Credibility Concerns in Optimal Policy Design, Technical
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Abstract:
This paper models credibility management by a government using a simple reputation game in which government type is not directly observable by the private sector. Two non-standard features of the game produce conditions under which it is optimal for a "trustworthy" type (able to pre-commit) to separate itself from an opportunistic type (unable to pre-commit). First, policy announcement is introduced as an instrument, in addition to policy action, so that not only the opportunistic but also the trustworthy type behaves strategically. Second, time preference can differ across types. The combination of a patient trustworthy type and an impatient opportunistic type thus leads to early stages of the game marked by active policymaking (announcements and actions) on the part of the government and rapid learning on the part of the private sector, a result absent in the literature but more in line with reality.
Managing Expectations (working paper version, May, 2008; with Robert G. King and Ernesto S. Pasten)
(Journal of Money, Credit and Banking, Vol 40, Issue 8, 1625-1666)
Abstract:
The idea that monetary policy is principally about "managing expectations" has taken hold in central banks around the world. Discussions of expectations management by central bankers, academics and by financial market participants frequently also include the idea that central bank credibility is imperfect. We adapt a familiar macroeconomic model so as to discuss key concepts in the area of expectations management. Our work also exemplifies a model construction approach to analyzing the dynamics of announcements, actions and credibility which we think makes feasible a wide range of future investigations concerning the management of expectations.
Coordinating Expectations and the Informational Role of Policy (REVISED. June, 2009; with Ernesto S. Pasten)
Abstract:
An informational role of policy arises in
economies where large fluctuations are triggered by self-fulfilling expectation
switches between efficient "optimism" and inefficient
"pessimism," a feature that is common in many dynamic economies with
coordination failures. Policy affects the information about underlying
fundamentals contained in aggregate outcomes, and thus affects the timing of
switches and expectations of future switches. We use a problem of optimal
taxation on labor income as a laboratory to study this role of policy from a
positive and a normative perspective. Our main result is that a stabilization
policy is ineffective after an expectation switch. Instead, policy should
anticipate switches with small permanent tax cuts to extend
"optimism" and severe transitory tax cuts to break "pessimism."
These tax cuts should be reverted once a switch is triggered, when policy must
focus on its short run objectives.
Modeling and Forecasting Stock Return Volatility Using a Random Level Shift Model (August, 2009; with Pierre Perron)
(forthcoming Journal of Empirical Finance)
Abstract:
We consider the estimation of a random level shift model for which the series of interest is the sum of a short memory process and a jump or level shift component. For the latter component, we specify the commonly used simple mixture model such that the component is the cumulative sum of a process which is 0 with some probability (1-α) and is some random variable with probability α. Our estimation method transforms such a model into a linear state space form with mixture of normal innovations, so that an extension of Kalman filter algorithm can be applied. We estimate this random level shifts models for volatility series, proxied by the logarithm of the absolute returns. We do this for the S&P 500, AMEX, Dow Jones and the NASDAQ stock market return indices. Our point estimates imply few level shifts for all series. But once these are taken into account, there is little evidence of serial correlation in the remaining noise and, hence, no evidence of long memory. Once the estimated shifts are introduced to a standard GARCH model, any evidence of GARCH effects disappears. We also produce rolling out-of-sample forecasts. In most cases, our simple random level shift model clearly outperforms a standard GARCH(1,1) model and, in many cases, it also provides better forecasts than a fractionally integrated GARCH model.
Endogenous Sticky Information, Macroeconomic Volatility and Phillips Curve (Apr, 2007; with Ernesto S. Pasten)
(Under Revision)
Coherent Beliefs with Costless Imitative Signaling (with Robert G. King and Ernesto S. Pasten)
(in progress)
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