Presentation on theme: "Monetary Policy and a Stock Market Boom-Bust Cycle"— Presentation transcript:
1 Monetary Policy and a Stock Market Boom-Bust Cycle Lawrence Christiano, Roberto Motto and Massimo Rostagno
2 Inflation has been relatively stable for a while Attention has shifted to other issues: stock market volatility
3 Stock market has been volatile: Is it ‘excessively’ volatile in the welfare sense?What role (if any) does (should) monetary policy play?Conventional wisdom –Bernanke-Gertler: ‘leave it alone’In any case, inflation targeting will automatically stabilize
4 Inflation appears to be falling during the start-up of boom-bustepisodes in US.
5 ‘Stock Market Boom-Bust Cycle’ Episode in which:Stock prices, consumption, investment, output, employment rise sharply and then fallInflation low during boomUS examples:Interwar periodMid 1950s - mid 1970sMid 1990s - presentWe’re going back to the drawing board to build a model of a boom-bust cycle.
6 Rational Theory of Boom-Bust Follow Beaudry-Portier (see also more recently Jaimovich-Rebelo)Boom-bust cycle triggered by:Expectation that technology will be strong in futureExpectation ultimately not realizedExamples:Fiber-optic cableMotorola satellitesIn principle, there are lots of models you could build. At the broadest level there is the question of whether it is a rational one or a bubble model. We follow the lead of Beaudry-Portier and build a rational bubble.
7 Key FindingsStart by trying to build a non-monetary theory of boom-bust cycleWith investment adjustment costs, habit persistence, can almost get successful theoryHowever, miss on several key dimensionsStock market goes wrong way, highly volatile real rate, no persistenceWhen we integrate sticky (allocative) wages and an inflation-targeting central bank, we obtain a more successful theory.perhaps boom-bust cycles reflect interaction of sticky wages and inflation targeting monetary policyan example of Levin, et al point that inflation targeting not optimal when wages are sticky
8 Outline Boom-bust in non-monetary economy Bring in sticky wages/prices and monetary policy as simply as possibleRedo analysis in model with additional financial frictionsbanking system (CCE), agency costs (BGG)permits addressing role of credit and monetary aggregates
10 Parameterization of RBC Model Model is specialized version of model with many frictions estimated for US by Christiano-Motto-Rostagno (2006)Parameters:Steady state:
11 Results for RBC ModelHabit persistence in preference and adjustment costs on change in investment crucial for getting ‘close’ to stock-market boom-bust…However,Stock market wrongReal interest rate highly volatileNo persistence
17 Conclusions so far: Need: habit persistenceneed adjustment costs in changing the flow of investment (for economic interpretation of this formulation, see Matsuyama and Lucca).Still, not good enough…..not great on persistenceIncrease lead time in signal (p) from 4 to 12
31 Findings Now have a (sort of) reasonable model of boom-bust highly persistentex post real interest rate moves only a very small amountStock price moves in ‘right’ way (though a little anemic).Quantity movements in monetary model swamp movements in RBC modelBoom-bust (though triggered by real event) is primarily a monetary policy phenomenon
32 Basic Diagnosis Application of logic in Erceg, Christopher, Dale Henderson, and Andrew Levin, 2000, `Optimal Monetary Policy with Staggered Wage and Price Contracts,' Journal of Monetary Economics, 46,Levin, A., Onatski, A., Williams, J., Williams, N., "Monetary Policy under Uncertainty in Microfounded Macroeconometric Models." In: NBER Macroeconomics Annual 2005, Gertler, M., Rogoff, K., eds. Cambridge, MA: MIT Press.Sticky wages are the key, sticky prices unimportantInflation targeting importantReal wage ‘should’ rise in boom, but is prevented:wage is stickyprice is sticky downward, because of monetary policy
38 ‘Full’ Model has Credit, Monetary Aggregates Model incorporates banking sector, as in Chari, Christiano and Eichenbaum.M1, M3, demand deposits, currency, bank reserves.Financial frictions as in Bernanke, Gertler and Gilchrist.Total credit (borrowing of working capital by banks, plus loans to entrepreneurs).
39 M1 ~ currency + demand deposis M2/M3 ~ M1 + savings deposits Credit ~ total borrowing (includes time deposits, but not currency)Entrepreneurs:own and rent outcapitalFirms:need workingcapital to pay factorsBanks(hold reserves)Demand deposits,Savings deposits,Time depositsHouseholds
40 FindingsBGG financial frictions attenuate somewhat the effects of boom-bustRationalizes monetary policy of looking at credit.
45 ConclusionWith habit persistence and cost-of-change adjustment costs, can make progress on generating stock market boom-bust.But, problems…Bring in sticky wages and inflation targeting, and can generate boom-bustPerhaps monetary policy should react to other variables, such as credit growth.