Assessing Australian Monetary Policy in the Twenty-First Century, forthcoming Economic Record, with Andrew Leigh.
Using the Reserve Bank of Australia’s MARTIN model we compare actual monetary policy decisions to a counterfactual in which the cash rate is set according to an optimal simple rule. We find that monetary policy played a crucial role in avoiding a potential recession in 2001 and mitigating the downturn in 2008-2009. By contrast we find that the cash rate was too high during 2016-2019, keeping inflation below the Reserve Bank’s target band. Optimal monetary policy in 2016-2019 would have involved a substantially lower cash rate and would have produced significantly better employment outcomes.
Optimal policy design in nonlinear DSGE models: An n-order accurate approximation 2021 European Economic Review, with Hansen J.
We derive an n-order accurate approximation of optimal policy for a wide class of nonlinear DSGE models analytically. Using Taylor polynomials to approximate welfare and the equilibrium, the (n; n + 1) approximation relaxes symmetry in the objective and certainty equivalence in the solution, as implied by a Linear-Quadratic (LQ) approximation with n = 1. When n > 1, we illustrate how curvature in preferences and the constraints can a§ect optimal policy, deriving a solution that is n-order accurate as opposed to first-order accurate only. Comparing solutions when n = 2 (a Quadratic- Cubic approximation) and n = 1 (LQ), in a New Keynesian economy with nominal frictions, we find significant differences in the optimal response to shocks; the joint distributions of wage ináation, the output gap and nominal interest rates; welfare and accuracy.
Commodity Price Volatility with Endogenous Natural Resources, 2018 European Economic Review, with Hansen, J.
Natural resource reserves are exogenous in models of small commodity exporters. We consider richer supply dynamics and model exploration and depletion. These are important for capturing the effects of commodity price shocks including a commodity currency and crowding-out of non-commodity activity. We also consider how welfare and the ranking of optimal monetary and taxation policies change. Without exploration or depletion, optimal monetary and taxation policies can efficiently stabilise the economy in response to commodity price shocks. However, when exploration and depletion are accounted for, changing interest rates to offset price shocks becomes inefficient. Using taxation policy, specifically an ad valorem royalty, remains efficient.
Optimal Monetary Policy Rules for Australia
Using the Reserve Bank of Australia’s macro-econometric model MARTIN and their multi-sector DSGE model we simulate alternative monetary policy rules. We find that the current policy, which sets interest rates in response to both trimmed-mean inflation and the unemployment gap performs well. However targeting the price level in conjunction with the output gap, would further reduce inflation volatility and improve aggregate welfare. We also consider a range of nominal aggregates as policy targets, but we find that they are strictly inferior to a flexible inflation target. Among these nominal aggregates, targeting nominal consumption generates the lowest loss, while targeting nominal gross domestic product produces the highest. These results are robust to an increase in the volatility and correlation of future shocks to the Australian economy that might be caused by worsening climate change.
Anticipated House Purchases and Household Consumption
This paper evaluates how anticipated purchases of housing affect households’ consumption of non-durable goods. I build a non-linear, heterogeneous agent model in which households save in liquid assets and illiquid housing, where the latter can be used as collateral for borrowing. I show that it is able to replicate the empirical distributions of income and wealth within the US economy. In the model there is substantial heterogeneity in households’ marginal propensities to consume. Households with a high probability of buying housing stock lower their consumption of non-durable goods in anticipation of being credit constrained after their purchase. This results in households with low, even negative, marginal propensities to consume. I verify the model’s predictions using micro-data from the PSID to show that (i) consumption falls in anticipation of, and after, changes in the stock of housing and (ii) households who are planning on purchasing housing have negative marginal propensities to consume. Finally, I use this model to examine the general equilibrium effects of tax credits for first home buyers and show that they lead to decreases in aggregate consumption.
We estimate optimal monetary policy in a non-linear New Keynesian model in which nominal wages are downwardly rigid. In our economy there is a welfare trade-off over the optimal rate of inflation. A higher rate of inflation gives workers more flexibility when setting real wages, at the cost of greater price dispersion in the goods market. After outlining a numerical algorithm to solve the model we use micro-data on the distribution of workers’ change in wages to calibrate the nominal wage rigidity. We find that the optimal inflation rate is positive, around 5.4 per cent, and that this optimal rate is inversely related to the assumed rate of productivity growth. Furthermore, we find that downward nominal wage rigidities bend the Phillips curve constraining the inflation rate from falling in times of low demand. This indicates that an inflation rate that is only moderately below its target can mask large falls in the output gap. Finally, we find that the optimal monetary policy rule is given by strictly targeting either wage inflation or the output gap.
Research in Progress
Double Down: How Downwardly Rigid Wages Affects the Economy at the Zero Lower Bound
We build a non-linear New Keynesian model to investigate the interaction between two asymmetric rigidities: the lower bound on nominal interest rates and the inability for nominal wages to decrease. We show that downwardly rigid wages can either amplify or mitigate the welfare loss caused by the zero lower bound depending on the weight the central bank places on stabilisation inflation over the output gap. Finally, we show that the optimal rate of inflation is increased by the presence of both nominal frictions, when modelled either separately or in tandem, and is 2.5 per cent in the baseline calibration.
NIMBYism and Housing Supply
Tariff Uncertainty and Optimal Policy