Costas Milas

TESTING THE OPPORTUNISTIC APPROACH TO MONETARY POLICY

The opportunistic approach to monetary policy is an influential but untested model of optimal monetary policy. We provide the first tests of the model, using US data from 1983Q1 to 2004Q1. Our results support the opportunistic approach. We find that policy-makers respond to the gap between inflation and an intermediate target that reflects the recent history of inflation. We find that there is no response of interest rates to inflation when inflation is within 1 per cent of the intermediate target but a strong response when inflation is further from the intermediate target.

Time-varying excess returns on UK government bonds: A non-linear approach

Abstract This paper provides an empirical examination of the behaviour of excess returns on UK government discount bonds in terms of risk factors such as the forward premium, the slope of the term structure, dividend yields and excess stock returns. We identify the existence of a time-varying term structure of expected excess returns. Further, the dynamics of the expected returns are characterised by regime-switching behaviour where the transition from one regime to the other is controlled by the slope of the term structure of interest rates. The first regime, which is characterised by flat or downward sloping term structures, occurs during periods of economic recession. The second regime, which is characterised by upward sloping term structures, occurs during periods of economic expansion. The main risk factors explaining expected returns are the slope of the term structure in the recessionary regime and the excess stock returns in the expansionary regime.

Modelling the spot prices of various coffee types

Abstract We investigate long-run relationships among the spot prices of four coffee types. Two cointegrating vectors emerge: one between the prices of Arabica coffee varieties, and the other one between Unwashed Arabicas and Robusta. A persistence profile analysis shows a more rapid adjustment to equilibrium for the first compared to the second vector due to the fact that the former involves the Arabica coffees, which are more homogeneous. Adjustment is relatively fast, implying that economic forces act rapidly and discrepancies in the equilibrium relationships are short-lived. We also find evidence of non-linear adjustment back to equilibrium; when prices are too high, adjustment takes place at a slower rate than when they are too low.

Nonlinearities and the Sustainability of the Government's Intertemporal Budget Constraint

We analyze the sustainability of the governments intertemporal budget constraint and the corresponding fiscal reaction function within a nonlinear error‐correction framework. Our empirical analysis, based on Italy, provides some evidence that the Italian government is meeting its intertemporal budget constraint. Nevertheless, we show that the burden of correcting budgetary disequilibria is entirely carried out by changes in the average tax rate, with a weakly exogenous government spending, possibly determined by the political process. We also document some rigidities of the tax instrument, in terms of downward inflexibility of the average tax rate with respect to its long‐run level. Finally, we provide some evidence in favor of a nonlinear adjustment toward a sustainable long‐run equilibrium, as the average tax rate adjusts faster the further away it gets from the equilibrium. By considering the behavior of taxes across the economic cycle, we also provide some evidence of inflexibility of the tax instrument during bad times.

Financial conditions and nonlinearities in the European Central Bank (ECB) reaction function: In-sample and out-of-sample assessment

Our purpose is to investigate how the European Central Bank (ECB) sets interest rates in the context of both linear and nonlinear policy reaction functions. This work contributes to the current debate on central banks having additional objectives over and above control of inflation and output. Three findings emerge. First, the ECB takes financial conditions into account when setting interest rates. Second, amongst Taylor rule models, linear and nonlinear models are empirically indistinguishable within sample, and model specifications with real-time data provide the best description of in-sample ECB interest rate setting behaviour. Third, the 2007-2009 financial crisis witnessed a shift from inflation targeting to output stabilization, and a shift from an asymmetric policy response to financial conditions at high inflation rates to a more symmetric response regardless of the state of inflation. Finally, guidance is provided as regards models for forecasting interest rates in the Eurozone area. Without imposing an a priori choice of the parametric functional form, semiparametric models and autoregressive processes forecast the out-of-sample ECB interest rate setting behaviour better than linear and nonlinear Taylor rule models.

The Role of Omitted Variables in Identifying a Long-run Equilibrium Relationship for the Italian Government Growth

We discuss the role of omitted variables in the long run empirical modeling of the Italian government growth based on a Wagners Law framework. We identify a non-spurious long-run relationship between general government expenditure and domestic product only when our Wagners Law model is enhanced by a measure of bureaucratic power, as a supply-side variable, and by the ratio of local to state expenditure, as an institutional factor that captures the division of competencies between local and central government in allocating public expenditure. This result is independent from the Wagners Law specification chosen. The persistence profile analysis shows a slow adjustment to equilibrium for the estimated government growth relationship following system-wide shocks, pointing to rigidities and complex functioning of the public sector.

On the dynamics of lending and deposit interest rates in emerging markets:a non-linear approach

This paper studies the dynamics of lending and deposit rates in two emerging markets in Latin America: Colombia and Mexico. The dynamics of lending (deposit) interest rates are driven by the exogenous interbank interest rate and deviations from the long-run lending-interbank (deposit-interbank) interest rate relationship. Allowing for different interest rate behavior during periods characterized by large and small values of the spread, the non-linear specification proves superior to the linear one.

UNCERTAINTY AND MONETARY POLICY RULES IN THE UNITED STATES

This paper analyses the impact of uncertainty on monetary policy rules in the US since the early 1980s. Extending the Taylor rule to allow the response of interest rates to inflation and the output gap to depend on uncertainty, we find evidence that the predictions of the theoretical literature on responses to uncertainty are reflected in the behaviour of policymakers, suggesting that policymakers are adhering to prescriptions for optimal policy.

Smooth transition vector error correction models for the spot prices of coffee

The nonlinear behaviour of four coffee price series is examined, that is, unwashed Arabicas (i.e. coffee from Brazil), Colombian Mild Arabicas (i.e. coffee from Colombia), other Mild Arabicas (i.e. coffee from other Latin American countries), and Robusta coffee (i.e. coffee from Africa and Southeast Asia). First is identified the cointegrating relationships and then that these enter the error correction equations in a nonlinear way is shown. The estimates suggest a rather common pattern of nonlinear adjustment for the same variety Arabica coffees.

A Multivariate Approach to the Growth of Governments

The Italian general government expenditure is empirically modeled by considering demand-side, supply-side, and institutional factors. The authors estimate a long-run relationship with government expenditure driven by the demand-side and supply-side effects of domestic income and bureaucratic power, respectively, as well as by an institutional factor, namely, the decentralization of public expenditure. The disequilibrium error positively affects income growth and local spending, implying that when government expenditure is above its equilibrium level, both economic growth and local governments benefit. However, tighter government spending within the European Monetary Union environment suggests that local governments will have to become more efficient to find additional resources for their financing.