson and Pugsley’s Evidence

• Narrative evidence from statements and actions.
• Behavior of commodity prices.
• Behavior of long-rates relative to short rates.
• The behavior of the economy when statements and

actions changed back.

From: Eggertsson and Pugsley, “The Mistake of 1937”

From: Eggertsson and Pugsley, “The Mistake of 1937”

From: Eggertsson and Pugsley, “The Mistake of 1937”

From: Eggertsson and Pugsley, “The Mistake of 1937”

Evaluation

• IV. JOHANNES WIELAND, “ARE NEGATIVE SUPPLY

SHOCKS EXPANSIONARY AT THE ZERO LOWER BOUND?”

Motivation

• Standard models have counterintuitive implications

at the zero lower bound (various “paradoxes”).

• A central implication of this type: An adverse supply

shock, by raising expected inflation and so lowering the real interest rate, is expansionary at the zero lower bound.

• Wieland wants to test this prediction and investigate

the implications of the results.

Key Questions

• Empirical: Are specific supply shocks (the Great

Japan Earthquake, falls in oil supply) expansionary at the zero lower bound.

• Theoretical: If the answer is no, how broad are the

implications? (For example, does it have implications for the fiscal multiplier at the zero lower bound? For measures to raise expected inflation through expectations of future monetary policy?)

Test 1: The Japanese Great Earthquake of March 2011

From: Wieland, “Are Negative Supply Shocks Expansionary at the Zero Lower Bound?”

What Do We Learn from:

• The behavior of forecasts?
• The fact that the Bank of Japan loosened monetary

policy?

• The actual behavior of output and inflation?

Test #2: Adverse Oil Supply Shocks

• 1. Addressing the complications coming from the

fact that oil is both consumed directly and used as an input into production.

• 2. Identifying oil supply shocks.
• 3. Are they temporary?
• 4. Results.

Step 1: Oil in Production and Consumption

Step 2: Identifying Oil Supply Shocks

• A VAR with a timing assumption: “I assume

that oil production responds to other structural shocks (e.g., demand shocks) with at least a one-month delay.”

Step 3: Are the Oil Price Changes Temporary?

An Aside on Unit Root Tests

• Figure 3b addresses the relevant question

here.

• The unit root tests do not.

A Preliminary Result: Checking the Conditions

• f Proposition 6

From: Wieland, “Are Negative Supply Shocks Expansionary at the Zero Lower Bound?”

Step 4: Results

From: Wieland, “Are Negative Supply Shocks Expansionary at the Zero Lower Bound?”

Step 4: Results

From: Wieland, “Are Negative Supply Shocks Expansionary at the Zero Lower Bound?”

Discussion

Interpretation

• Is he presenting evidence against a narrow or a broad

class of models?

• Hard to know!
• Example: Fiscal policy.
• Wieland argues that his evidence “suggests that

the inflation expectations channel is unlikely to be a source of large fiscal multipliers” at the zero lower bound.

• But this doesn’t rule out large fiscal multipliers at

the zero lower bound through a traditional Keynesian multiplier.

Wieland’s Alternative: A Model Where Credit Constraints Are Central

• V. HAUSMAN AND WEILAND, “OVERCOMING THE LOST

DECADES? ABENOMICS AFTER THREE YEARS”

Overview

Types of Evidence

• Financial markets.
• Macro aggregates (including comparisons with

forecasts).

• Digging into specific variables:
• Inflation (including the Phillips curve).
• Nominal wages.
• Consumption (including micro evidence).
• Imports.

Financial Market Variables

GDP Forecasts

GDP

Digging into Specific Variables

• Inflation (including the Phillips curve).
• Nominal wages.
• Consumption (including micro evidence).
• Imports.

Discussion