Anton Nakov

Optimal and Simple Monetary Policy Rules with Zero Floor on the Nominal Interest Rate

Recent treatments of the issue of a zero floor on nominal interest rates have been subject to some important methodological limitations. These include the assumption of perfect foresight or the introduction of the zero lower bound as an initial condition or a constraint on the variance of the interest rate, rather than an occasionally binding non-negativity constraint. This paper addresses these issues offering a global solution to a standard dynamic stochastic sticky price model with an explicit occasionally binding non-negativity constraint on the nominal interest rate. It turns out that the dynamics and sometimes the unconditional means of the nominal rate, inflation and the output gap are strongly affected by uncertainty in the presence of the zero lower bound. Commitment to the optimal rule reduces unconditional welfare losses to around one-tenth of those achievable under discretionary policy, while constant price level targeting delivers losses which are only 60% larger than under the optimal rule. Even though the unconditional performance of simple instrument rules is almost unaffected by the presence of the zero lower bound, conditional on a strong deflationary shock simple instrument rules perform substantially worse than the optimal policy.

Distributional dynamics under smoothly state-dependent pricing

Starting from the assumption that firms are more likely to adjust their prices when doing so is more valuable, this paper analyzes monetary policy shocks in a DSGE model with firm-level heterogeneity. The model is calibrated to retail price microdata, and inflation responses are decomposed into “intensive”, “extensive”, and “selection” margins. Money growth and Taylor rule shocks both have nontrivial real effects, because the low state dependence implied by the data rules out the strong selection effect associated with fixed menu costs. The response to sector-specific shocks is gradual, but inappropriate econometrics might make it appear immediate.

Inflation-Output Gap Trade-Off With a Dominant Oil Supplier

An exogenous oil price shock raises inflation and contracts output, similar to a negative productivity shock. In the standard New Keynesian model, however, this does not generate any trade-off between inflation and output gap volatility: under a strict inflation-targeting policy, the output decline is exactly equal to the efficient output contraction in response to the shock. Modeling the oil sector from optimizing first principles rather than assuming an exogenous oil price, we show that the presence of a dominant oil supplier (OPEC) leads to inefficient fluctuations in the oil price markup. The latter reflects a dynamic distortion of the production process, and as a result, stabilizing inflation does not automatically stabilize the distance of output from first-best. Our model is a step away from discussing the effects of exogenous oil price changes and toward analyzing the implications of the underlying shocks that cause the oil price to change in the first place.

Optimal Monetary Policy with State-Dependent Pricing

Estudiamos la politica monetaria optima desde una perspectiva atemporal en un modelo general de fijacion de precios dependiente del estado (state-dependent pricing). Las empresas tienen poder monopolistico y estan sujetas a perturbaciones idiosincraticas a sus costes de menu. Encontramos que, bajo preferencias iso-elasticas y en ausencia de gasto publico, la estabilidad estricta de precios es optima tanto en el largo plazo como en respuesta a perturbaciones agregadas. La clave de este resultado es una propiedad «envolvente»: con inflacion cero, un incremento marginal en la tasa de inflacion no tiene ningun efecto sobre el beneficio de las empresas y por tanto tampoco sobre la frecuencia de ajuste de los precios. Ofrecemos una solucion analitica que no requiere de aproximaciones locales ni de la eficiencia del estado estacionario.

Learning from experience in the stock market

New evidence suggests that individuals “learn from experience,” meaning they learn from events occurring during their lives as opposed to the entire history of events. Moreover, they weigh more heavily recent events compared to events occurring in the distant past. This paper analyzes the implications of such learning for stock pricing in a model with finitely lived agents. Individuals learn about the rate of change of the stock price and of dividends using a weighted decreasing-gain algorithm. As a result of waves of optimism and pessimism, the stock price exhibits stochastic fluctuations around the rational expectations equilibrium. Conditional on the historical path of dividends, the model produces a price–dividend ratio which is in line with the evidence for the last century, except for the “dot-com” bubble in the 1990s.

A general equilibrium model of the oil market

We present a general equilibrium model of the global oil market, in which the oil price, oil production, and consumption, are jointly determined as outcomes of the optimizing decisions of oil importers and oil exporters. On the supply side the oil market is modelled as a dominant firm – Saudi Aramco – with competitive fringe. We establish that a dominant firm may exist as long as it enjoys a cost advantage over the fringe. We provide an expression for the optimal markup and compute the spare capacity maintained by such a firm. The model produces plausible dynamics in response to oil supply and oil demand shocks. In particular, it reproduces successfully the jump in oil output of Saudi Aramco following the output collapse of Iraq and Kuwait during the first Gulf War, explaining it as the profit-maximizing response of the dominant firm. Oil taxes and subsidies affect the oil price and welfare through their effect on the trade-off between oil production efficiency and oil market competition.

Precautionary price stickiness

This paper proposes a model in which retail prices are sticky even though firms can always change their prices at zero cost. Instead of imposing a “menu cost”, we assume that more precise decisions are more costly. In equilibrium, firms optimally make some errors in price-setting, thus economizing on managerial time. Both the time cost of choice, and the resulting risk of errors, give firms an incentive to leave their prices unchanged until they perceive a sufficiently costly deviation from the optimal price. We show that this error-prone “control cost” framework helps explain many puzzling observations from microdata. However, on the macroeconomic side, pricing errors do little to explain the real effects of monetary shocks.

Communication of Monetary Policy in Unconventional Times

Monetary policy communication is particularly important during unconventional times because high uncertainty about the economy, the introduction of new policy tools and possible limits to the central bank’s toolkit could hamper the predictability of policy actions. We study how monetary policy communication should and has worked under such circumstances. Our main results relate to announcements of asset purchase programmes and the use of forward guidance. We show that announcements of asset purchase programmes have lowered market uncertainty, particularly when accompanied by a contextual release of implementation details such as the envisaged size of the programme. We also show that forward guidance reduces uncertainty more effectively when it is state‐contingent or when it provides guidance about a long horizon than when it is open‐ended or covers only a short horizon, and that the credibility of forward guidance is strengthened if the central bank also has embarked on an asset purchase programme. JEL Classification: E43, E52, E58

Oilgopoly: A General Equilibrium Model of the Oil-Macroeconomy Nexus

Saudi Arabia Is The Largest Player In The World Oil Market. It Maintains Ample Spare Capacity, Restricts Investment In Developing Reserves, And Its Output Is Negatively Correlated With Other Opec Producers. While This Behavior Does Not F T Into The Perfect Competition Paradigm, We Show That It Can Be Rationalized As That Of A Dominant Producer With Competitive Fringe. We Build A Quantitative General Equilibrium Model Along These Lines Which Is Capable Of Matching The Historical Volatility Of The Oil Price, Competitive And Non-Competitive Oil Output, And Of Generating The Observed Comovement Among The Oil Price, Oil Quantities, And U.S. Gdp. We Use Our Framework To Answer Questions On Which Available Models Are Silent: (1) What Are The Proximate Determinants Of The Oil Price And How Do They Vary Over The Cycle? (2) How Large Are Oil Prof Ts And What Losses Do They Imply For Oil-Importers? (3) What Do Different Fundamental Shocks Imply For The Comovement Of Oil Prices And Gdp? (4) What Are The General Equilibrium Effects Of Taxes On Oil Consumption Or Oil Production? We F Nd, In Particular, That The Existence Of An Oil Production Distortion Does Not Necessarily Justify An Oil Consumption Tax Different From Zero.

Logit Price Dynamics

We model retail price stickiness as the result of costly, error‐prone decision making. Under our assumed cost function for the precision of choice, the timing of price adjustments and the prices firms set are both logit random variables. Errors in the prices firms set help explain micro facts related to the size of price changes, the behavior of adjustment hazards, and the variability of prices and costs. Errors in adjustment timing increase the real effects of monetary shocks, by reducing the “selection effect.” Allowing for both types of errors also helps explain how trend inflation affects price adjustment.