Takushi Kurozumi

Inflation Dynamics And Labor Market Specifications: A Bayesian Dynamic Stochastic General Equilibrium Approach For Japan'S Economy

Which labor market specification is better able to describe inflation dynamics, a widely used sticky wage model or a recently investigated labor market search model? Using a Bayesian likelihood approach, we estimate these two models with Japans data. This article shows that the labor market search model is superior to the sticky wage model in terms of both marginal likelihood and out‐of‐sample forecast performance, particularly regarding inflation. The labor market search model is better able to replicate the cross‐correlation among inflation, real wages, and output in the data. Moreover, in this model, real marginal cost is determined by both hiring cost and unit labor cost that varies with employment fluctuations, which gives rise to a high contemporaneous correlation between inflation and real marginal cost as represented in the New Keynesian Phillips curve.

Learning about monetary policy rules when labor market search and matching frictions matter

This paper examines the implications of labor market search and matching frictions for determinacy and E-stability of rational expectations equilibrium (REE) in a sticky price model with interest rate policy. When labor adjustment takes place solely at the extensive margin, forecast-based policy that meets the Taylor principle is likely to induce indeterminacy and E-instability, regardless of whether it is strictly or flexibly inflation targeting. When labor adjustment takes place at both the extensive and intensive margins, the strictly inflation-forecast targeting policy remains likely to induce indeterminacy, but it generates a unique E-stable fundamental REE as long as the Taylor principle is satisfied. Therefore, the presence of search and matching frictions changes the determinacy properties of a strictly inflation-forecast targeting policy, and alters its E-stability properties when only an extensive margin is present but not when labor adjustment takes place at both margins.

OPTIMAL MONETARY POLICY UNDER PARAMETER UNCERTAINTY IN A SIMPLE MICROFOUNDED MODEL

This paper examines optimal monetary policy under uncertainty about fundamental parameters of a dynamic stochastic general-equilibrium model. In contrast to previous studies, a microfoundation of the model leads this uncertainty to generate uncertainty not only about the transmission of monetary policy but also about the transmission of shocks and about a social welfare loss function. In the presence of such uncertainty, this paper finds conditions under which optimal discretionary policy responds to shocks more aggressively than in the absence of the uncertainty. These conditions depend crucially on the persistence of shocks and the magnitude of policy multipliers. To obtain the conditions, taking proper account of uncertainty about the transmission of shocks and about the welfare loss function is of crucial importance.

Firm-Specific Labor, Trend Inflation, and Equilibrium Stability

The present paper explores the implications for monetary policy of different labor market structures. In one labor market workers are identical and thus easily interchangeable between firms, while in another labor market workers are specialized to fill the needs of specific firms. The labor market structure turns out to be a crucial determinant of the effectiveness of monetary policies guided by the Taylor principle in an environment of high trend inflation. ; According to the Taylor principle, an undesirable rise in inflation requires a disproportionately strong response of interest rates. Otherwise, self-fulfilling private-sector expectations of inflation may push prices upward. It is widely believed that the Federal Reserve’s approach to setting interest rates did not conform to the Taylor principle prior to the early 1980s, but since then has done so, to good effect. Recent research, however, has suggested that when trend inflation is high—about four percent or higher—the Taylor principle may become less effective. ; Studies on the subject have made varying assumptions about the structure of the labor market, with some presuming that all firms hire the same type of labor, while others assume that firms need specialized labor. These differing assumptions matter: the need for specialized labor affects the way firms’ costs adjust in reaction to shifts in demand, and that has implications for inflation dynamics and for the Taylor principle. ; We find that in a model economy with specialized labor, a policy rule for setting interest rates cannot ensure keeping inflation stable even if it satisfies the Taylor principle, if trend inflation is high. This differs from a model where workers are identical, in which adhering to the Taylor principle does achieve stability of inflation, whether trend inflation is high or low. The finding suggests that whether the Federal Reserve’s policy shift in the early 1980s was sufficient, alone, to bring about the period of stable inflation that followed, or whether it also depended on a decline in trend inflation, depends on the structure of the labor market.

Determinacy Under Inflation Targeting Interest Rate Policy in a Sticky Price Model with Investment (and Labor Bargaining)

In a sticky price model with investment spending, recent research shows that inflation-forecast targeting interest rate policy makes determinacy of equilibrium essentially impossible. We examine a necessary and sufficient condition for determinacy under interest rate policy that responds to a weighted average of an inflation forecast and current inflation. This condition demonstrates that the average-inflation targeting policy ensures determinacy as long as both the response to average inflation and the relative weight of current inflation are large enough. We also find that interest rate policy which responds solely to past inflation guarantees determinacy when its response satisfies the Taylor principle and is not large. These results still hold even when wages and hours worked are determined by Nash bargaining.

TREND INFLATION AND EQUILIBRIUM STABILITY: FIRM-SPECIFIC VERSUS HOMOGENEOUS LABOR

In sticky price models based on micro evidence that each period a fraction of prices are kept unchanged, recent studies reach the qualitatively equivalent conclusion that higher trend inflation is a more serious source of indeterminacy of rational expectations equilibrium, regardless of whether labor is firm-specific or homogeneous. This paper shows that the model with firm-specific labor is more susceptible to indeterminacy induced by high trend inflation than the model with homogeneous labor, because these two different specifications of labor lead to distinct representations of inflation dynamics. In addition, the model with firm-specific labor is more susceptible to expectational instability of the equilibrium caused by high trend inflation.

Monetary Policy, Trend Inflation, and the Great Moderation: An Alternative Interpretation: Comment Based on System Estimation

What caused the U.S. economys shift from the Great Inflation era to the Great Moderation era? {{p}} A large literature shows that the shift was achieved by the change in monetary policy from a passive to an active response to inflation. However, Coibion and Gorodnichenko (2011) attribute the shift to a fall in trend inflation along with the policy change, based on a solely estimated Taylor rule and a calibrated staggered-price model. We estimate the Taylor rule and the staggered-price model jointly and demonstrate that the change in monetary policy responses to inflation and other variables suffices for explaining the shift.

A Pitfall of Expectational Stability Analysis

A pitfall of expectational stability (E-stability) analysis can arise in models with multiperiod expectations: if an auxiliary variable is introduced as substitute for an expectational endogenous variable in such a model, this shrinks the region of the model parameters that guarantee E-stability of a fundamental rational expectations equilibrium. Moreover, in the model representation with no auxiliary variable, the same E-stability region as in that with the auxiliary variable is obtained if economic agents are assumed to make multiple forecasts in an inconsistent manner. Therefore, we argue that the introduction of an auxiliary variable as substitute for an expectational endogenous variable in models with multi-period expectations can induce misleading implications that are biased toward E-instability.

Slow Post-Financial Crisis Recovery and Monetary Policy

Post-financial crisis recoveries tend to be slow and be accompanied by slowdowns in TFP and permanent losses in GDP. To prevent them, how should monetary policy be conducted? We address this issue by developing a model with endogenous TFP growth in which an adverse financial shock can induce a slow recovery. In the model, a welfare-maximizing monetary policy rule features a strong response to output, and the welfare gain from output stabilization is much larger than when TFP expands exogenously. Moreover, inflation stabilization results in a sizable welfare loss, while nominal GDP stabilization works well, albeit causing high interest-rate volatility.

Price Dispersion and Inflation Persistence

Persistent responses of inflation to monetary policy shocks have been difficult to explain by existing models of the monetary transmission mechanism without embedding controversial intrinsic inertia of inflation. Our paper addresses this issue using a staggered price model with trend inflation, a smoothed-off kink in demand curves, and a fixed cost of production. In this model, inflation exhibits a persistent response to a policy shock even in the absence of its intrinsic inertia, because the kink causes a measure of price dispersion, which is intrinsically inertial, to become a key source of inflation persistence under the positive trend inflation rate. {{p}} In addition, output and labor productivity both rise after an expansionary policy shock as in an estimated structural vector autoregression model. Moreover, credible disinflation induces a gradual decline in inflation and a fall in output as observed during the Volcker disinflation era.