Thomas Laubach

Measuring the Natural Rate of Interest

The natural rate of interest-the real interest rate consistent with output equaling its natural rate and stable inflation-plays a central role in macroeconomic theory and monetary policy. Estimation of the natural rate of interest, however, has received little attention. We apply the Kalman filter to estimate jointly time-varying natural rates of interest and output and trend growth. We find a close link between the natural rate of interest and the trend growth rate, as predicted by theory. Estimates of the natural rate of interest, however, are very imprecise and subject to considerable real-time measurement error.

Measuring the NAIRU: evidence from seven economies

Several specifications of state-space models are used to obtain estimates of the NAIRU for the G7 except Japan, plus Australia, over the past 28 years. A Phillips curve-type regression is shown to deliver estimates that do not mimic low-frequency movements in unemployment rates, even when a drift is included in the specification of the NAIRU. Standard errors around the estimates are extremely large. Using information about the behavior of unemployment, in addition to inflation, alleviates both these shortcomings.

ESTIMATION AND CONTROL OF AN OPTIMIZATION BASED MODEL WITH STICKY PRICES AND WAGES

Abstract This paper provides estimates of an optimization-based equilibrium model with sticky prices and wages. The estimated model is used to analyse the welfare properties of various interest rate rules for conducting monetary policy. An important feature of this model is that it involves a tradeoff between the variances of price and wage inflation and the output gap. This tradeoff implies that it is desirable for the monetary authority to respond to wage inflation, in addition to price inflation, output, and past interest rates, when setting the current interest rate. The issue whether wages and prices can be indexed to steady-state inflation has important implications both for the characterization of optimal interest rate rules and interest rate volatility. In particular, optimal policy in the presence of indexation induces implausibly high steady-state inflation.

The Responses of Wages and Prices to Technology Shocks

This paper reexamines wage and price dynamics in response to permanent shocks to productivity. We estimate a micro-founded dynamic general equilibrium (DGE) model of the U.S. economy with sticky wages and sticky prices using impulse responses to technology and monetary policy shocks. We utilize a flexible specification for wage- and price-setting that allows for the sluggish adjustment of both the levels of these variables as in standard contracting models as well as intrinsic inertia in wage and price inflation. On the price front, we find that in our VAR inflation jumps in response to an identified permanent technology shock, implying that, on average, prices adjust quickly and that there is little evidence for any intrinsic inflation inertia like that commonly found in models used for monetary policy evaluation. On the wage front, we find evidence for significant inertia in wages and some intrinsic inertia in nominal wage inflation. Our results provide support for the standard sticky-price specification of the New Keynesian model; however, the evidence on the high degree of wage inertia presents a challenge for standard models of wage setting.

The Macroeconomic Effects of the Federal Reserve's Unconventional Monetary Policies

After reaching the effective lower bound for the federal funds rate in late 2008, the Federal Reserve turned to two unconventional policy tools--quantitative easing and increasingly explicit and forward-leaning guidance for the future path of the federal funds rate--in order to provide additional monetary policy accommodation. We use survey data from the Blue Chip Economic Indicators to infer changes in private-sector perceptions of the implicit interest rate rule that the Federal Reserve would use following liftoff from the effective lower bound. Using our estimates of the changes over time in private expectations for the implicit policy rule, and estimates of the effects of the Federal Reserves quantitative easing programs on term premiums derived from other studies, we simulate the FRB/US model to assess the actual economic stimulus provided by unconventional policy since early 2009. Our analysis suggests that the net stimulus to real activity and inflation was limited by the gradual nature of the changes in policy expectations and term premium effects, as well as by a persistent belief on the part of the public that the pace of recovery would be much faster than proved to be the case. Our analysis implies that the peak unemployment effect--subtracting 1-1/4 percentage points from the unemployment rate relative to what would have occurred in the absence of the unconventional policy actions--does not occur until early 2015, while the peak inflation effect--adding 1/2 percentage point to the inflation rate--is not anticipated until early 2016.

Monetary Policy in an Estimated Optimisation-Based Model with Sticky Prices and Wages

This paper serves two purposes. First, it provides estimates of an optimisation-based equilibrium model with sticky prices and wages. Second, the estimated model is used to analyse the welfare properties of various interest rate rules for conducting monetary policy. As shown by Erceg et al (1999), an important feature of this model is that it involves a trade-off between the variances of price and wage inflation and the output gap. This trade-off implies that it is desirable for the monetary authority to respond to more than inflation, output and past interest rates when setting the current interest rate. Indeed, the welfare optimal policy can be approximated with responses to both price and wage inflation and the past interest rate. By contrast, rules that call for a strong response to either detrended output or the output gap result in much lower level of welfare.

The FRB/US Model : A Tool for Macroeconomic Policy Analysis

The FRB/US model of the U.S. economy is one of several that Federal Reserve Board staff consults for forecasting and the analysis of macroeconomic issues, including both monetary and fiscal policy.

Financial Stability and Optimal Interest-Rate Policy

We study optimal interest-rate policy in a New Keynesian model in which the economy can experience financial crises and the probability of a crisis depends on credit conditions. The optimal adjustment to interest rates in response to credit conditions is (very) small in the model calibrated to match the historical relationship between credit conditions, output, inflation, and likelihood of financial crises. Given the imprecise estimates of key parameters, we also study optimal policy under parameter uncertainty. We find that Bayesian and robust central banks will respond more aggressively to financial instability when the probability and severity of financial crises are uncertain.

The Effects of Budget Deficits on Interest Rates: A Review of Empirical Results

Laubach provides a critical review of the empirical literature that focuses on the effects of budget deficits on interest rates. The main empirical problem in estimating this relationship is to control for other factors determining real interest rates. In particular, the simultaneous response of monetary policy and automatic stabilisers can in principle mask the effect of discretionary fiscal policy on interest rates. The paper stresses that simple regressions of current interest rates on current budget deficit yield ambiguous results which are consistent with the view that endogeneity problems in such regressions are pervasive. The paper considers different solutions for coping with these problems. It shows that when endogeneity problems are properly accounted for, mainly by adequately considering expectations of both deficits and interest rates, available studies tend to find strong evidence that increases in budget deficits raise interest rates.

Signalling commitment with monetary and inflation targets

Abstract This article studies a two-period game between the public and a central bank about whose ability to commit to an announced target the public is uncertain. The central bank chooses between announcing a target for an intermediate variable (money growth) and its goal variable, inflation. Prior to setting its instrument, the central bank receives private, noisy information about the link between money growth and inflation. Monetary targeting facilitates communication of the central banks type, in that the probability of separation is always higher than under inflation targeting. This advantage of monetary targets from a dependable central banks perspective is outweighed for most parameter values by the advantage of inflation targeting in terms of inflation control. If the regime choice is treated as a strategic decision, over a large range of parameter values both central banks choose the regime that a dependable central bank would prefer.