Essays on macroeconomic policy

Abstract

This thesis consists of four relatively independent essays in macroeconomics. Chapter 1 focuses on inflation targeting (IT) as a monetary framework. While the importance of achieving stable inflation is well established from a theoretical perspective, whether inflation targeting economies have achieved policy results which are significantly different from other regimes is still a subject of debate in the literature. This study contributes by addressing the endogeneity of IT adoption in a formal way and addresses Gertler’s (2005) critique by contrasting the performance of IT against another clearly defined monetary framework. As results do not show much evidence in favour of IT in the long run, I explore other reasons for the success of IT. It turns out that apart from being a clearly defined policy framework, which puts pressure on a central bank to commit to policy targets and be transparent about its decisions, IT improves the dynamics of an economy’s response to some of the common macro shocks. In Chapter 2, I use Bayesian shrinkage methods to examine the determinants of the recovery after the recent financial crisis. Having examined a wide range of macroeconomic preconditions, I find that only the financial deepening and fiscal policy are the most important determinants of the recovery. Interestingly, even accounting for unconventional measures, the statistical significance of the monetary response is limited. During the work on the Chapter 2, it became clear that measuring fiscal response is quite challenging and most of the statistical approaches are prone to serious issues. So, chapter 3 contributes by building an action-based dataset of fiscal decisions (2006 to 2015) on the basis of an examination of a range of policy documents. As a result I produce an index of a country’s fiscal stance, which I subsequently use in my Chapter 2 to investigate the effect of fiscal policy on the recovery of output following the crisis. Chapter 4 produces a regime-switching extension to a theoretical DSGE model of financial intermediation and unconventional monetary policy by Gertler and Karadi (2011), by allowing for switches in the capital quality process and an unconventional policy rule. Its important contribution is allowing for the possibility of switches to a zero-lower bound (ZLB) regime. It turns out that the agents may interpret a shock in various ways across the regimes, and that forms the dynamics of the system and results in certain welfare outcomes. For example, the possibility of a switch to ZLB massively influences the expectations of the agents and makes them behave very differently than they would in a model without a ZLB constraint. The results of Bayesian estimation fitted to quarterly US data show that even a simple New Keynesian model may be used as a tool to examine the economic history of the United States and explore the effects of unconventional monetary policy measures.