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Huigang Chen works in the Technology and General Services Department. Kevin Clinton (formerly Bank of Canada) and Marianne Johnson (Bank of Canada) were Visiting Scholars at the Fund when most of the work for this paper was completed. Ondra Kamenik is a Senior Economist in the Research Department and Douglas Laxton is an Advisor in the Research Department. The authors wish to thank Olivier Blanchard, Charles Collyns and Larry Schembri for encouraging us to do this work. The authors also wish to thank Marcello Estevao and Robert Lafrance for comments as well as Laura Leon for her help in the preparation of the paper. The views expressed here are those of the authors and do not necessarily represent the position of the International Monetary Fund or any other institution that the authors are affiliated with. The model and programs used to construct the confidence bands can be downloaded from www.douglaslaxton.org.
This specification is based on Carabenciov and others (2008b), which contains an extensive discussion of credit-channel effects and their modeling. It is also in the spirit of earlier work by Bayoumi and Swiston (2007). Bayoumi and Melander (2008), Lown, Morgan and Rohatgi (2000), Lown and Morgan (2002), Lown (2006), and Swiston (2008).
For example, Laxton and Pesenti (2003) derive Euler equations for consumption that contain lagged and expected consumption, real interest rates and a habit-persistence parameter.
The equation also contains a limiting upper value to the output gap (ymax), which implies that the short-run Phillips curve becomes vertical—at some point, because of very low excess capacity, increases in demand would fail to induce increases in output, and result only in accelerating inflation. This mechanism does not, however, come into play in the recessionary environment of the current forecasts.
Woodford (2003) provides a theoretical rationale for the smoothed interest rate response. In essence, smoothing increases the impact of changes in short-term rates on long-term rates, because the changes are likely to have some persistence.
Monetary Policy Report to Congress, February 24, 2009 (Table 1).
We use the No Shocks solution to represent the central tendency of all simulation-derived distributions. In every scenario, the median path of the solutions underlying the confidence intervals differed negligibly from the No Shocks path.
The lack of symmetry in the confidence band for the level of the oil price results mainly from conversion from the logarithmic equation.
This is in line with the width of the range that inflation targeters often announce (Roger and Stone, 2005), Table 6.
One might conjecture that respondents to the survey confuse tightening (the derivative) with tight (the level).