Peter Tillmann

Inflation Targeting and Inflation Persistence in Asia-Pacific

Following the Asian financial crisis in 1997-98, a number of Asian central banks adopted inflation targeting. While it is possible for the average inflation rate to be close to target, deviations of inflation could nevertheless be large and protracted. We therefore explore how successful this framework has been by looking at the persistence of inflation, as measured by the sum of the coefficients in an autoregressive model for inflation, using a median unbiased estimator and bootstrapped confidence bands. We find a significant reduction in inflation persistence following the adoption of inflation targeting. The speed by which persistence falls varies across countries. Interestingly, the economies not adopting inflation targeting do not show a decline in persistence. Measuring the performance of monetary policy strategies in terms of inflation persistence rather than the level of inflation shows that inflation targeting performs better than alternative strategies.

PARAMETER UNCERTAINTY AND NONLINEAR MONETARY POLICY RULES

Empirical evidence suggests that the instrument rule describing the interest rate–setting behavior of the Federal Reserve is nonlinear. This paper shows that optimal monetary policy under parameter uncertainty can motivate this pattern. If the central bank is uncertain about the slope of the Phillips curve and follows a min–max strategy to formulate policy, the interest rate reacts more strongly to inflation when inflation is further away from target. The reason is that the worst case the central bank takes into account is endogenous and depends on the inflation rate and the output gap. As inflation increases, the worst-case perception of the Phillips curve slope becomes larger, thus requiring a stronger interest rate adjustment. Empirical evidence supports this form of nonlinearity for post-1982 U.S. data.

Robust Monetary Policy with the Cost Channel

Recent research argues that model uncertainty leads the central bank to adjust interest rates stronger to exogenous disturbances than under certainty. This paper investigates whether the introduction of a cost channel of monetary transmission, whose presence is empirically supported, changes the impact of model uncertainty on interest rate setting. The model is simple enough to facilitate an analytical solution. I find that the presence of the cost channel dampens the effect of model uncertainty on interest rate setting and can offset the activist policy stance. A richer model that allows for persistent supply and demand shocks corroborates these findings.

The Regime-Dependent Determination of Credibility: A New Look at European Interest Rate Differentials

Abstract With persistence in macroeconomic variables two aspects of exchange rate credibility emerge whose relative importance varies over time. Both aspects have opposite implications for the relation between fundamentals and credibility. Hence, the effect of policy measures on interest rate differentials becomes ambiguous. In this paper a Markov-switching VAR that allows for parameter shifts across regimes is employed to test the hypothesis of regime-dependent determination of credibility for major EMS currencies. Regime-dependent impulse response functions reveal substantial differences in the response of spreads to macroeconomic shocks across regimes.

Inflation Targeting and Regional Inflation Persistence: Evidence from Korea

The adoption of a credible monetary policy regime such as inflation targeting is known to reduce the persistence of inflation fluctuations. This conclusion, however, is derived from aggregate inflation or sectoral inflation rates, not from regional inflation data. This paper studies the regional dimension of inflation targeting, i.e. the consequences of inflation targeting for regional inflation persistence. Based on data for Korean cities and provinces it is shown that the adoption of inflation targeting leads (i) to a fall in inflation persistence at the regional level and (ii) to a reduction in the cross-regional heterogeneity in inflation persistence. A common factor model lends further support to the role of the common component, and hence monetary policy, for regional inflation persistence.

Does Model Uncertainty Justify Conservatism? Robustness and the Delegation of Monetary Policy

This paper analyzes the rationale for delegating monetary policy to an inflation-averse central banker when there is a preference for robustness of optimal policy with respect to misspecifications of the underlying model of the economy. We use a simple New Keynesian model to show how the optimal output gap weight in the central banks objective function depends on the degree of model uncertainty. In particular, we show numerically that the rationale for appointing a conservative central bank prevails even if the central bank is concerned about the robustness of policy with respect to model misspecifications. Moreover, we find that the central bank should put more relative weight on inflation stabilization if the degree of uncertainty increases. Interestingly, if the degree of uncertainty is large, monetary policy should be delegated to a conservative central banker even in the absence of shock persistence.

Has Inflation Persistence Changed under EMU

Abstract This paper analyzes the persistence of inflation in the euro area and, in particular, whether the persistence properties have changed since the start of European Monetary Union(EMU). For that purpose, we compare pre- and post-EMU inflation persistence, use rolling-window estimates of persistence, and apply tests specifically designed to detect break dates near the end of the sample period. In contrast to previous research, we find that inflation persistence has fallen significantly since the start of EMU. Persistence of consumer price inflation, which is central to the European Central Bank’s policy mandate, has fallen more than the persistence of deflator inflation. The drop in inflation persistence is consistent with the results from a simulated small New Keynesian model with a shift toward a more aggressive monetary policy stance.

Credit Market Distortions and Policy Aggressiveness: The Fed vs. the ECB

This paper employs a New Keynesian model in which the central bank formulates a robust control approach to policy and firms hold working capital. We model credit market distortions in terms of a worst-case interest rate spread. The degree of policy aggressiveness increases in the size of the working capital channel. With a larger working capital channel in the U.S. than in the Euro area, the Fed should set interest rates more vigorously than the ECB.

A note on the stability of the New Keynesian Phillips Curve in Europe

This note investigates how the explanatory power of the forward-looking New Keynesian Phillips Curve evolves over time. We exploit the present-value implications of the model and use VAR forecasts to assess whether the model matches the behaviour of actual inflation in the Euro area. A set of rolling regressions shows that the models explanatory power varies substantially over the sample. Regime changes in the underlying monetary framework, i.e. realignment crises in the European Monetary System, the Maastricht treaty and, eventually, the introduction of European Monetary Union, are reflected in a deterioration of the models explanatory power.

The Credibility of Private Sector Involvement in the Resolution of Financial Crises

To correct the disincentives of liquidity assistance during financial crises, the official sector recently announced attempts to involve the private sector in the resolution of debt crises. This paper empirically tests the reaction of investors to announcements of Private Sector Involvement (PSI). For this purpose we disentangle shifts in risk premia incorporated in excess returns on emerging market bonds into changes in risk and shifts in the price of risk. A regime-switching GARCH-M model is employed to separate two regimes with respect to the market price of risk. It is shown that the likelihood of switching to a state with a high price of risk rises in response to PSI announcements. Thus, the results indicate that burden sharing was credible and effective.