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What is the impact of large swings in economic policy on the risk-return trade-off faced by i nvestors? What is the impact of changes in policy regimes on investment strategies? In this paper we study the impact on returns of switches between periods of market-friendly economic policies and periods of populist policies. To quantify the impact of policy instability, we use data from Argentina--a country that has experienced frequent and very large regime changes--and find that the risk-return for individual assets and minimum variance portfolios are quite different across regimes. We then develop a dynamic model to understand optimal portfolios when investors are cognizant that regimes can change. We find that when portfolios are unrestricted, it is optimal for investors to take a large amount of risk. On the other hand, when portfolios are restricted to include only long positions, a real asset (real estate) dominates financial assets. [ABSTRACT FROM AUTHOR]

This paper uses an example to show that a model that fits the available data perfectly may provide worse answers to policy questions than an alternative, imperfectly fitting model. The author argues that, in the context of Bayesian estimation, this result can be interpreted as being due to the use of an inappropriate prior over the parameters of shock processes. He urges the use of priors that are obtained from explicit auxiliary information, not from the desire to obtain identification. [ABSTRACT FROM AUTHOR]

Two recent strands of research have contributed to our understanding of the effects of foreign exchange intervention: (i) the use of high-frequency data and (ii) the use of event studies to evaluate the effects of intervention. This article surveys recent empirical studies of the effect of foreign exchange intervention and analyzes the implicit assumptions and limitations of such work. After explicitly detailing such drawbacks, the paper suggests ways to better investigate the effects of intervention. [ABSTRACT FROM AUTHOR]

This paper develops a generalization of the formulas proposed by Kuttner (2001) and others for purposes of measuring the effects of a change in the federal funds target on Treasury yields of different maturities. The generalization avoids the need to condition on the date of the target change and allows for deviations of the effective fed funds rate from the target as well as gradual learning by market participants about the target. The paper shows that parameters estimated solely on the basis of the behavior of the fed funds and fed funds futures can account for the broad calendar regularities in the relation between fed funds futures and Treasury yields of different maturities. Although the methods are new, the conclusion is quite similar to that reported by earlier researchers—changes in the fed funds target seem to be associated with quite large changes in Treasury yields, even for maturities of up to 10 years. [ABSTRACT FROM AUTHOR]

The author reflects on the importance of predictability in monetary policy, basing on Bill Poole's paper on monetary policy and on more recent experiences of predictability in practice. He contends that Poole's active policy rules were more predictable and could reduce uncertainty, and the private sector rules of thumb ways of monetary policy can improve the operation of the economy.

Monetary policy analysts often rely on rules of thumb, such as the Taylor rule, to describe historical monetary policy decisions and to compare current policy with historical norms. Analysis along these lines also permits evaluation of episodes where policy may have deviated from a simple rule and examination of the reasons behind such deviations. One interesting question is whether such rules of thumb should draw on policymakers' forecasts of key variables, such as inflation and unemployment, or on observed outcomes. Importantly, deviations of the policy from the prescriptions of a Taylor rule that relies on outcomes may be the result of systematic responses to information captured in policymakers' own projections. This paper investigates this proposition in the context of Federal Open Market Committee (FOMC) policy decisions over the past 20 years, using publicly available FOMC projections from the semiannual monetary policy reports to Congress (Humphrey-Hawkins reports). The results indicate that FOMC decisions can indeed be predominantly explained in terms of the FOMC's own projections rather than observed outcomes. Thus, a forecast-based rule of thumb better characterizes FOMC decisionmaking. This paper also confirms that many of the apparent deviations of the federal funds rate from an outcome-based Taylor-style rule may be considered systematic responses to information contained in FOMC projections. [ABSTRACT FROM AUTHOR]

This paper studies the design of optimal monetary policy under uncertainty using a Markov jumplinear-quadratic (MJLQ) approach. To approximate the uncertainty that policymakers face, the authors use different discrete modes in a Markov chain and take mode-dependent linear-quadratic approximations of the underlying model. This allows the authors to apply a powerful methodology with convenient solution algorithms that they have developed. They apply their methods to analyze the effects of uncertainty and potential gains from experimentation for two sources of uncertainty in the New Keynesian Phillips curve. The examples highlight that learning may have sizable effects on losses and, although it is generally beneficial, it need not always be so. The experimentation component typically has little effect and in some cases it can lead to attenuation of policy. [ABSTRACT FROM AUTHOR]

The output gap—the deviation of output from potential output—has played an important role in the conduct of monetary policy in Canada. This paper reviews the Bank of Canada's definition of potential output, as well as the use of the output gap in monetary policy. Using a real-time staff economic projection dataset from 1994 through 2005, a period during which the staff used the Quarterly Projection Model to construct economic projections, the authors investigate the relationship between shocks (data revisions or real-time projection errors) and revisions to projections of key macroeconomic variables. Of particular interest are the interactions between shocks to real gross domestic product (GDP) and inflation and revisions to the level of potential output, potential growth, the output gap, and real GDP growth. [ABSTRACT FROM AUTHOR]

This paper estimates a Bayesian vector autoregression for the U.S. economy that includes a housing sector and addresses the following questions: Can developments in the housing sector be explained on the basis of developments in real and nominal gross domestic product and interest rates? What are the effects of housing demand shocks on the economy? How does monetary policy affect the housing market? What are the implications of house price developments for the stance of monetary policy? Regarding the latter question, we implement a Céspedes et al. (2006) version of a monetary conditions index. [ABSTRACT FROM AUTHOR]

The names Milton Friedman and John Taylor are associated with different monetary policy rules; but, as shown in this paper, the difference between their perceptions of how the economy works is not great. The monetary policy rules advanced by Taylor and Friedman are compared by linking the rules to the two economists' underlying views about nominal rigidity, the source of trade-offs, the sources of shocks, and model uncertainty. Taylor and Friedman both emphasized Phillips curve specifications that impose temporary nominal price rigidity and the long-run natural-rate restriction; and they basically agreed on the specification of shocks, policymaker objectives, and trade-offs. Where they differed was on the extent to which structural models should enter the monetary policy decisionmaking process. This difference helps account for the differences in their preferred monetary policy rules. (JEL E42, E51, E61) [ABSTRACT FROM AUTHOR]

Can monetary policy guide expectations toward desirable outcomes when equilibrium and welfare are sensitive to alternative, commonly held rational beliefs? This paper studies this question in an exchange economy with endogenous debt limits in which dynamic complementarities between dated debt limits support two Pareto-ranked steady states: a suboptimal, locally stable autarkic state and a constrained optimal, locally unstable trading state. The authors identify feedback policies that reverse the stability properties of the two steady states and ensure rapid convergence to the constrained optimal state. [ABSTRACT FROM AUTHOR]

This paper, using extensive archival material from several countries, brings together scattered information about Milton Friedman's views and predictions regarding U.S. monetary policy developments after 1960 (i.e., the period beyond that covered by his and Anna Schwartz's Monetary History of the United States). The author evaluates these interpretations and predictions in light of subsequent events. [ABSTRACT FROM AUTHOR]

Comments on Lars Svensson's article "Targeting Versus Instrument Rules for Monetary Policy: What Is Wrong With McCallum and Nelson?," which appeared in the September/October 2005 issue of "Review (Federal Reserve Bank of Saint Louis)." Purpose of the article; Justification for the stated limitation of targeting rules; Views on Svensson's conclusions about the implications of consumption decisions for modeling central bank behavior.

The article discusses various reports published within the issue, including one by Lars Svensson and Noah Williams on policy makers who face uncertainty and another by Athanasios Orphanides and Volker Wieland on the rules of thumb for monetary policy.

Researchers have long studied the reaction of foreign exchange returns to macroeconomic announcements in order to infer changes in policy reaction functions and foreign exchange micro - structure, including the speed of market reaction to news and how order flow helps impound public and private information into prices. These studies have often been disconnected, however; and this article critically reviews and evaluates the literature on announcement effects on foreign exchange returns. [ABSTRACT FROM AUTHOR]

The article discusses the measurement of potential output and potential growth while formulating economic policy. The New Keynesian (NK) model is used currently for analysis of monetary policy. Two different concepts of the output gap are used in monetary policy analysis. It is stated that the best measure of potential output for monetary policy analysis is the output gap derived in the NK model. It is mentioned that aspects of robust policy can also be incorporated while designing the policy.

The authors use data from the Gallup World Poll to analyze what determines individual assessments of past, present, and future personal and country well-being. These measures allow the analysis of two dimensions of happiness data not previously examined in the literature: the better-than-average effect and optimism. The authors find that individuals tend to evaluate their personal well-being as being better than their country's and tend to expect that their future well-being will improve. The authors also analyze the impact of inflation and unemployment on these subjective measures and find that both variables have a negative effect on individuals' assessments of past and present well-being for themselves and their country; in contrast with other studies, however, they do not find that the effect of unemployment is significantly different from that of inflation. [ABSTRACT FROM AUTHOR]

The article presents the author's perspective on the study by Lars Svensson and Noah Williams concerning the design of optimal monetary policy under uncertainty using a Markov jump linear-quadratic (MJLQ) approach. He raises the issue about the model's assumption on central bank monetary policy behavior and the assumption of the state of knowledge in the private sector. He contends that the research misses a critical component in the context of the parameters of monetary policies.

The article relates the author's view on the study by J. Hamilton which assesses the affects of monetary policy using daily federal funds futures contracts in the U.S. The author asserts that the signal-extraction approach to determine the market's reaction of the study allows the market's reaction to be estimated using an entire sample and allows the measurement of financial markets' response to evolving expectations of future federal actions.

The article presents the author's view on the study by A. Orphanides and V. Wieland which examines the usefulness of Taylor rule to the Federal Open Market Committee monetary policy projections in the U.S. He remarks that the study indicates that in the presence of different types of uncertainty, simple rules for monetary policy are able to deliver good economic outcomes. He argues that it points to some unresolved issues that pertains to the ability to describe actual policy as rule based.

The author reflects on the contributions of Bill Poole in the policy debate on monetary policy making under uncertainty. He remarks that Poole's theories on monetary policy have helped policymakers on how to make policy in an uncertain environment by taking into account a range of possible scenarios about the state or structure of the economy. He notes that the economy's structure and the inferences that the public will draw from policy actions are a pervasive features of monetary policymaking.

The article presents the author's comment on the study by Marek Jarociński and Frank R. Smets on house prices and monetary policy in the U.S. The author remarks that the study briefly show that the recent U.S. housing boom is explained by a combination of increases in housing demand and loose monetary policy. He notes that the study also shows that housing demand shocks have a very limited impact on the overall volatility of real growth and inflation.

The article presents the author's view on the study by A. Orphanides and V. Wieland which examines whether a Taylor rule can be fitted to the Federal Open Market Committee monetary policy projections in the U.S. He contends that the finding that a Taylor rule gives a unique stable solution under rational expectations and resolves various puzzles regarding the data on outcomes is an interesting finding. However, he argues that the Taylor rule is an incomplete description of monetary policy.

The analysis in this article was presented to the Federal Open Market Committee as background for its discussion of the Federal Reserve's review of monetary policy strategy, tools, and communication practices. The Committee discussed issues related to the review at five consecutive meetings from July 2019 to January 2020. References to the Federal Open Market Committee's current framework for monetary policy refer to the framework articulated in the "Statement on Longer-Run Goals and Monetary Policy Strategy" first issued in January 2012 (FOMC, 2021). [ABSTRACT FROM AUTHOR]

Opinion. Comments on the paper `Discretion, Rules, and Volatility,' presented by Costas Azariadis and Vincenzo Galasso, to the Federal Reserve Bank of Saint Louis' 1996 Economic Policy Conference. Focus on the impact of economic policy discretion on economic equilibrium.

The article presents the author's comments on the study by J. Hamilton which assesses the effects of monetary policy using daily federal funds futures contracts daily movements in the U.S. The author asserts that the study contains innovative econometric work that offers understanding on the links between federal funds futures prices, the policy rate and other market rates. However, he contends that the results have no apparent implications to revise views of how monetary policy works.

Opinion. Comments on the paper `Discretion, Rules, and Volatility,' presented by Costas Azariadis and Vincenzo Galasso, to the Federal Reserve Bank of Saint Louis' 1996 Economic Policy Conference. Focus on the impact of economic policy discretion on economic equilibrium; Importance of commitment.

One of the goals of stabilization policy is to reduce the output gap-the difference between potential and actual output-during downturns. Potential output, however, is an unobserved variable whose definition can vary. For example, some view potential output as the level of output that can be produced when employment is at the natural rate. Others use trend measures of output to measure potential. We survey some of these measures using both full-sample data (all of the data that would be available through June 2017) and real-time data (the actual data that would have been available at different points in the sample). We construct six different measures of potential: a linear trend, a quadratic trend, the Congressional Budget Office measure, and three filtered trends. We compare these measures across methods and across time. We also use the measures to compute the monetary policy prescription in a standard interest rate rule and find very little difference across methods. [ABSTRACT FROM AUTHOR]

By providing guidance about future economic developments, central banks can affect private sector expectations and decisions. This can improve welfare by reducing private sector forecast errors, but it can also magnify the impact of noise in central bank forecasts. I employ a model of heterogeneous information to compare outcomes under opaque and transparent monetary policies. While better central bank information is always welfare improving, more central bank information may not be. (JEL E52, E58) [ABSTRACT FROM AUTHOR]

In this article, the author comments on an article on potential output by Susanto Basu and John G. Fernald, published within this issue. The theoretical models of potential output used as a framework for policy evaluation are appreciated. The author assesses situations about future productivity growth. The author favors the path of the policy-based economic research outlined in the article by Basu and Fernald.

This article was originally published in the Board of Governors of the Federal Reserve System Open Market Policies and Operating Procedures—Staff Studies, July 1971. It is reprinted here as an addendum to these conference proceedings. [ABSTRACT FROM AUTHOR]

By providing guidance about future economic developments, central banks can affect private sector expectations and decisions. This can improve welfare by reducing private sector forecast errors, but it can also magnify the impact of noise in central bank forecasts. I employ a model of heterogeneous information to compare outcomes under opaque and transparent monetary policies. While better central bank information is always welfare improving, more central bank information may not be. [ABSTRACT FROM AUTHOR]

The article presents the author's comment on the study by Marek Jarociński and Frank R. Smets on house prices and monetary policy in the U.S. The author contends that the study highlights important questions about the linkages of housing and mortgage markets and their implications for monetary policy. He remarks that the analysis also provides empirical evidence on the consideration of the potential role of house prices in a monetary conditions index.

This analysis addresses changing views of the role and effectiveness of monetary policy, inflation targeting as an "effective monetary policy," monetary policy and short-run (output) stabilization, and problems in implementing a short-run stabilization policy. [ABSTRACT FROM AUTHOR]

It is widely acknowledged that the Fed can control the average inflation rate over a period of time reasonably well. Because of this and the Federal Open Market Committee's (FOMC's) long-standing commitment to price stability, the author argues that the FOMC has an implicit long-run inflation objective (LIO)--lower and upper bounds to the long-run inflation rate. He shows that the statements made by the FOMC in 2003 clarified the lower bound of its LIO and that the average of long-run inflation expectations responded by rising about 80 basis points. Moreover, consistent with reducing the market's uncertainty about the FOMC's LIO, long-run inflation expectations became more stable. The FOMC has recently been more specific about the upper bound of its LIO as well. The FOMC could eliminate the remaining uncertainty by establishing an explicit, numerical inflation objective. [ABSTRACT FROM AUTHOR]

This article first explores the implications of model specification on the design of targeting rules in a world of model certainty. As a general prescription, a targeting rule must counterbalance the private-sector dynamics: The more backward-looking behavior is observed in either the output gap or inflation, the more forward-looking monetary policy should be. Likewise, a more forward-looking economy would require stronger backward-looking reactions of the nominal interest rate to the output gap or inflation. The article also analyzes the effects of implementing monetary policy in an environment with uncertainty. Our results indicate that a simple model-invariant rule of the style proposed by Taylor (1993) performs better than a model-dependent targeting rule in the presence of moderate parameter uncertainty. [ABSTRACT FROM AUTHOR]

The article explores the nature of the rule followed by the U.S. Federal Reserve Board in making its monetary policy. It argues that monetary economists have not yet developed a formal rule that is likely to have better operating properties than the Federal Reserve's practice. It discusses the predictability of the Federal Reserve's policy decisions. It analyzes the goal of low and stable inflation as used to sustain economic growth.

Many estimated macroeconomic models assume interest rate smoothing in the monetary policy equation. In practice, monetary policymakers adjust a target level for the federal funds rate by discrete increments. One often-neglected consequence of using a quarterly average of the daily federal funds rate in empirical work is that any change in the target federal funds rate will affect the quarterly average in the current quarter and the subsequent quarter. Despite this clear source of predictable change in the quarterly average of the federal funds rate, the vast bulk of the literature that estimates policy rules ignores information concerning the timing and magnitude of discrete changes to the target federal funds rate. Consequently, policy equations that include interest rate smoothing inadvertently make the strong and unnecessary assumption that the starting point for interest rate smoothing is last quarter's average level of the federal funds rate. The authors consider, within an estimated general equilibrium model, whether policymakers put weight on the end-of-quarter target level of the federal funds rate when choosing a point at which to smooth the interest rate. [ABSTRACT FROM AUTHOR]

Discusses the implications of central bank transparency for the formation of U.S. monetary policy. Fundamentals of macroeconomics equilibrium; Cases of miscommunication; Examination of the economic purpose of disclosure.

Identifies economic policy discretion as a cause of indeterminate equilibrium. Discretion's effects on the number of equilibria, and on their volatility; Definition of the term discretion; Baseline model; Social security with majority voting.

Examines the criteria for interest rates, inflation rates, government finances and exchange rates in establishing an economic and monetary union (EMU) within the European Union. Creation of a committee for the study of EMU called the Delors Committee; Recommendations of the committee as the basis for the negotiations on EMU in the Maastricht Treaty. INSET: Institutions of the European Union..

The article discusses the importance of potential output in economic policy-making in Brazil. The economic slowdown and inflationary pressures can be determined through potential output. It is stated that potential output helps to build measures of the output gap and is considered an important variable in economic models. According to the author, estimates of potential output are mostly incorrect. Several statistical methods are used by the Central Bank of Brazil to measure potential output.