LECTURE 10 Monetary Policy at the Zero Lower Bound ... · 10/26/2016 · • Example: Fiscal policy. • Wieland argues that his evidence “suggests that the inflation expectations

LECTURE 10 Monetary Policy at the Zero Lower Bound:

Expectations Effects

October 26, 2016

Economics 210c/236a Christina Romer Fall 2016 David Romer

I. OVERVIEW

Cases of Countries Hitting the Zero Lower Bound

• US and UK in the 1930s.

• Japan starting in the late 1990s.

• US, Europe, and Japan starting in 2008.

Papers for Today

• Temin and Wigmore (U.S. in the 1930s)

• With a brief discussion of Eggertsson and Pugsley

• Wieland (Japan, mainly in the 1990s and 2000s)

• Hausman and Weiland (Japan after 2012)

How can monetary policy matter at the zero lower bound?

• Expectations effects.

• Expectations of prices, growth, future interest rates.

• Quantitative easing and portfolio balance effects.

• Others?

• Special case of the exchange rate.

II. TEMIN AND WIGMORE, “THE END OF ONE BIG DEFLATION”

From: Romer, “What Ended the Great Depression?”

Nominal Interest Rate (3-6 mo. Treasury Notes)

0

1

2

3

4

5

6

Jan-

29

Jul-2

9

Jan-

30

Jul-3

0

Jan-

31

Jul-3

1

Jan-

32

Jul-3

2

Jan-

33

Jul-3

3

Jan-

34

Jul-3

4

Jan-

35

Jul-3

5

Per

cent

Industrial Production

1929

-01

1929

-06

1929

-11

1930

-04

1930

-09

1931

-02

1931

-07

1931

-12

1932

-05

1932

-10

1933

-03

1933

-08

1934

-01

1934

-06

1934

-11

1935

-04

1935

-09

1936

-02

1936

-07

1936

-12

1937

-05

1937

-10

1

1.2

1.4

1.6

1.8

2

2.2

2.4In

dust

rial

Prod

uctio

n (L

ogar

ithm

s)

What is a regime shift?

• A dramatic change in the policy framework.

• Leads agents to expect long-lasting changes in policy.

Roosevelt’s Regime Shift

• Hoover was committed to the gold standard, monetary inaction, and fiscal orthodoxy.

• Roosevelt devalued in April 1933. Temin and Wigmore believe devaluation was the key sign of the regime shift.

• Followed up with fiscal and monetary expansion.

Roosevelt’s Communications Policy

• Second Fireside Chat, May 7, 1933:

“The Administration has the definite objective of raising commodity prices to such an extent that those who have borrowed money will, on the average, be able to repay that money in the same kind of dollar which they borrowed. … That is why powers are being given to the Administration to provide, if necessary, for an enlargement of credit …”

Inflation Video

DepressionVideo.mp4

Stock Prices

1.5

6.5

11.5

16.5

21.5

26.5

31.5

36.5

Jan-

27

Aug-

27

Mar

-28

Oct

-28

May

-29

Dec-

29

Jul-3

0

Feb-

31

Sep-

31

Apr-

32

Nov

-32

Jun-

33

Jan-

34

Aug-

34

Mar

-35

Oct

-35

May

-36

Dec-

36

Mon

thly

S&

P St

ock

Pric

e In

dex

Producer Price Index, All Commodities

2.3

2.4

2.5

2.6

2.7

2.8

2.9

Jan-

29

Aug-

29

Mar

-30

Oct

-30

May

-31

Dec-

31

Jul-3

2

Feb-

33

Sep-

33

Apr-

34

Nov

-34

Jun-

35

Jan-

36

Aug-

36

Mar

-37

Oct

-37

Prod

ucer

Pric

e In

dex,

Log

arith

ms

Expected Inflation as Measured Using Commodity Futures Prices

-12.00

-9.00

-6.00

-3.00

0.00

3.00

6.00

9.00

1928

:1

1929

:1

1930

:1

1931

:1

1932

:1

1933

:1

1934

:1

1935

:1

1936

:1

1937

:1

Perc

ent

From: Hamilton, “Was the Deflation During the Great Depression Anticipated?”

Fig. 3. Daily Average Frequency Over the Month of the Terms “Inflation” and “Deflation” Note: The figure displays the daily average frequency over the month of the following terms: “inflation” or “inflationary” and “deflation” or “deflationary.” For each term, one series considers only the article's title while the other series considers the entire article. The figure presents the aggregate results across five national daily news sources: the New York Times, the Wall Street Journal, the Los Angeles Times, the Chicago Tribune, and the Washington Post. These newspapers are available electronically via ProQuest.

From: Jalil and Rua, “Inflation Expectations and Recovery in Spring 1933”

Devaluation in April 1933

Price of Cotton ($)

Exchange Rate ($ / ₤)

Pric

e of

Cot

ton,

in c

ents

Exch

ange

Rat

e

From: Temin and Wigmore, “The End of One Big Deflation”

Truck Production, 1927-1936

0

10

20

30

40

50

60

70

80

90

100

Jan-

27Ju

l-27

Jan-

28Ju

l-28

Jan-

29Ju

l-29

Jan-

30Ju

l-30

Jan-

31Ju

l-31

Jan-

32Ju

l-32

Jan-

33Ju

l-33

Jan-

34Ju

l-34

Jan-

35Ju

l-35

Jan-

36Ju

l-36

Thou

sand

s of

Tru

cks

From: FRED, Federal Reserve Bank of St. Louis

Temin and Wigmore’s Auto Sales Regression


Steel Production and Industrial Production

Consumption

Investment

Industrial Production

Steel Inde

x, 1

935-

39=1

00


Investment and Consumption Spending, 1932-33

Nondurables Consumption

Investment


Evaluation

III. EGGERTSSON AND PUGSLEY, “THE MISTAKE OF 1937”

How Eggertsson and Pugsley Fit Into the Lecture

• Temin and Wigmore say a switch to an inflationary regime can be helpful at the ZLB

• Use April 1933 as an example.

• Eggertsson and Pugsley say a change in expectations of future policy away from reflation and expansion can be very damaging at the ZLB.

• Use 1937–38 recession as an example.

Industrial Production, 1926–1941

https://fred.stlouisfed.org/graph/?g=7V5B

Alternative Explanations for the 1937–38 Recession

• Increase in reserve requirements (Friedman and Schwartz, Calomiris, Mason, and Wheelock)

• Sterilization of gold inflows (Irwin)

• Fiscal contraction

• Supply shocks (Hausman)

Eggertsson and Pugsley’s Explanation

• Policymakers started expressing concern about inflation and deficits.

• Caused a negative change in expectations of future policy.

• This had contractionary effects on real activity.

Eggertsson and Pugsley’s Model

• DSGE model with binding zero lower bound due to real shocks.

• Calibrate model and find that inflation and output are extremely sensitive to changes in beliefs about future policy at ZLB. (Sensitivity is asymmetric.)

• Source of sensitivity is “contractionary spiral”—change in expectations in one instance affects expectations in other situations, and those expectations feed on each other (vicious feedback loop).

Eggertsson and Pugsley’s Evidence

• Narrative evidence from statements and actions.

• Behavior of commodity prices.

• Behavior of long-rates relative to short rates.

• The behavior of the economy when statements and actions changed back.

From: Eggertsson and Pugsley, “The Mistake of 1937”




Evaluation

IV. JOHANNES WIELAND, “ARE NEGATIVE SUPPLY

SHOCKS EXPANSIONARY AT THE ZERO LOWER BOUND?”

Motivation

• Standard models have counterintuitive implications at the zero lower bound (various “paradoxes”).

• A central implication of this type: An adverse supply shock, by raising expected inflation and so lowering the real interest rate, is expansionary at the zero lower bound.

• Wieland wants to test this prediction and investigate the implications of the results.

Key Questions

• Empirical: Are specific supply shocks (the Great Japan Earthquake, falls in oil supply) expansionary at the zero lower bound.

• Theoretical: If the answer is no, how broad are the implications? (For example, does it have implications for the fiscal multiplier at the zero lower bound? For measures to raise expected inflation through expectations of future monetary policy?)

Test 1: The Japanese Great Earthquake of March 2011

From: Wieland, “Are Negative Supply Shocks Expansionary at the Zero Lower Bound?”

What Do We Learn from:

• The behavior of forecasts?

• The fact that the Bank of Japan loosened monetary policy?

• The actual behavior of output and inflation?

Test #2: Adverse Oil Supply Shocks

1. Addressing the complications coming from the fact that oil is both consumed directly and used as an input into production.

2. Identifying oil supply shocks.

3. Are they temporary?

4. Results.

Step 1: Oil in Production and Consumption

Step 2: Identifying Oil Supply Shocks

• A VAR with a timing assumption: “I assume that oil production responds to other structural shocks (e.g., demand shocks) with at least a one-month delay.”

Step 3: Are the Oil Price Changes Temporary?

An Aside on Unit Root Tests

• Figure 3b addresses the relevant question here.

• The unit root tests do not.

A Preliminary Result: Checking the Conditions of Proposition 6


Step 4: Results


Step 4: Results


Discussion

Interpretation

• Is he presenting evidence against a narrow or a broad class of models?

• Hard to know!

• Example: Fiscal policy.

• Wieland argues that his evidence “suggests that the inflation expectations channel is unlikely to be a source of large fiscal multipliers” at the zero lower bound.

• But this doesn’t rule out large fiscal multipliers at the zero lower bound through a traditional Keynesian multiplier.

Wieland’s Alternative: A Model Where Credit Constraints Are Central

V. HAUSMAN AND WEILAND, “OVERCOMING THE LOST DECADES? ABENOMICS AFTER THREE YEARS”

Overview

Types of Evidence

• Financial markets.

• Macro aggregates (including comparisons with forecasts).

• Digging into specific variables:

• Inflation (including the Phillips curve).

• Nominal wages.

• Consumption (including micro evidence).

• Imports.

Financial Market Variables

GDP Forecasts

GDP

Digging into Specific Variables

• Inflation (including the Phillips curve).

• Nominal wages.

• Consumption (including micro evidence).

• Imports.

Discussion

Documents

LECTURE 10 Monetary Policy at the Zero Lower Bound ... · 10/26/2016 · • Example: Fiscal policy. • Wieland argues that his evidence “suggests that the inflation expectations