ForeignExchangeInterven1onat
theZeroLowerBound
OrinLevinthalandIritRozenshtrom
Discussion,Mar1nEichenbaum
IDC,12/28/2015
1
Keymessageofthepaper
•  Foreignexchangerateinterven1onhasverysmalleffectson
aggregateoutputduring`normal’1mes.
•  WhentheZLBisbinding,theseeffectscanbemuchbigger.
•  ConsistentwithstandardDSGEanalyses,BoImodelimplies:
–  themorebindingtheZLBis,thelargeristheimpactofanypolicythat
increaseaggregatedemand,
–  examplesincludeincreaseingovernmentpurchasesandpoliciesthat
s1mulatenetexports.
2
Outline
•  WhydoestheZLBmaVersomuch?
•  WastheZLBbindinginIsraelin2008?
•  IstheZLBbindingnow?
•  Thelimitstomonetarypolicyinasmallopeneconomy.
3
ASimpleTaylorRule
i=π+φ1(π–2)–φ2(OutputGap)+r
•  i:short-termpolicyrate
•  r:realinterestrate(2%)andBOI’stargetinfla1onrateis2%
–  Ifπ=2andtheoutputgapzero,thenthepolicyrateis4percent.
•  Foreachone-pointincreaseinπ,raisepolicyrateby1+φ1
percentagepoints.
•  Foreachonepercentagepointriseintheoutputgap,reduce
thepolicyratebyφ2percentagepoints.
4
Assumewe’rebelowfullemployment
•  Saygovernmentincreasesspendingongoods.
•  Leadstoarisetoariseinaggregatedemand,eventaking
associatedriseintaxliabili1esintoaccount.
•  Employmentandoutputrise.
•  Riseinoutputleadstoariseinrealwages,otherproduc1on
costs.
•  Firmsreacttorisingmarginalcostsbyraisingprices,soinfla1on
rises.
Thenormalmul1plier
•  BoIrespondstoriseininfla1onbyraisingrealinterestrate.
•  Consump1onandinvestmentdemandfallsoaggregatedemand
risesbylessthanone-to-onewiththeriseingovernment
spending.
•  RiseinGcrowdsoutconsump1onandinvestment.
•  Somul1plierwillbeposi1vebutlessthanone.
ExchangeRateInterven1on
•  PushdownvalueofNISbysellingNIS/buying$’s
•  Resul1ngfallinrela1vepriceofIsraeligoodsboostsexports,
lowerimports.
•  LikeanincreaseinG,thispolicyraisesaggregatedemandfor
Israeligoods
–  EvenmorepowerfulthanincreaseinGbecausetherearenooffsehng
taxeffects.
•  Problems:
–  AweakerNISgeneratesinfla1on,soBoIwillraiserates,offsehngboostin
aggregatedemand.
–  Howlongcanyoucanlowerrela1vepricesfor?
–  Howresponsiveareexportstoatemporarychangeinrela1veprices?
TheZeroLowerBound
•  TheTaylorrule:
iff=π+φ1(π–2)–φ2(OutputGap)+2
•  Keyconstraint:ican’tbe(too)nega1ve.
•  SupposeZLBisbinding
Realinterestrate(t)=R(t)-πe(t)=-πe(t)
•  WhentheZLBbindsandthere’shighexpectedinfla1on,the
realrateislow.
VirtuousCyclesintheZLB
•  AnincreaseinGleadstoariseinoutput,marginalcostand
expectedinfla1on.
•  Withnominalinterestratestuckatzero,resul1ngriseinexpected
infla1ondrivesdownrealinterestrate,drivingupprivate
spending.
•  Thisriseinspendingleadstoafurtherriseinoutput,marginal
costandexpectedinfla1on,afurtherdeclineintherealinterest
rateandariseinconsump1on.
•  Netresultisalargeriseininfla1onandoutput.
•  Mul1pliercanbemuchlargerthanone.
Exchangerateinterven1onsintheZLB
•  Samelogicappliestointerven1onthatleadsto
deprecia1oninNIS.
•  Deprecia1onleadstoariseinnextexports.
–  AriseindemandforIsraeligoods.
–  Similartoariseingovernmentspending.
•  Passthroughinfla1onleadstoaseparateinfla1onary
channelwhichlowersrealinterestrate(inZLB).
Thesizeofthemul1plier
•  Theexactvalueofthemul1plierdependson
variousfactors.
•  Structuralnew-Keynesianmodels
–  Mul1plierislargewhenoutputcostassociatedwithZLB
problemislarge.
–  Highlycorrelatedwitthesizeoftheoutputgap.
•  IstheoutputgapbiginIsrael?
OutputGap/UnemploymentinIsrael
Mixedsignals:dependsonwhetheryoulookatoutput
gap(produc1onfunc1onbased)orunemploymentrate.
Infla1oninIsrael
CPIinfla1onisverylow.
ExchangeRates
Adropinthisexchangeratemeasureindicatesanapprecia1onoftheNIS
TaylorRuleforIsrael
WhyistheZLBborder-linebinding?
•  It’snotbecauseofalargeoutputgap.
–  Mixedsignalsonsignofoutputgap.
–  OECDprojectsGDPgrowthtoberoughly3.5%in2016
and2017.
•  MainreasonZLBmightisborderlinebindingin
Israel:CPIinfla1onissolow.
•  Absentacompellingargumentthatoutputgapis
verylarge,adesiretoincreaseinfla1onperse
seemslikeastrangereasontointervenein
exchangeratemarket.
Israeliexportshavebeenweak
•  Primarilyreflectstheglobalslowdown.
•  Thatweaknessraisestworelated,muchlargerissues.
•  WhatisthecorrectrealinterestratetoputinIsrael’sTaylorrule?
–  Ifinterestrateislower,theZLBismorebindingthanstandardcalcula1ons
indicate.
•  Secularstagna1onhypothesis:realinterestarenowpermanentlyand
substan1allylowerthan2%
–  Perhapsaslowzero(Summers).
–  Reflectspersistentlylowergrowthrateintherestofworld.
•  Combina1onoflowgrowth,lowrealinterestrates,lowinfla1onrates
suggestsit’saglobal`demand’problem,notasupplyproblem.
DecliningRealInterestRatesand
Infla1onExpecta1ons
IfSummersiscorrect...
•  Lowerrealinterestrateswillbeaverypersistentproblem.
•  Conven1onalmonetaryisunlikelytohavestrongeffects.
•  It’sunlikelythatinterven1onsthattemporarilyaffectthe
realexchangeratecanhaveabigimpactonIsraelioutput.
•  Israelshouldfocusonfiscalpolicyandstructuralreforms
toincreaseitscompe11veness.