Hostname: page-component-cd9895bd7-gxg78 Total loading time: 0 Render date: 2024-12-23T06:14:22.315Z Has data issue: false hasContentIssue false
  • English
  • Français

“WAIT-AND-SEE” MONETARY POLICY

Published online by Cambridge University Press:  30 October 2017

Xiaowen Lei  and
Michael C. Tseng
Xiaowen Lei*
Affiliation:
Simon Fraser University
Michael C. Tseng
Affiliation:
Swiss Finance Institute
*
Address correspondence to: Xiaowen Lei, Department of Economics, Simon Fraser University, WMC 2700, 8888 University Dr, Burnaby, BC, V5A 1S6, Canada; e-mail: [email protected].
Get access Rights & Permissions [Opens in a new window]

Abstract

This paper develops a model of the optimal timing of interest rate changes. With fixed adjustment costs and ongoing uncertainty, changing the interest rate involves the exercise of an option. Optimal policy therefore has a “wait-and-see” component, which can be quantified using option pricing techniques. We show that increased uncertainty makes the central bank more reluctant to change its target interest rate, and argue that this helps explain recent observed deviations from the Taylor Rule. An optimal wait-and-see policy fits the target interest rates of the Fed and Bank of Canada better than the Taylor Rule.

Keywords

Monetary PolicyInterest Rate InertiaOptimal Stopping
Type
Articles
Information
Macroeconomic Dynamics , Volume 23 , Issue 5 , July 2019 , pp. 1793 - 1814
Copyright
Copyright © Cambridge University Press 2017 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

We gratefully acknowledge Kenneth Kasa, without whose guidance, patience, and encouragement this paper would not have been possible. We are also especially grateful to an anonymous referee for many useful suggestions. We also thank Galo Nuño, James Costain, Janet Hua Jiang, Jinill Kim, Edouard Djeutem, David Andolfatto, Robert Jones, Luba Petersen, John Knowles, Lucas Herrenbrueck, Peter Zadrozny, and participants in the Simon Fraser University Economics PhD seminar, and Simon Fraser University Economics Brown Bag seminar, for helpful comments. We are responsible for all the remaining errors.

References

REFERENCES

Adams, Robert A. and Fournier, John J. F. (2003) Sobolev Spaces. Amsterdam: Academic Press.Google Scholar
Alba, Joseph D. and Wang, Peiming (2017) Taylor Rule and discretionary regimes in the United States: Evidence from a k-state Markov regime-switching model. Macroeconomic Dynamics 21, 817–833.Google Scholar
Alvarez, Fernando and Dixit, Avinash (2014) A real options perspective on the future of the Euro. Journal of Monetary Economics 61, 78–109.Google Scholar
Barndorff-Nielsen, E. Ole, Mikosch, Thomas, and Resnick, Sidney I. (2001) Lévy Processes: Theory and Applications. New York: Springer.Google Scholar
Blinder, Alan S. (2009) Making monetary policy by committee. International Finance 12, 171–194.Google Scholar
Bloom, Nicholas, Floetotto, Max, Jaimovich, Nir, Saporta-Eksten, Itay, and Terry, Stephen J. (2012) Really Uncertain Business Cycles. Technical report no. w18425, National Bureau of Economic Research.Google Scholar
Caplin, Andrew and Leahy, John (1994) Business as usual, market crashes, and wisdom after the fact. American Economic Review 84, 548–565.Google Scholar
Davig, Troy and Leeper, Eric M. (2008) Endogenous monetary policy regime change. In Reichlin, Lucrezia and West, Kenneth (eds.), NBER International Seminar on Macroeconomics 2006, pp. 345–391. Chicago: University of Chicago Press.Google Scholar
Dixit, Avinash K. (1993) The Art of Smooth Pasting. Switzerland: Harwood Academic Publishers.Google Scholar
Dixit, Avinash K. (1994) Investment Under Uncertainty. Princeton, NJ: Princeton University Press.Google Scholar
Dynkin, Evgeniĭ B. (1965) Markov Processes. New York: Springer.Google Scholar
Fernández-Villaverde, Jesús, Posch, Olaf, and Rubio-Ramírez, J. F. (2012) Solving the new Keynesian model in continuous time. Unpublished manuscript, Federal Reserve Bank of Atlanta.Google Scholar
Froot, Kenneth A. and Obstfeld, Maurice (1989) Stochastic Process Switching: Some Simple Solutions. Technical report no. w2998, National Bureau of Economic Research.Google Scholar
Galí, Jordi (2009) Monetary Policy, Inflation, and the Business Cycle: An Introduction to the New Keynesian Framework. Princeton, NJ: Princeton University Press.Google Scholar
Galí, Jordi and Gertler, Mark (1999) Inflation dynamics: A structural econometric analysis. Journal of Monetary Economics 4, 195–222.Google Scholar
Gel'fand, Izrail M. and Vilenkin, N. Ya. (2014) Generalized Functions: Applications of Harmonic Analysis. New York: Academic Press.Google Scholar
Holston, Kathryn, Laubach, Thomas, and Williams, John (2017) Measuring the natural rate of interest: International trends and determinants. Journal of International Economics. doi:10.1016/j.jinteco.2017.01.004.Google Scholar
Kahn, George A. (2010) Taylor rule deviations and financial imbalances. Federal Reserve Bank of Kansas City, Economic Review 95 (2), 63–99.Google Scholar
Levin, Andrew T. and Williams, John C. (2003) Robust monetary policy with competing reference models. Journal of Monetary Economics 50, 945–975.Google Scholar
Levin, Andrew T., Wieland, Volker, and Williams, John C. (1999) Robustness of simple monetary policy rules under model uncertainty. In Taylor, John B. (ed.), Monetary Policy Rules, pp. 263–318. Chicago: University of Chicago Press.Google Scholar
Lipster, Robert S. and Shiryayev, Albert N. (1989) Theory of Martingales. Pordrecht, The Netherlands: Kluwer.Google Scholar
Littman, Walter, Stampacchia, Guido, and Weinberger, Hans F. (1963) Regular points for elliptic equations with discontinuous coefficients. Annali della Scuola Normale Superiore di Pisa-Classe di Scienze 17, 43–77.Google Scholar
Mankiw, N. Gregory and Reis, Ricardo (2002) Sticky information versus sticky prices: A proposal to replace the New Keynesian Phillips curve. The Quarterly Journal of Economics 117, 1295–1328.Google Scholar
Miao, Jianjun and Wang, Neng (2011) Risk, uncertainty, and option exercise. Journal of Economic Dynamics and Control 35, 442–461.Google Scholar
Murray, Christian J., Nikolsko-Rzhevskyy, Alex, and Papell, David H. (2015) Markov switching and the Taylor principle. Macroeconomic Dynamics 19, 913–930.Google Scholar
Øksendal, Bernt (1985) Stochastic processes, infinitesimal generators and function theory. Operators and Function Theory 153, 139–162.Google Scholar
Protter, Philip E. (2004) Stochastic Integration and Differential Equations. Berlin: Springer.Google Scholar
Rotemberg, Julio J. and Woodford, Michael (1999) Interest rate rules in an estimated sticky price model. In Taylor, John B. (ed.), Monetary Policy Rules, pp. 57–126. Chicago: University of Chicago Press.Google Scholar
Rudebusch, Glenn D. (2006) Monetary policy inertia: Fact or fiction? International Journal of Central Banking 2, 85–135.Google Scholar
Sargent, Thomas J. (1999) The Conquest of American Inflation. Princeton, NJ: Princeton University Press.Google Scholar
Sims, Christopher A. (2010) Rational inattention and monetary economics. In Friedman, Benjamin M. and Woodford, Michael (eds.), Handbook of Monetary Economics, 1st ed., vol. 3, pp. 155–181. Amsterdam: North Holland.Google Scholar
Stokey, Nancy L. (2008) The Economics of Inaction: Stochastic Control Models with Fixed Costs. Princeton, NJ: Princeton University Press.Google Scholar
Stokey, Nancy L. (2016) Wait-and-see: Investment options under policy uncertainty. Review of Economic Dynamics 21, 246–265.Google Scholar
Svensson, Lars E. O. and Williams, Noah (2008) Optimal monetary policy under uncertainty: A Markov jump-linear-quadratic approach. Federal Reserve Bank of St. Louis Review 90, 275–293.Google Scholar
Taylor, John B. (2014) The role of policy in the Great Recession and the weak recovery. American Economic Review 104, 61–66.Google Scholar
Trojanowska, Magdalena and Kort, Peter M. (2010) The worst case for real options. Journal of Optimization Theory and Applications 146, 709–734.Google Scholar
Woodford, Michael (1999) Optimal monetary policy inertia. The Manchester School 67, 1–35.Google Scholar
Woodford, Michael (2003) Interest and Prices: Foundations of A Theory of Monetary Policy. Princeton, NJ: Princeton University Press.Google Scholar