What Does the Paper Do?
Comments
Discussion of
"Monetary Policy and the Great Moderation"
by Klaus Adam
Marc Giannoni
Columbia University, CEPR, NBER
JME Conference on “Monetary Policy under Imperfect Information"
Gerzensee, December 12, 2008
Conclusion
What Does the Paper Do?
Comments
Paper’s objective
Present a model in which increased emphasis on in‡ation
stabilization by CB causes a “signi…cant” reduction in variance of
output and in‡ation
Conclusion
What Does the Paper Do?
Comments
Paper’s objective
Present a model in which increased emphasis on in‡ation
stabilization by CB causes a “signi…cant” reduction in variance of
output and in‡ation
Why?
Stock Watson (2005, JEEA): Estimated standard dev.(y )
Conclusion
What Does the Paper Do?
Comments
Paper’s objective
Present a model in which increased emphasis on in‡ation
stabilization by CB causes a “signi…cant” reduction in variance of
output and in‡ation
Conclusion
What Does the Paper Do?
Comments
Paper’s objective
Present a model in which increased emphasis on in‡ation
stabilization by CB causes a “signi…cant” reduction in variance of
output and in‡ation
Why?
Conclusion
What Does the Paper Do?
Comments
Paper’s objective
Present a model in which increased emphasis on in‡ation
stabilization by CB causes a “signi…cant” reduction in variance of
output and in‡ation
Why?
Following in‡ation in 1970s, CBs increasingly focused on in‡ation
stability
Conclusion
What Does the Paper Do?
Comments
Paper’s objective
Present a model in which increased emphasis on in‡ation
stabilization by CB causes a “signi…cant” reduction in variance of
output and in‡ation
Why?
Following in‡ation in 1970s, CBs increasingly focused on in‡ation
stability
Could explain Great Moderation (reduction in output and in‡ation
volatility since mid-80s)
Conclusion
What Does the Paper Do?
Comments
Conclusion
Paper’s objective
Present a model in which increased emphasis on in‡ation
stabilization by CB causes a “signi…cant” reduction in variance of
output and in‡ation
Why?
Following in‡ation in 1970s, CBs increasingly focused on in‡ation
stability
Could explain Great Moderation (reduction in output and in‡ation
volatility since mid-80s)
Paper suggests existing models do not convincingly account for great
moderation
What Does the Paper Do?
Comments
Conclusion
Paper’s objective
Present a model in which increased emphasis on in‡ation
stabilization by CB causes a “signi…cant” reduction in variance of
output and in‡ation
Why?
Following in‡ation in 1970s, CBs increasingly focused on in‡ation
stability
Could explain Great Moderation (reduction in output and in‡ation
volatility since mid-80s)
Paper suggests existing models do not convincingly account for great
moderation
E.g. CGG (2000) rely on multiple equilibria to explain high in‡ation
in 70s
What Does the Paper Do?
Comments
Conclusion
Paper’s objective
Present a model in which increased emphasis on in‡ation
stabilization by CB causes a “signi…cant” reduction in variance of
output and in‡ation
Why?
Following in‡ation in 1970s, CBs increasingly focused on in‡ation
stability
Could explain Great Moderation (reduction in output and in‡ation
volatility since mid-80s)
Paper suggests existing models do not convincingly account for great
moderation
E.g. CGG (2000) rely on multiple equilibria to explain high in‡ation
in 70s
Branch et al. (2007): high/low volatility with limited attention
model, but non rational
What Does the Paper Do?
Comments
Conclusion
Paper’s objective
Present a model in which increased emphasis on in‡ation
stabilization by CB causes a “signi…cant” reduction in variance of
output and in‡ation
Why?
Following in‡ation in 1970s, CBs increasingly focused on in‡ation
stability
Could explain Great Moderation (reduction in output and in‡ation
volatility since mid-80s)
Paper suggests existing models do not convincingly account for great
moderation
E.g. CGG (2000) rely on multiple equilibria to explain high in‡ation
in 70s
Branch et al. (2007): high/low volatility with limited attention
model, but non rational
So great moderation explained largely by "shocks" (Sims-Zha, 2006)
What Does the Paper Do?
Comments
Conclusion
What does the paper do?
Proposed model:
fully rational agents
‡exible prices
info processing constraints for …rms (
Sims, 2003)
Monetary policy: optimal, 2 cases
Discretionary = pre-80
Commitment (or discretion + weight on price variability) = post-80
Prediction: CB’s increased focus on price stability =) drop in
price/output volatility
Key: info frictions introduce a new ampli…cation mechanism:
“coordination e¤ect”
Firms’info frictions depend on mon policy.
If mon pol. mitigates movements of pro…t maximizing price, yields
small processing errors, and reduces var (p ) , var (y )
What Does the Paper Do?
Comments
Conclusion
Why is this important?
Shocks
Propagation (Model)
-- private sector
-- monetary policy
Var(p)
Var(y)
Is it propagation or shocks?
If shocks: recent large shock =) should expect to see as large e¤ect
as in 70s, or great depression
What Does the Paper Do?
Comments
Conclusion
Why is this important?
Shocks
Propagation (Model)
-- private sector
-- monetary policy
Var(p)
Var(y)
Is it propagation or shocks?
If shocks: recent large shock =) should expect to see as large e¤ect
as in 70s, or great depression
If propagation: even if shock is large, economy (or policy response)
would mitigate e¤ects =) great depression unlikely
What Does the Paper Do?
Comments
Conclusion
Why is this important?
Shocks
Propagation (Model)
-- private sector
-- monetary policy
Var(p)
Var(y)
Is it propagation or shocks?
If shocks: recent large shock =) should expect to see as large e¤ect
as in 70s, or great depression
If propagation: even if shock is large, economy (or policy response)
would mitigate e¤ects =) great depression unlikely
Problem: "shocks" are not all structural shocks (e.g. oil), but also
"measure of our ignorance"
What Does the Paper Do?
Comments
Conclusion
Why is this important?
Shocks
Propagation (Model)
-- private sector
-- monetary policy
Var(p)
Var(y)
Is it propagation or shocks?
If shocks: recent large shock =) should expect to see as large e¤ect
as in 70s, or great depression
If propagation: even if shock is large, economy (or policy response)
would mitigate e¤ects =) great depression unlikely
Problem: "shocks" are not all structural shocks (e.g. oil), but also
"measure of our ignorance"
Here: mechanism provides more to propagation, less to shocks
What Does the Paper Do?
Comments
Outline
1
2
3
4
Review of key mechanism: "coordination e¤ect"
Mark-up shocks
Other shocks and their propagation
Conclusion
Conclusion
What Does the Paper Do?
Comments
Conclusion
Key mechanism
Firms
Firms choose p, I to maximize pro…ts (2nd order approx)
h
i
E (p p )2 jI
s.t.
entropy reduction: H (p )
H (p jI ) < K
Optimal full-info price:
p =q
yn + ξ
1
ε
ε = markup shock
yn = e¢ cient output (fct of underlying shocks)
Result: " var (p ) =) " …rms’pricing errors (var (p
p ))
What Does the Paper Do?
Comments
Conclusion
Key mechanism (cont.)
Monetary policy
CB chooses nominal expenditures q = y + p to maximize expected
utility (2nd order approx)
h
i
E ( y yn ) 2
s.t. restrictions imposed by private sector
Optimal discretionary policy (after shocks)
q = yn +
k
(1
k) ξ
ε
Optimal commitment policy (i.e., chosen before shock realization)
q = yn
What Does the Paper Do?
Comments
Conclusion
Implication: Coordination e¤ect
Optimal full info price:
p =q
yn + ξ
1
ε
Optimal policy
discretion
commitment
p = (1
:
:
p =ξ
k)
1
1
ξ
1
ε
ε
Implications
"p
=) "" p
" q =)" p
commitment: " ε =) " p but q constant
discretion: " ε =)
Mechanism: # var (p ) =) # …rms’pricing errors (var (p
=) # var (p ) and # var (y )
p ))
What Does the Paper Do?
Comments
Conclusion
Coordination e¤ect: Detailed look
var (y )
var (p )
Discretion
k
var (yn ) +
k
σ2
(1 k )2 ξ 2 ε
(1 k ) ξ
2
2 σε
Commitment
> var (yn ) + ξk2 σ2ε
>
k
ξ2
σ2ε
Shift from discretion (pre-80) to commitment (post-80) implies
great moderation
What Does the Paper Do?
Comments
Conclusion
Coordination e¤ect: Detailed look
var (y )
var (p )
Discretion
k
var (yn ) +
k
σ2
(1 k )2 ξ 2 ε
(1 k ) ξ
2
2 σε
Commitment
> var (yn ) + ξk2 σ2ε
>
k
ξ2
σ2ε
Shift from discretion (pre-80) to commitment (post-80) implies
great moderation
Great moderation due to change in propagation
What Does the Paper Do?
Comments
Conclusion
Coordination e¤ect: Detailed look
var (y )
var (p )
Discretion
k
var (yn ) +
k
σ2
(1 k )2 ξ 2 ε
(1 k ) ξ
2
2 σε
Commitment
> var (yn ) + ξk2 σ2ε
>
k
ξ2
σ2ε
Shift from discretion (pre-80) to commitment (post-80) implies
great moderation
Great moderation due to change in propagation
same-sized shocks result in smaller volatility of y and p
What Does the Paper Do?
Comments
Conclusion
Coordination e¤ect: Detailed look
var (y )
var (p )
Discretion
k
var (yn ) +
k
σ2
(1 k )2 ξ 2 ε
(1 k ) ξ
2
2 σε
Commitment
> var (yn ) + ξk2 σ2ε
>
k
ξ2
σ2ε
Shift from discretion (pre-80) to commitment (post-80) implies
great moderation
Great moderation due to change in propagation
same-sized shocks result in smaller volatility of y and p
But great moderation only through mark-up shocks (also true in
dynamic model)
What Does the Paper Do?
Comments
Conclusion
Coordination e¤ect: Detailed look
var (y )
var (p )
Discretion
k
var (yn ) +
k
σ2
(1 k )2 ξ 2 ε
(1 k ) ξ
2
2 σε
Commitment
> var (yn ) + ξk2 σ2ε
>
k
ξ2
σ2ε
Shift from discretion (pre-80) to commitment (post-80) implies
great moderation
Great moderation due to change in propagation
same-sized shocks result in smaller volatility of y and p
But great moderation only through mark-up shocks (also true in
dynamic model)
In fact, in the absence of mark-up shocks: y
yn = p = 0
What Does the Paper Do?
Comments
Two issues
Are mark-up shocks su¢ ciently important for mechanism to play a
signi…cant role?
Has transmission of other shocks remained unchanged?
Conclusion
What Does the Paper Do?
Comments
Conclusion
Are markup shocks su¢ ciently important?
Smets-Wouters (2007): estimate medium sized DSGE model
( CEE, 2005) with multiple shocks
Price & wage markup shocks contribute a lot to in‡ation ‡uctuations
Source: Smets and Wouters (2007)
Markup story has potential
What Does the Paper Do?
Comments
Conclusion
Are markup shocks su¢ ciently important?
But Smets-Wouters (2007) …nd large iid markup shocks because
quarterly in‡ation has high-frequency component
Indicators of Inflation
10
GDP deflator
PCE deflator
CPI
5
0
-5
1965
1970
1975
1980
1985
1990
1995
2000
Pairwise Coherence of Inflation Rates
1
GDP-PCE
GDP-CPI
PCE-CPI
0.8
0.6
0.4
0.2
0
0
pi/8
pi/4
3pi/8
pi/2
Frequency
5pi/8
3pi/2
7pi/8
pi
What Does the Paper Do?
Comments
Conclusion
Are markup shocks su¢ ciently important?
But Smets-Wouters (2007) …nd large iid markup shocks because
quarterly in‡ation has high-frequency component
Indicators of Inflation
10
GDP deflator
PCE deflator
CPI
5
0
-5
1965
1970
1975
1980
1985
1990
1995
2000
Pairwise Coherence of Inflation Rates
1
GDP-PCE
GDP-CPI
PCE-CPI
0.8
0.6
0.4
0.2
0
0
pi/8
pi/4
3pi/8
pi/2
Frequency
5pi/8
3pi/2
7pi/8
pi
Problem: high-frequency component for CPI and PCE very di¤erent
What Does the Paper Do?
Comments
Conclusion
Are markup shocks su¢ ciently important?
But Smets-Wouters (2007) …nd large iid markup shocks because
quarterly in‡ation has high-frequency component
Indicators of Inflation
10
GDP deflator
PCE deflator
CPI
5
0
-5
1965
1970
1975
1980
1985
1990
1995
2000
Pairwise Coherence of Inflation Rates
1
GDP-PCE
GDP-CPI
PCE-CPI
0.8
0.6
0.4
0.2
0
0
pi/8
pi/4
3pi/8
pi/2
Frequency
5pi/8
3pi/2
7pi/8
pi
Problem: high-frequency component for CPI and PCE very di¤erent
Boivin-Giannoni (2007): "measurement error" important for
in‡ation, not mark-up shocks (consistent with Justiniano-Primiceri,
2008)
What Does the Paper Do?
Comments
Conclusion
Has transmission of other shocks remained unchanged?
Boivin-Giannoni (2006, ReStat): Estimate response of in‡ation,
output to given surprise Fed fund rate change (of 100bp)
Pre-80: response of output 3 times larger than Post-80 (or 84)
What Does the Paper Do?
Comments
Conclusion
Has transmission of other shocks remained unchanged?
Boivin-Giannoni (2006, ReStat): Estimate response of in‡ation,
output to given surprise Fed fund rate change (of 100bp)
Pre-80: response of output 3 times larger than Post-80 (or 84)
Using estimated structural RE model: most of change in IRFs can
be explained by change in monetary policy rule
What Does the Paper Do?
Comments
Conclusion
Has transmission of other shocks remained unchanged?
Boivin-Giannoni (2006, ReStat): Estimate response of in‡ation,
output to given surprise Fed fund rate change (of 100bp)
Pre-80: response of output 3 times larger than Post-80 (or 84)
Using estimated structural RE model: most of change in IRFs can
be explained by change in monetary policy rule
Great moderation: explained both by change in policy and shocks
What Does the Paper Do?
Comments
Other issues
Change from discretion to commitment (around 1980): Key for
mechanism, but loosely discussed
Other stories endogenize policy change (e.g. Sargent et al.)
Paper exclusively analytical, but cries for quantitative evaluation
proposes an ampli…cation mechanism: fundamentally quantitative
how much of volatility reduction does it explain, given plausible info
frictions?
Supporting evidence mentioned very indirect
Conclusion
What Does the Paper Do?
Comments
Other issues (cont.): International evidence
Can mechanism explain diverse reductions in volatility?
Stock Watson (2005, JEEA): Estimated standard dev.(y )
Conclusion
What Does the Paper Do?
Comments
Conclusion
Very nice paper!
solid theory, careful analysis
New ampli…cation mechanism: interesting
Conclusion
What Does the Paper Do?
Comments
Conclusion
Very nice paper!
solid theory, careful analysis
New ampli…cation mechanism: interesting
very nice interaction of monetary policy and info frictions
Conclusion
What Does the Paper Do?
Comments
Conclusion
Very nice paper!
solid theory, careful analysis
New ampli…cation mechanism: interesting
very nice interaction of monetary policy and info frictions
Is it the explanation of the great moderation?
Conclusion
What Does the Paper Do?
Comments
Conclusion
Very nice paper!
solid theory, careful analysis
New ampli…cation mechanism: interesting
very nice interaction of monetary policy and info frictions
Is it the explanation of the great moderation?
I am skeptical (relies too much on markup shocks, does not explain
change in transmission of other shocks)
Conclusion
What Does the Paper Do?
Comments
Conclusion
Very nice paper!
solid theory, careful analysis
New ampli…cation mechanism: interesting
very nice interaction of monetary policy and info frictions
Is it the explanation of the great moderation?
I am skeptical (relies too much on markup shocks, does not explain
change in transmission of other shocks)
What triggered change form discretion to commitment?
Conclusion
What Does the Paper Do?
Comments
Conclusion
Very nice paper!
solid theory, careful analysis
New ampli…cation mechanism: interesting
very nice interaction of monetary policy and info frictions
Is it the explanation of the great moderation?
I am skeptical (relies too much on markup shocks, does not explain
change in transmission of other shocks)
What triggered change form discretion to commitment?
Great moderation can be explained by simple full info RE model
Conclusion