This paper examines empirically the impact of financial stress on the transmission of monetary policy shocks in Canada. The model used is a threshold vector autoregression in which a regime change occurs if financial stress conditions cross a critical threshold.
Topics: Financial stability; Uncertainty and monetary policyThis article examines recent research on the influence of various forms of economic uncertainty on the performance of different classes of monetary policy rules: from simple rules to fully optimal monetary policy under commitment. The authors explain why uncertainty matters in the design of monetary policy rules and provide quantitative examples from the recent literature. They also present results for several policy rules in ToTEM, the Bank of Canada's main model for projection and analysis, including rules that respond to price level, rather than to inflation.
Topics: Econometric and statistical methods; Economic models; Monetary policy framework; Uncertainty and monetary policyMany important economic variables are subject to revision. This article explains how, when, and why such revisions occur; how revisions to Canadian gross domestic product (GDP) compare with GDP revisions in some other countries; which GDP components are subject to the largest revisions; and how data revisions can affect policy decisions. The author finds that revisions to Canadian GDP tend to be smaller, on average, than those of some other countries, and that among the GDP components, exports and imports are most heavily revised.
Topics: Business fluctuations and cycles; Uncertainty and monetary policyModel-based forecasts of important economic variables are part of the range of information considered for monetary policy decision making. Since some of the data underpinning these forecasts can be revised over time as new information is released, having access to the data that are available when decisions are made can have a significant impact on assessments of forecasting models.
A database of published information for a set of money and credit variables has been developed at the Bank of Canada. This real-time database, which will make available estimates of money and credit data that have been published at different times, is expected to be of great help to researchers developing models based on money and credit data.
The authors describe the contents of the new database and discuss patterns in data revisions. While they find that most revisions are unbiased, they provide evidence that revisions to some of the money and credit aggregates are biased. In particular, revisions to long-term business credit and total business credit tend to show an upward bias over longer periods. The authors argue that this may be because there tends to be a delay in factoring the effects of financial innovations into time series. Practitionners should consider this when interpreting developments in business credit.
Topics: Credit and credit aggregates; Monetary aggregates; Uncertainty and monetary policyThe purpose of this paper is to make a quantitative contribution to the inflation versus price level targeting debate. It considers a policy-maker that can set policy either through an inflation targeting rule or a price level targeting rule to minimize a quadratic loss function using the actual projection model of the Bank of Canada (ToTEM).
Topics: Uncertainty and monetary policySurveys provide direct information on expectations, but only short histories are available at quarterly frequencies or for long-horizon expectations.
Topics: Inflation and prices; Inflation targets; Uncertainty and monetary policyHow can policy-makers avoid large policy errors when they are uncertain about the true model of the economy?
Topics: Uncertainty and monetary policySuppose that the dynamics of the macroeconomy were given by (partly) random fluctuations between two equilibria: "good" and "bad."
Topics: Uncertainty and monetary policyIn the interest of better understanding the impact of the Bank of Canada's policy actions on bond and bill yields, Andreou assesses the impact of policy-rate announcements on short and long bonds over the period 1996 to 2004. To aid the analysis, policy actions are decomposed into expected and surprise components. He also examines whether the introduction of fixed announcement dates (FADs) has affected these results, including markets' perceptions. The main finding is that unexpected policy actions by the Bank have a significant effect on market rates at the shorter end of the yield curve, with the effect dissipating as the maturity increases. A second finding, that the impact on longer-term interest rates of a surprise action by the Bank has diminished since the introduction of the FADs, suggests that the Bank's long-term policy goals are well understood and credible.
Topics: Credibility; Financial markets; Uncertainty and monetary policyPolicy-makers in the United States over the past 15 to 20 years seem to have been cautious in setting policy: empirical estimates of monetary policy rules such as Taylor's (1993) rule are much less aggressive than those derived from optimizing models.
Topics: Uncertainty and monetary policyWhen it launched a new system for regularly announcing its decisions regarding the overnight rate of interest in December 2000, the Bank of Canada had a number of key objectives in mind. These included reduced uncertainty in financial markets, greater focus on the Canadian rather than the U.S. economic environment, more emphasis on the medium-term perspective of monetary policy, and increased transparency regarding the Bank's interest rate decisions.
Evidence to date suggests that all four objectives have been met to a substantial degree. Fixed announcement dates have provided regular opportunities for the Bank to communicate its views on the state of the Canadian economy to the public. This has helped to improve understanding of the broad direction of monetary policy and of the rationale behind the Bank's policy decisions although the decisions themselves are not always fully anticipated.
Topics: Credibility; Financial markets; Interest rates; Monetary policy implementation; Uncertainty and monetary policyThe author explores the role that Taylor-type rules can play in monetary policy, given the degree of uncertainty in the economy. The optimal rule is derived from a simple infinite-horizon model of the monetary transmission mechanism, with only additive uncertainty.
Topics: Uncertainty and monetary policyIn this report, the authors examine and compare twelve private and public sector models of the Canadian economy with respect to their paradigm, structure, and dynamic properties. These open-economy models can be grouped into two economic paradigms.
Topics: Economic models; Uncertainty and monetary policyThe benefits of transparency—the outcome of the measures taken by the central bank to allow financial markets and economic agents to understand the factors it takes into account in formulating monetary policy—are now widely recognized. These benefits include smoother implementation of monetary policy and increased effectiveness as markets improve their ability to anticipate the Bank's policy decisions and account for them in their operations.
How interest rates respond to the publication of macroeconomic data depends on the degree of transparency in monetary policy, as the rates will rise or fall as a reflection of the market's revised expectations. Before the Bank of Canada adopted initiatives to improve transparency, such as the inflation-control targets, the semi-annual publication of the Monetary Policy Report and Updates, and the fixed announcement dates, changes to the overnight rate created some volatility in interest rates, and publishing Canadian macroeconomic data did not appear to have a major impact on rates. This article shows how the Bank of Canada's steps towards greater transparency have increased the impact of Canadian data on short-term interest rates and have improved financial markets' understanding of how monetary policy decisions are taken.
Topics: Financial markets; Interest rates; Uncertainty and monetary policyIn this report, we evaluate several simple monetary policy rules in twelve private and public sector models of the Canadian economy. Our results indicate that none of the simple policy rules we examined is robust to model uncertainty, in that no single rule performs well in all models.
Topics: Uncertainty and monetary policyWe develop an equilibrium model of the monetary policy transmission mechanism that highlights information frictions in the market for money and search frictions in the market for labour.
Topics: Transmission of monetary policy; Uncertainty and monetary policyCentral banks must cope with considerable uncertainty about what will happen in the economy when formulating monetary policy. This article describes the different types of uncertainty that arise and looks at examples of uncertainty that the Bank has recently encountered. It then reviews the strategies employed by the Bank to deal with this problem.
The other articles in this special issue focus on three of these major strategies.
Topics: Monetary policy framework; Uncertainty and monetary policyThe third strategy employed by the Bank when dealing with uncertainty is the consideration of appropriate simple reaction functions or "rules" for the setting of the policy interest rate. Since John Taylor's presentation of his much-discussed rule, research on simple policy rules has exploded. Simple rules have several advantages. In particular, they are easy to construct and communicate and are believed by some to be robust, in the sense of generating good results in a variety of economic models.
This article provides an overview of the recent research regarding the usefulness and robustness of simple monetary policy rules, particularly in models of the Canadian economy. It also describes and explains the role of simple rules in the conduct of monetary policy in Canada.
Topics: Uncertainty and monetary policyIn recent years, there has been a lot of interest in Taylor-type rules. Evidence in the literature suggests that Taylor-type rules are optimal in a number of models and are fairly robust across different models.
Topics: Economic models; Monetary policy framework; Uncertainty and monetary policyThis article summarizes the proceedings of a conference hosted by the Bank of Canada in November 1999.
Three major themes emerged at the conference. The first concerned uncertainty about the transmission mechanism by which monetary policy affects output and inflation. The second concerned the potential usefulness of monetary aggregates in guiding the economy along a stable non-inflationary growth path. The third was the recent developments in dynamic monetary general-equilibrium models.
The work presented suggests that a wide range of models is useful for understanding the various paths by which monetary policy actions might influence the economy.
Topics: Economic models; Monetary aggregates; Uncertainty and monetary policyThe effective conduct of monetary policy is complicated by uncertainty about the level of potential output, and thus about the size of the monetary policy response that would be sufficient to achieve the targeted inflation rate. One possible response to such uncertainty is for the monetary authority to "probe," interpreted here as actively using its [...]
Topics: Credibility; Potential output; Uncertainty and monetary policyThis paper examines the implications of changes in economic behaviour for simple inflation-forecast–based monetary rules of the type currently used at two inflation-targeting central banks. Three types of changes in economic behaviour are considered, changes that are motivated by developments in monetary and fiscal policy in the 1990s: changes in monetary policy credibility, changes in [...]
Topics: Credibility; Monetary policy framework; Uncertainty and monetary policyThis paper studies the implications of certain kinds of uncertainty for monetary policy. It first describes the optimum policy rule in a simple model of the transmission mechanism as in Ball and Svensson.
Topics: Monetary policy framework; Uncertainty and monetary policyAn important challenge facing central banks is making decisions under uncertainty about the dynamic effects of monetary policy actions. The authors stress the importance of explicitly recognizing uncertainty about the transmission mechanism when formulating policy advice. They argue that one way to manage monetary policy under uncertainty is to draw on both an output-gap paradigm [...]
Topics: Monetary policy framework; Uncertainty and monetary policyCanada's economic performance in the first half of the 1990s was adversely affected by high premiums in interest rates that were brought on by political and economic uncertainties.
Topics: Monetary policy implementation; Transmission of monetary policy; Uncertainty and monetary policy
