David Currie

Rational expectations models with partial information

Abstract This paper provides a general solution to the problem of partial information in linear discrete time stochastic rational expectations models. The full information case is first reviewed and the solution of Blanchard and Kahn [4] extended. Then we consider the problem of partial information for the special case where only the current values of some variables are unobserved. The solution can be treated as a straightforward extension to the full information case. In the general problem where in addition to some current variables being unobserved, certain variables are unobserved for all lags, we provide a solution which requires the use of Kalman filters. The paper concludes by examining the covariance properties of the rational expectations system under different informational assumptions.

The design of feedback rules in linear stochastic rational expectations models

Abstract This paper is concerned with optimal and sub-optimal feedback rules for linear stochastic continuous time models with rational expectations. We consider four types of feedback rules: (1) the optimal but time-inconsistent rule which is available if the controller is able to commit himself or herself; (2) quasi-optimal and time-inconsistent rules of the form w = Dy where w is the vector of instruments, y the state vector and D a matrix of constants possibly with constraints; (3) the optimal time-consistent rule which is also linear in y ; (4) ‘over-stable’ rules which have ‘too many’ stable roots. We show that rules of type (1) can be expressed and implemented as a form of integral control, all except type (2) satisfy certainty equivalence and that rules of type (4) will always be inferior to the optimal rule (1). These results are demonstrated in two illustrative examples.

Evaluating the Extended Target Zone Proposal for the G3

This paper evaluates the extended target zone proposal of Williamson and Miller using the National Institute world economic model (GEM). Williamson and Millers proposals envisage that real exchange rates will be controlled by movements in relative interest rates, that fiscal policy will be used to steer nominal demand towards a target which depends on capacity utilization, inflation and the current balance, and that the average level of world interest rates will be used to control global nominal demand. We evaluate the performance of these rules for the United States, Germany and Japan over the period 1975-84, using control methods to determine the best choice of parameters in the feedback rules. We then consider how history would have differed from actual events had such rules been in place. The results suggest that such rules would have led to a significant improvement in economic performance: exchange rate variability would have been reduced and the dramatic increase in United States interest rates which took place after 1980 would have been avoided.

Credibility and Time Inconsistency in a Stochastic World

This paper re-examines the issue of the credibility and sustainability of optimal policies derived from Pontryagins Maximum Principle and generally regarded as time-inconsistent, in models with forward-looking rational expectations. Specifically, it considers the behaviour of such models in the presence of continuing stochastic noise. This is shown to convert the policy problem from a one-shot dynamic policy game to a continuing game, giving governments an incentive to invest in a reputation for not reneging on the full optimal rule. This incentive may, in certain circumstances, render the full optimal rule credible and therefore sustainable. It is demonstrated that a sufficiently low degree of discounting on the part of government, or a sufficiently high variance of shocks (measured relative to the initial displacement) ensures the sustainability of the full optimal rule. Using a simple dynamic open economy model, these conditions are shown to be plausible unless the discount rate is very high.

Optimal feedback rules in an open economy macromodel with rational expectations

This paper outlines procedures for deriving optimal time-invariant linear feedback rules in continuous time linear stochastic models under rational expectations. It also examines the derivation of optimal simple rules of a similar type. These procedures are applied to an open economy model under rational expectations, and the consequences of uncertainty about stochastic disturbance structures for policy design are considered. The results indicate some preference for price level or nominal income rules rather than a monetary rule for the open economy.

European monetary union or hard EMS

This paper contributes to the debate engendered by the Delors Report on the issue of European Monetary Union. It focuses on the options of a strengthened (or hard-) EMS, with a commitment to a fixed exchange rate relative to the Deutschmark, or a European central bank with full monetary union (EMU). Under hard-EMS, an anti-inflationary reputation is acquired by all as a result of Bundesbank credibility. As regards EMU, it is possible that too rapid a move through the latter stages of the Delors process will produce a central bank with little or no anti-inflation credibility. Here we make starkest assumption of no credibility under EMU, and compare it with hard-EMS for various supply and demand shocks using a two-bloc model, the latter exhibiting short-run wage/price stickiness but with long run natural rate properties. A non-EMS regime with floating exchange rates is used to examine the incentive compatibility of hard-EMS and EMU, with a cooperative reputational regime acting as a benchmark.

Macroeconomic interactions between North and South

This volume contains the proceedings of a September 1987 conference organised by the Centre for Economic Policy Research and the International Economics Study Group. The contributors in this volume explore the North–South macroeconomic interactions. The volume will interest those involved in policy debates concerning international debt, the global consequences of macroeconomic policy choices in the North, commodity markets and the economic policies of the less developed countries. It will also form a valuable addition to undergraduate and postgraduate reading lists in trade, finance, international macroeconomics and the economics of developing countries.

An appraisal of alternative blueprints for international policy coordination

This paper examines two schemes for the international coordination of macroeconomic policy using a world econometric model, the National Institute Global Econometric Model. The first is the extended target zone scheme proposed by J. Williamson and M. Miller (1987), which involves targeting fundamental equilibrium exchange rates using monetary policy and using fiscal policy to control domestic demand. The second uses fiscal policy to target the current account and monetary policy to stabilize domestic demand. Both schemes are parameterized using optimal control techniques on the National Institute Global Econometric Model, and the welfare gains in using these schemes compared to historical experience from 1974 to 1986 are assessed.

Target zones and alternative proposals for G3 policy coordination: An empirical evaluation using GEM

Abstract The Extended Target Zone (ETZ) proposal for economic policy coordination is quantitatively assessed and compared with a number of alternative schemes that do not adopt explicit exchange rate targeting. The main finding of the paper is that if exchange rate volatility matters, then the ETZ scheme is clearly superior to the alternatives compared here. However, an important qualification is the high degree of fiscal activism required to prevent output and inflation from deviating from target levels in order to offset the active monetary policy employed to achieve the exchange rate targets. Moreover, when this is combined with an uneven distribution of welfare gains and associated incentive compatibility problems, the ETZ scheme may become unsustainable leading to a breakdown of cooperation.

Expectations, learning and empirical macroeconomic models

The developments in the treatment of expectations in empirical macroeconomic models that have taken place over the last 30 years are surveyed. The main concern is to focus on the implications of expectation effects in the practical use of models, i.e. in forecasting and policy analysis, rather than to consider either the theoretical literature or the literature on econometric estimation and identification, both of which are already well surveyed. The general development in expectations models is discussed first. Then the literature on linear models is considered and the development of expectations effects to large nonlinear econometric models is examined.