Dynamic Expectations Formation and U.S. Monetary Policy Regime Change

INFLATION EXPECTATIONS AND MONETARY POLICY DESIGN: EVIDENCE FROM THE LABORATORY

Macroeconomic Dynamics ◽

10.1017/s1365100516000560 ◽

2016 ◽

Vol 22 (4) ◽

pp. 1035-1075 ◽

Cited By ~ 20

Author(s):

Damjan Pfajfar ◽

Blaž Žakelj

Keyword(s):

Monetary Policy ◽

Laboratory Experiments ◽

Policy Design ◽

New Keynesian ◽

Inflation Expectations ◽

Central Question ◽

Policy Regime ◽

Expectations Formation ◽

Reaction Coefficient ◽

Inflation Variability

Using laboratory experiments within a New Keynesian framework, we explore the interaction between the formation of inflation expectations and monetary policy design. The central question in this paper is how to design monetary policy when expectations formation is not perfectly rational. Instrumental rules that use actual rather than forecasted inflation produce lower inflation variability and reduce expectational cycles. A forward-looking Taylor rule where a reaction coefficient equals 4 produces lower inflation variability than rules with reaction coefficients of 1.5 and 1.35. Inflation variability produced with the latter two rules is not significantly different. Moreover, the forecasting rules chosen by subjects appear to vary systematically with the policy regime, with destabilizing mechanisms chosen more often when inflation control is weaker.

Download Full-text

Absence of price pressures checks central bank hawks

Emerald Expert Briefings ◽

10.1108/oxan-db222067 ◽

2017 ◽

Keyword(s):

Monetary Policy ◽

Regime Change ◽

Emerging Market ◽

Balance Sheet ◽

Policy Regime ◽

Bank Of Canada ◽

Content Type ◽

Full Swing ◽

The Impact ◽

First Time

Subject The impact of persistently low inflation on the pace of monetary policy 'regime change' in most countries. Significance The US Federal Reserve (Fed) published the minutes of its June 14 interest rate-setting meeting on July 5, showing increasing divisions over the pace of tightening as inflation eases. The Fed remains committed to starting to shrink its 4.5-trillion-dollar balance sheet this year, but there are disagreements over the timing of both the unwinding and further rate hikes. Subdued inflation is also constraining the ECB’s plans to withdraw its monetary stimulus, despite speculation about a ‘regime change’ in monetary policy driving the yield on the benchmark 10-year Bund to its highest point since January 2016. Impacts The yield on 10-year US Treasuries has risen since June but remains below its mid-March level when ‘reflation trading’ was in full swing. Emerging market bond funds are vulnerable to tighter policy and suffered outflows for the first time this year in the week ending July 5. The average world oil price has fallen by more than 10% since May to below 50 dollars a barrel amid concerns of a supply glut. The Bank of Canada may raise rates for the first time in nearly seven years on July 12, while the Fed chair will testify before Congress.

Download Full-text