Macroeconomic Modeling for Monetary Policy Evaluation

Abstract

We describe some of the main features of the recent vintage macroeconomic models used for monetary policy evaluation. We point to some of the key di¤erences with respect to the earlier generation of macro models, and highlight the insights for policy that these new frameworks have to o¤er. Our discussion emphasizes two key aspects of the new models: the signi…cant role of expectations of future policy actions in the monetary transmission mechanism, and the importance for the central bank of tracking the natural levels of output and the real interest rate. We argue that both features have important implications for the conduct of monetary policy. In the 1980s and 1990s, many central banks continued to use reduced form statistical models to produce forecasts of the economy that presumed no structural change, but they did so knowing that these models could not be used with any degree of con…dence to generate forecasts of the results of policy changes. Thus, monetary policy-makers turned to a combination of instinct, judgment, and raw hunches to assess the implications of di¤erent policy paths for the economy. Romer (1991)). The models of this literature, however, were typically static and designed mainly for qualitative as opposed to quantitative analysis.By contrast, real business cycle theory, which was developing concurrently, demonstrated how it was possible to build quantitative macroeconomic models exclusively from the "bottom up"-that is, from explicit optimizing behavior at the individual level (e.g. Prescott (1986)) These models, however, abstracted from monetary and …nancial factors and thus could not address the issues that we just described. In this context, the new frameworks re ‡ect

Stock market response to monetary and fiscal policy shocks: Multi-country evidence

“…Gali and Gertler (2007), Bjornland and Jacobsen (2008), Bjornland andLeitemo (2009), Kurov (2010), as well as, Castelnuovo and Nistico (2010) maintain that stock market prices are mainly forward looking and contain relevant information regarding expectations about the future. In this regard, monetary policy innovations can greatly affect these expectations.…”

“…It is widely believed that monetary policy should not be examined in isolation from fiscal policy, and vice versa, as both their individual stances, as well as their interaction, play an important role in the economy and thus, we argue, that they also influence stock market performance. Even though a significant number of past studies have concentrated their attention on the relationship between monetary policy and stock market performance (see, inter alia, Fama and French, 1989;Gertler and Gilchrist, 1993;Jensen and Johnson, 1995;Thorbecke, 1997;Patelis, 1997;Conover, Jensen and Johnson, 1999;Gali and Gertler, 2007;Bjornland and Leitemo, 2009), only few investigate the effects of fiscal policy on stock markets (see, for example, Darrat, 1988;Jansen, Li, Wang and Yang, 2008;Agnello and Sousa 2010;Sousa, 2011, 2012). In addition, we know little, if any, on the effects of fiscal and monetary policy on stock market performance when the two policies interact (Jansen et al, 2008).…”

Macroeconomic Policy in DSGE and Agent-Based Models Redux: New Developments and Challenges Ahead

“…The canonical DSGE model has a real-business-cycle (RBC) core supplemented with monopolistic competition, nominal imperfections and a monetary policy rule (for a more detailed exposition of the DSGE model, cf. Clarida et al, 1999;Woodford, 2003;Galí and Gertler, 2007).…”

The ECB’s Monetary Analysis Revisited

“…In the cashless New Keynesian model (NKM), money plays little or no role for inflation and is introduced, if at all, more or less as an afterthought (see, among others, Galí and Gertler 2007). Central banks influence the economy only through the interest rate and its impact on consumption and investment decisions.…”