[PPT] - Lawrence Christiano Objective Boom-bust Cycles and Estimate a PowerPoint Presentation

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Boom-bust Cycles and Monetary Policy

Lawrence Christiano

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Boom-bust Cycles and Monetary Policy

It has often been argued that there is

It has often been argued that there is advanced information about technology shocks shocks.

– Beaudry-Portier, Michelle Alexopoulos, Jaimovic-Rebelo Christiano-Ilut-Motto- Jaimovic Rebelo, Christiano Ilut Motto Rostagno

In the presence of such advance

In the presence of such advance information, standard monetary policy can create an inefficient boom followed by a create an inefficient boom, followed by a bust.

Objective

E ti t d l i hi h t h l h k

Estimate a model in which technology shocks

are partially anticipated

‘Normal’ technology shock: – Normal technology shock: – Shock considered here (J Davis):

at aat1 t

Shock considered here (J Davis):

‘recent information’

1 2 3 4

‘earlier information’

5 6 7 8 at aat1 t t1

1

t2

2

t3

3

t4

4

t5

5

t6

6

t7

7

t8

8

Evaluate importance of for business cycles

ti

i

Explore implications of for monetary policy.

ti

i

Outline

Estimation

– Results esu s – ‘Excessive optimism’ and 2000 recession

Implications for monetary policy
Implications for monetary policy

– Monetary policy causes economy to over- react to signals inadvertently creates ‘boom react to signals....inadvertently creates boom- bust’

Model

Features (version of CEE)

– Habit persistence in preferences Investment adjustment costs in change of – Investment adjustment costs in change of investment – Variable capital utilization – Calvo sticky (EHL) wages and prices Calvo sticky (EHL) wages and prices

Non-optimizers:

Pit Pi,t1, Wj,t zWj,t1

Probability of not adjusting prices/wages: p, w

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Observables and Shocks

Six observables:

– output growth, i fl ti – inflation, – hours worked, i t t th – investment growth, – consumption growth, – T-bill rate.

Sample Period: 1984Q1 to 2007Q1

Et

j l0

1

1.031/4

l preference shock

c,tl

logCtl bCtl1 L ltl,j

2

l0

K 1 0 02K 1 S

marginal (in-) efficiency of investment

It

I Kt1 1 0.02Kt 1 S I,t It It1 It Yt

1

Yjt

1 f,t dj markup shock

f,t

, Yj,t zt exp

technology shock

at

Lj,t

1

utKj,t, zt expzt R R

1

1

a yt log Rt R log Rt1 R 1 1 R a log t1

ay

4 log yt y t

M

Shock representations

markup markup log f,t f f log f,t1 f f,t discount rate logc,t c logc,t1 c,t efficiency of investment logI t logI t 1 t logI,t I logI,t1 I,t technology at aat1

iid

t
iid
t1

1

iid
t2

2

iid
t3

3

iid
t4

4

iid
t5

5

iid
t6

6

iid
t7

7

iid
t8

8

monetary policy t

M Mt1 M u,t.

Variance Decomposition, Technology Shocks variable t i1

8 ti i

t t i1

4 ti i

i5

8 ti i

consumption growth 46.6 7.0 24.1 22.5 investment growth 16.1 2.3 8.2 7.9

utput growth

45.4 6.2 23.1 22.3 log hours 45.3 5.5 20.0 25.3 inflation 49.0 7.0 23.8 25.2 interest rate 52.1 7.1 24.9 27.2

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Estimated technology shock process:

Estimated technology shock process:

log, technology shock

at

aat1

‘recent information’

t t1

1

t2

2

t3

3

t4

4

‘earlier information’

t5

5

t6

6

t7

7

t8

8

Centered 5-quarter moving average of shocks Signals 5-8 quarters in past past NBER trough Current shock plus most recent Four quarters’ signals NBER peak

Implications for Monetary Policy p y y

Estimated monetary policy rule induces over-

reaction to signal shock g

Problem:

– positive signal induces expectation that consumption will be high in the future – Ramsey-efficient (‘natural’) real rate of interest jumps – Under Taylor rule, real rate not allowed to jump, so monetary policy is expansionary

Intuition easy to see in Clarida-Gali-Gertler model

The standard New-Keynesian Model

at at1 t tp at log, technology

p

rrt

rr 1 at t1p (natural (Ramsey) rate)

rrt rr 1 at t1p (natural (Ramsey) rate) E

1 x

(Calvo pricing equation) t Ett1 xt t (Calvo pricing equation)

E
E

(i t t l ti ) xt rt Ett1 rrt

Etxt1 (intertemporal equation)

rt Ett1 xxt (policy rule)

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Response to signal that technology will expand 1% in period 1 Equilibrium Ramsey Equilibrium Ramsey Period Period Case Where Signal is False 1 2 3 0 1 2 3 4t

1

0 0 l A 0 0 logAt 0 0 loght 0.7 0 0 logyt 0.7 0 0 gy Case Where Signal is True 1 2 3 0 1 2 3

0.95, 1.5, x 0.5, 0.82

4t

1

0 0 logAt 1 .95 .9025 0 1 .95 .9025 loght 0 7 -0 04 -0 04 -0 04 0 0 loght 0.7 0.04 0.04 0.04 0 0 logyt 0.7 1.0 0.9 0.9 0 1 .95 .9025

Let’s see how a signal that turns out to be

Let s see how a signal that turns out to be false works in the full, estimated model.

The following slide corrects the hours

The following slide corrects the hours worked response in the previous slides, which was graphed incorrectly which was graphed incorrectly.

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Why is the Boom-Bust So Big? y g

Most of boom-bust reflects suboptimality

p y

f monetary policy.
What’s the problem?

–Monetary policy ought to respond to the natural (Ramsey) rate of interest natural (Ramsey) rate of interest. Relatively sticky wages and inflation –Relatively sticky wages and inflation targeting exacerbate the problem

Policy solution

Modify the Taylor rule to include:

– Natural rate of interest (probably not feasible) – Credit growth Credit growth – Stock market – Wage inflation instead of price inflation. g p

Explored consequences of adding credit

p q g growth and/or stock market by adding Bernanke-Gertler-Gilchrist financial frictions.

Conclusion

Estimated a model in which agents receive advance

Estimated a model in which agents receive advance information about technology shocks.

Advance information seems to play an important role in

b i l d i p y p business cycle dynamics

– Important in variance decompositions – Boom-bust of late 1990s seems to correspond to a period in which there was a lot of initial optimism about technology, which later came to be seen as excessive

Monetary policy appears to be overly expansionary in

response to signal shocks

– Ramsey-efficient allocations require sharp rise in rate of interest, which `standard monetary policy does not deliver’. – Problem is most severe when wages are sticky relative to prices.