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We propose a multicountry quantile factor augmeneted vector autoregression (QFAVAR) to model heterogeneities both across countries and across characteristics of the distributions of macroeconomic time series. The presence of quantile factors allows for summarizing these two heterogeneities in a parsimonious way. We develop two algorithms for posterior inference that feature varying level of trade-off between estimation precision and computational speed. Using monthly data for the euro area, we establish the good empirical properties of the QFAVAR as a tool for assessing the e ects of global shocks on country-level macroeconomic risks. In particular, QFAVAR short-run tail forecasts are more accurate compared to a FAVAR with symmetric Gaussian errors, as well as univariate quantile autoregressions that ignore comovements among quantiles of macroeconomic variables. We also illustrate how quantile impulse response functions and quantile connectedness measures, resulting from the new model, can be used to implemennt joint risk scenario analysis.

We test for bias and efficiency of the ECB inflation forecasts using a confidential dataset of ECB macroeconomic quarterly projections. We investigate whether the properties of the forecasts depend on the level of inflation, by distinguishing whether the inflation observed by the ECB at the time of forecasting is above or below the target. The forecasts are unbiased and efficient on average, however there is evidence of state dependence. In particular, the ECB tends to overpredict (underpredict) inflation at intermediate forecast horizons when inflation is below (above) target. The magnitude of the bias is larger when inflation is above the target. These results hold even after accounting for errors in the external assumptions. We also find evidence of inefficiency, in the form of underreaction to news, but only when inflation is above the target. Our findings bear important implications for the ECB forecasting process and ultimately for its communication strategy.

We use a TVP-VAR model to investigate possible changes in the time series properties of key Norwegian macroeconomic variables since the 1980s. The sample period is characterised by deregulation, globalization, sizable petroleum revenues, a switch from exchange rate to inflation targeting and adoption of a policy rule for the use of petroleum revenues.We find that the long-run means of CPI and core inflation rates declined significantly until the mid-1990s and have since then remained close to the inflation target of 2.5% from 2001 onwards. The persistence in especially CPI inflation has fallen during the inflation targeting period while the volatility of both inflation rates and the nominal effective exchange rate has increased. We document an increase in the correlations between money market rates and the inflation rates as well as the output gap during the inflation targeting period and a steady decline towards zero in the correlations between money market rates and nominal exchange rate changes. There is evidence of an increase in the correlations between oil prices and the other macroeconomic variables over time. Our counterfactual analysis suggests oil shocks to have been important for output gap and inflation volatility while monetary policy shocks have been important for driving inflation persistence and the correlation of money market rates with macroeconomic variables.

With sticky prices, optimizing agents and money in the utility function, I derive the exact analytical solution for optimal monetary policy given a zero lower bound (ZLB) on the interest rate. The Phillips curve is Neo-Classical, and the ZLB is then not a constraint on optimal policy. Optimal policy is history dependent even without a commitment problem and implements a Friedman rule equilibrium. The role of forward guidance in policy is more limited than under a New-Keynesian Phillips curve. The optimal policy rule intercept term is time varying and depends on the variance of the natural real rate.

The lumpy nature of plant-level investment is generally not taken into account in the context of monetary theory (see, e.g., Christiano et al. 2005 and Woodford 2005). We formulate a generalized (S,s) pricing and investment model which is empirically more plausible along that dimension. Surprisingly, our main result shows that the presence of lumpy investment casts doubt on the ability of sticky prices to imply a quantitatively relevant monetary transmission mechanism.

We consider standard monetary-policy rules with inflation-rate targets and interest-rate or money-growth instruments using a flexible-price, perfect foresight model. There is always a locally-unique target equilibrium. There are also below-target equilibria (BTE) with inflation always below target and constant or asymptotically approaching or eventually reaching a below-target value. Liquidity traps are neither necessary nor sufficient for BTE which can arise if monetary policy keeps the interest rate above a lower bound. We construct monetary-policy rules, that preclude BTE, some of which are monotonic in inflation but all of which are non-differentiable at a point. For standard monetary-policy rules there are plausible fiscal policies that insure uniqueness by precluding BTE; those policies exclude perpetual surpluses and, possibly, perpetual balanced budgets.

We employ information-gap decision theory to derive a robust monetary policy response to Knightian parameter uncertainty. This approach provides a quantitative answer to the question: For a specified policy, how much can our models and data err or vary, without rendering the outcome of that policy unacceptable to a policymaker? For a given acceptable level of performance, the policymaker selects the policy that delivers acceptable performance under the greatest range of uncertainty. We show that such information-gap robustness is a proxy for probability of policy success. Hence, policies that are likely to succeed can be identified without knowing the probability distribution. We adopt this approach to investigate empirically the robust monetary policy response to a supply shock with an uncertain degree of persistence.

We investigate the importance of employing a valid model for monetary policy analysis. Specifically, we investigate the economic significance of differences in specification and empirical validity of models. We consider three alternative econometric models of wage and price inflation in Norway. We find that differences in model specification as well as in parameter estimates across models can lead to widely different policy recommendations. We also find that the potential loss from basing monetary policy on a model that may be invalid, or on a suite of models, even when it contains the valid model, can be substantial, also when gradualism is exercised as a concession to model uncertainty. Furthermore, possible losses from such a practice appear to be greater than possible losses from failing to choose the optimal policy horizon to a shock within the framework of a valid model. Our results substantiate the view that a model for policy analysis should necessarily be empirically valid and caution against compromising this property for other desirable model properties, including robustness.

The output gap (measuring the deviation of output from its potential) is a crucial concept in the monetary policy framework, indicating demand pressure that generates inflation. The output gap is also an important variable in itself, as a measure of economic fluctuations. However, its definition and estimation raise a number of theoretical and empirical questions. This paper evaluates a series of univariate and multivariate methods for extracting the output gap, and compares their value added in predicting inflation. The multivariate measures of the output gap have by far the best predictive power. This is in particular interesting, as they use information from data that are not revised in real time. We therefore compare the predictive power of alternative indicators that are less revised in real time, such as the unemployment rate and other business cycle indicators. Some of the alternative indicators do as well, or better, than the multivariate output gaps in predicting inflation. As uncertainties are particularly pronounced at the end of the calculation periods, assessment of pressures in the economy based on the uncertain output gap could benefit from being supplemented with alternative indicators that are less evised in real time.

What are the consequences for monetary policy design implied by the fact that price setting and investment takes typically place simultaneously at the firm level? To address this question we analyze simple (constrained) optimal interest rate rules in the context of a dynamic New Keynesian model featuring firm-specific capital accumulation as well as sticky prices and wages à la Calvo. We make the case for Taylor type rules. They are remarkably robust in the sense that their welfare implications do not appear to hinge neither on the specific assumptions regarding capital accumulation that are used in their derivation nor on the particular definition of natural output that is used to construct the output gap. On the other hand we find that rules prescribing that the central bank does not react to any measure of real economic activity are not robust in that sense.

Smoothness in aggregate capital accumulation is a necessary condition for New-Keynesian (NK) models to imply a quantitatively relevant monetary transmission mechanism (see, e.g., Woodford 2005). Can that aggregate smoothness be entertained in the context of an NK model featuring lumpy plant-level investment? Our answer is yes. Imperfect competition in goods markets and/or sticky prices are identified as economic mechanisms which render lumpy investment relevant in general equilibrium.

We model capital accumulation in a dynamic New-Keynesian model with staggered price setting à la Calvo. It is assumed that firms do not have access to a rental market for capital. We compare our model with an alternative specification where households accumulate capital and rent it to firms. The difference in implied equilibrium dynamics is large, as we justify by proposing a simple metric. This result invites us to interpret some of the puzzling empirical findings that have been obtained using models with staggered price setting and a rental market for capital as an artefact of this particular set of assumptions.

In this paper we investigate the formation of Norwegian import prices of manufactures over the period 1970(1)–1998(3), thereby extending the sample period used in the study by Naug and Nymoen (1996). If international goods markets are perfectly integrated and the law of one price holds, then for a small open economy we would expect import prices to be exogenously given in foreign currency and to fully respond to movements in the exchange rate. However, empirical studies of small open economies have shown that exchange rate changes are not fully reflected in import prices, and that domestic variables have significant effects on import prices. Applying both single-equation and multivariate cointegration analysis we find evidence of a long-run cointegrating relationship between Norwegian import prices, foreign export prices measured in domestic currency, domestic unit labour costs, and the domestic unemployment rate. Our results indicate that exchange rate pass-through is complete in the long run. In contrast, Naug and Nymoen (1996) report a long-run pass-through coefficient of 0.63.

The paper describes the influx of mathematical statistics in economics. It focuses on an approach to macroeconometric modelling which is based on fundamental statistical concepts like the joint distribution function of all observable variables for the whole sample period. The methodology relies on valid conditioning and marginalisation of this function in order to arrive at tractable subsystems, which can be analysed with statistical methods. Two case studies - the modelling of the household sector and the modelling of wages and prices in the Norges Bank RIMINI model - highlight this.

Despite the emerging consensus on the validity of purchasing power parity (PPP) between trading countries in the long run, empirical evidence in favour of the PPP theory is scarce in data predominantly exposed to real shocks. This paper tests for PPP between Norway and its trading partners using quarterly observations from the post Bretton Woods period, in which the Norwegian economy has been exposed to numerous real shocks such as frequent revaluations of oil and gas resources through new discoveries and price fluctuations. The paper undertakes an extensive examination of the behaviour of the Norwegian real and nominal exchange rates and shows that it is remarkably consistent with the PPP theory. Moreover, convergence towards the equilibrium level appears relatively fast; our estimate of the half life of a deviation from the equilibrium level is just six quarters. This is partly attributed to the Norwegian government’s policies aimed at preserving the competitiveness of the economy and the system of centralized wage bargaining.

Three classes of inflation models are discussed: Standard Phillips curves, New Keynesian Phillips curves and Incomplete Competition models. Their relative merits in explaining and forecasting inflation are investigated theoretically and empirically. We establish that Standard Phillips-curve forecasts are robust to types of structural breaks that harm the Incomplete Competion model forecasts, but exaggerates forecast uncertainty in periods with no breaks. As the potential biases in after-break forecast errors for the Incomplete Competition model can be remedied by intercept corrections, it offers the best prospect of successful inflation forecasting.