Lenard Lieb

Taking Real Wage Rigidities Seriously: Implications for Optimal Policy Design in a Currency Union

This paper analyzes optimal monetary and fiscal policy in a monetary union from a union-wide perspective, using a multi-country New Keynesian business-cycle model with rigid real wages. Fiscal policy is implemented at the country level through decisions regarding government spending, while the monetary authority sets a common nominal interest rate. It is found that in the presence of country-specific shocks as well as symmetric shocks, there is a country-level trade-off between stabilizing inflation and the output gap. After a union-wide shock, the common monetary authority also faces a trade-off. If shocks are symmetric, the optimal union-wide policy requires that the common central bank conduct a countercyclical policy, allowing for more relative inflation volatility than the amount actually allowed by the ECB. The role of policies is reversed at the domestic level, where the government stabilizes the economy via a countercyclical policy, regardless of whether shocks are symmetric.

Testing for short-run threshold effects in a vector error-correction framework: a reappraisal of the stability of the US money demand

Abstract In this paper we analyze the stability of the money demand system in the US. To this aim, we develop an estimation and testing framework for a threshold vector error-correction model (VECM), where short-run dynamics are regime dependent and are driven by an exogenous, stationary and ergodic threshold variable. We modify a traditional Wald-type test for linearity and derive its asymptotic distribution, which turns out to be non-standard, but similar to the one proposed by Andrews [Andrews, D. 1993. “Tests for Parameter Instability and Structural Change with Unknown Change Point.” Econometrica 61 (4): 821–856]. Accounting for the diversity of the potential determinants of money holdings, a broad scope of money demand systems is analyzed. The linearity test confirms that money demand is not only suffering from structural breaks, but is driven by regimes governed by business cycles. Moreover, a similar pattern and a robust dating of the regimes is observed no matter the money demand system considered, offering hence a reconciling picture of previous empirical studies. From a policy perspective, our findings supports the implementation of cyclical monetary policy by the Federal Reserve.