Jan Libich

Monetary policy facing fiscal indiscipline under generalized timing of actions.

The paper analyzes interactions between monetary and fiscal policies, both in a single-country and in a monetary-union setting. As the policy interactions are strategic, we use game-theoretic methods. Specifically, we develop a framework that allows for an arbitrary, possibly stochastic timing of moves. Our analysis identifies a number of institutional and policy variables that influence the interplay and outcomes of monetary and fiscal policies, such as the average levels of inflation and debt, and that determine the likelihood of an unpleasant monetarist arithmetic. We then calibrate the model with European Monetary Union data.

Tracking Monetary-Fiscal Interactions Across Time and Space

The long-term fiscal outlook of most high-income countries is grim. Should independent central bankers be afraid of an unpleasant monetarist arithmetic, i.e., fiscal imbalances spilling over to monetary policy and jeopardizing price stability? To provide some insights, this paper tracks the interactions between fiscal and monetary policies in the data since 1980 for Australia, Canada, Japan, Switzerland, the United Kingdom, and the United States. In doing so it uses a combination of time-varying parameter vector autoregression with sign, magnitude, and contemporaneous restrictions identification. Unlike conventional approaches, this can capture changes in monetary and fiscal behavior that are gradual and differ across the two policies. Our results show that in the United States the degree of monetary policy accommodation of fiscal shocks (debt-financed government spending) increased gradually between the late 1980s and the 2008 crisis, i.e., over the whole tenure of Chairman Greenspan. In contrast, it seems to have decreased over this period in the United Kingdom, Australia, Switzerland, and Canada. Our benchmark analysis and several robustness checks show that legislating numerical inflation targets may account for some of the country differences, presumably because they may shift the strategic power from fiscal to monetary policy. We conclude by considering the implications of our results for the long-term likelihood of an unpleasant monetarist arithmetic in the six countries.

Macroprudential Policies and Financial Stability

The paper attempts to assess to what extent the central bank or the government should respond to developments that can cause financial instability, such as housing or asset bubbles, overextended budgetary policies, or excessive public and household debt. To analyse this question we set up a simple reduced-form model in which monetary and fiscal policy interact, and imbalances (bubbles) can occur in the medium-run. Considering several scenarios with both benevolent and idiosyncratic policy-makers, the analysis shows that the answer depends on a number of characteristics of the economy, as well as on the monetary and fiscal policy preferences with respect to inflation and output stabilization. We show that socially optimal financial instability prevention should be carried out by: (i) both monetary and fiscal policy (sharing region) under some circumstances, and (ii) fiscal policy only (specialization region) under others. There is however a moral hazard problem: both policy-makers have an incentive to be insufficiently pro-active in safeguarding financial stability, and shift the responsibility to the other policy. Specifically, under a range of circumstances we obtain a situation in which neither policy mitigates instability threats (indifference region). These results can be related to the build-up of the current global financial crisis, and have strong implications for the optimal design of the delegation process.

Inflation Nutters? Modelling the flexibility of inflation targeting.

Opponents of explicit inflation targeting (including ex-Chairman Greenspan) have argued that a commitment to a numerical inflation target is likely to reduce monetary policy flexibility, and hence increase output volatility. Our paper demonstrates that this claim may fail to account for the anchoring effect of explicit targets on expectations and wages—found in the data by a number of empirical studies. We do so in a novel, dynamic game theoretic framework with asynchronous moves that endogenizes the frequency of the private sector’s actions. We derive the conditions under which an explicit long-term inflation target makes the behaviour of private agents rationally inattentive and anchored. This is through enhancing monetary policy credibility, which leads private agents to reconsider expectations and wages less frequently to minimize the cost of processing information and/or wage negotiations. Such anchoring makes the policymaker’s interest rate instrument more effective in stabilization, giving it greater leverage over the real rate. This implies that an explicit inflation target may improve the variability tradeoff, i.e. shift the policy frontier inwards. It can therefore make both inflation and output less variable in equilibrium, unlike what inflation targeting sceptics argue. We show that our results are consistent with existing empirical evidence, and discuss them in light of the global financial crisis. The policy implication is that the Federal Reserve, the Swiss National Bank, the Bank of Japan, and the European Central Bank should be more explicitly committed to a long-run inflation target.

A NOTE ON THE ANCHORING EFFECT OF EXPLICIT INFLATION TARGETS

Empirical literature provided convincing evidence that explicit (ie legislated) inflation targets anchor expectations. We propose a novel game theoretic framework with generalized timing that allows us to formally capture this beneficial anchoring effect. Using the framework we identify several factors that in?uence whether and how strongly expectations are anchored, namely: (i) the public?s cost of decision-making, (ii) the public?s inflation aversion, (iii) the slope of the Phillips curve, (iv) the magnitude of supply shocks, (v) the degree of central bank conservatism, and under many (but not all) circumstances, (vi) the explicitness of the inflation target.

Monetary Exit Strategy and Fiscal Spillovers

The paper models strategic monetary-fiscal interactions in the aftermath of the global financial crisis - in a single country as well as a monetary union. It depicts both the short-term (stabilization) perspective and the long-term (sustainability) perspective, and the link between them. This is done in a game theoretic framework that allows for revisions of actions, deterministic or stochastic. In addition, we consider incomplete information about economic conditions, and different types of government. We find that, under ambitious fiscal policies, a legislated long-term monetary commitment may: (i) reduce the risk of a double-dip recession and deflation in the short-term, and at the same time (ii) facilitate the ‘exit strategy’ of monetary policy, ie prevent sub-optimally high future inflation caused by fiscal spillovers. Our analysis thus implies that an explicit numerical target for average inflation may play the role of a monetary ‘credibility insurance’ over all phases of the business cycle, and is beneficial especially in countries facing fiscal stress.

Macro Meets Micro: Stochastic (Calvo) Revisions in Games

Abstract The timing of moves in conventional games is deterministic. To better capture the uncertainty of many real world situations, we postulate a stochastic timing framework. The players get a revision opportunity at a pre-specified time (common to them) with some known probability (different across them). The probabilistic revisions resemble the Calvo (1983) timing widely used in macroeconomics, and by nesting the standard simultaneous move game and Stackelberg leadership they can serve as a “dynamic commitment” device. The analysis shows how the revision time and probabilities affect the outcomes in games with multiple and/or inefficient equilibria. Unsurprisingly, we show in the Battle of the sexes that commitment – low revision probability relative to the opponent – improves the player’s chances to uniquely achieve his preferred outcome (i.e. to dominate). What may, however, seem surprising is that the less committed (higher revision probability) player may dominate the game under some circumstances (for which we derive the necessary and sufficient conditions). This is in contrast to the intuition of Stackelberg leadership where the more committed player (leader) always does so. The paper then applies the framework to the strategic interaction between monetary and fiscal policies in the aftermath of the Global financial crisis. It is modelled as the Game of chicken in which a double-dip recession and deflation can occur when both policies postpone stimulatory measures – attempting to induce the other policy to carry them out. In order to link our theoretic results to the real world, we develop new indices of monetary and fiscal policy leadership (pre-commitment) and quantify them using institutional characteristics of high-income countries. This exercise shows that the danger of the undesirable deflationary scenario caused by a monetary–fiscal policy deadlock may be high in some major economies.

In search of goals: increasing ice hockey's attractiveness by a sides swap

The popularity and business impact of major sports have been growing globally over time. This paper focuses on ice hockey, specifically the National Hockey League in North America. It reports a striking irregularity in ice hockey’s scoring dynamics relative to comparable sports such as soccer and rugby, namely a scoring surge in the middle section of the game. We explore an explanation for this irregularity related to the convention on the spatial location of the teams’ benches (which are fixed throughout the game) and on-ice sides (which are switched every period). Because a large number of the players’ substitutions occur while the play is in progress, this convention determines the distance forwards and defenders need to travel to make a substitution, and thus indirectly substitution strategies and scoring. We consider two simple operational changes that could increase the number of goals in the NHL by approximately 5 and 10%, respectively, corresponding to roughly 350 and 700 additional goals each season. This would partly offset the current downward scoring trend and thus enhance the game’s attractiveness. The estimated impact of the proposed reforms, one of which is largely costless, is robust across several specifications—using per-minute and per-second scoring data and controlling for various factors, such as bookmakers’ odds.

Insurance by government or against government? Overview of public risk management policies

In what contexts is it desirable that the government, rather than the private sector, takes on the role of an insurer and helps people reduce risks? Our discussion implies that while in a number of areas individuals benefit from well-designed insurance provided by their government, ill-designed public policies (for example existing pay-as-you-go pension systems) force individuals to insure against their government. It is further discussed how governments could improve their risk managing role in many areas by using income contingent loans, provided the country has high-quality institutions and governance. Such loans to artists, sportspeople, flood victims or collapsing financial institutions would replace the existing nonrepayable transfers, grants, subsidies and bailouts. Using a simple efficiency-equity-sustainability framework for comparing income contingent schemes with conventional public and private insurance policies, we document that this would enable governments to extend their insurance assistance to a greater number of people and institutions – in a way that is not only equitable but also efficient and fiscally sustainable.