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In their view, the assumption of indexation to past inflation is the key factor driving this result. According to them, when viewed in the light of indexation to long-run inflation, the optimal inflation volatility often moves closer to zero. They equally showed that for the welfare rankings of policies, the initial conditions do matter to a very significant extent.
In their work, Leeper Erik et al. examined how the conventional dynamic stochastic general equilibrium models, including the Christiano-Eichenbaum-Evans model is affected or impacted by government investments. As a way of explaining the effects of government investments in this regard, they considered two main factors, namely, the future fiscal adjustments to debt-financed spending and implementation delays for building public capital projects. In their work they demonstrated that, in the short run implementation delays can produce small or even negative labor and output responses; while for both a qualitative and quantitative positive long-run growth effects, the financing instruments and the productivity of public capital matters more in that regard. Using the Christiano-Eichenbaum-Evans model and other models with features relevant for studying government spending (which include time-to-build for private investment, utility-yielding government consumption and government production) they examined these findings and observed similar results.
Having examined the their practical significance and application of the Christiano-Eichenbaum-Evans's model in this section, I will now proceed to the next section where I will explore the Mankiw and Reis Model .
The Mankiw and Reis Model
Most monetary policy theorists are convinced that the sticky information model proposed by Mankinaw and Reis can potentially address the failures of the New Keynesian Phillips curve. In Mankiw and Reis' view, because of information acquisition or re-optimization costs, information about macroeconomic conditions tends to spread slowly (Oleg Korenok, 2). Simply put, the idea that that information disseminates slowly through a population is the basic tenet of the model presented by Mankiw and Reis (1-34). As a result of this, their model is can be termed the sticky information model.
Broadly speaking, according to the Mankiw and Reis model, some firms set prices based on old information while others compute prices based on current information. As such, some restrictions are naturally placed on the adjustment of inflation.
To promote a better understanding of Mankiw and Reis model, I will now make a more elaborate explanation of the information presented above. The explanation of the dynamic effects of aggregate demand on output as well as the price level is the main goal of the model proposed by Mankiw and Reis. As I explained above, that information about macroeconomic conditions diffuses slowly through a given population is the key essence of their model. In their view, this slow diffusion can be caused by two main factors. First, the cost of acquiring information and second, the costs associated with re-optimization. In either case, pricing decisions are not always based on current information even though prices are constantly changing. Hence, to differentiate their model from the standard sticky-price model on which the new Keynesian Phillips curve is based, Mankiw and Reis called it the "sticky-information" model (Mankiw and Reis, 1-34).
As I explained earlier, two assumptions form the basis of Mankiew and Reis model. First, a fraction of the population generally updates itself on the current state of the economy as well as computes optimal prices based on that information at each period. Second, prices are set on the basis of old plans and outdated information by the rest of the population. Hence, Mankiw and Reis model combines both the elements of Lucas model of imperfect information with that of Calvo's model of random adjustment (Keen Benjamin and Wang Yongshang, 1-11; Lucas). On a closer examination, however, it can be seen that the implications of their sticky-information model is more close to that of Stanley Fischer's contracting model. Going in line with the Fischer model, their model equally posits that the expectations of the current price level formed far in the past is the factor that determines the current price level. According to Fischer model, because those expectations are built into contract, they are considered to be very important. In Mankiw and Reis model, those expectations matter given that some of the price setters are determining their prices on the basis of old information as well as old decision.
Having presented the Mankiw and Reis model above, my next work is to make a comparative analysis of the model and the Christiano-Eichenbaum-Evans. This I will do in the following section.
Comparative Analysis of the Christiano-Eichenbaum-Evans and Mankiw-Reis Models
Generally speaking, as I have already noted before, the Mankiw and Reis model is based on the plausible assumption that information disseminates slowly throughout the population. Compare to the Christiano-Eichenbaum-Evans model, the Mankiw and Reis model displays three related properties that are, to a very significant extent, more consistent with the generally accepted views regarding the effects of monetary policy. The first property is the one that postulates that disinflations are always contractionary. This property is valid regardless of the fact that surprise disinflations are more contractionary than announced ones. The second property is the one that posits that monetary policy shocks, to a very reasonable extent, have their maximum impact on inflation with a substantial delay. The third property can be stated thus: The level of economic activity and the change in inflation are positively correlated Mankiw and Reis, 1-34).
Centrally speaking, in contrast to the Christiano-Eichenbaum-Evans model, which allows for the possibility of disinflation booms, among the main predictions made in the Mankiw and Reis model is that disinflations always lead to recessions. Note that the Mankiw and Reis model has some degree of resemblance to the Phillips curves with backward-looking expectations. However there is an important difference, which is that in the Mankiw and Reis model credibility matters and expectations are equally more rational. In particular, the resulting recession from the monetary policy shock is expected to be smaller whenever the anticipated disinflationary policy is farther in advance. Broadly speaking, the largest impact on inflation usually occurs immediately. By contrast, some of the inflation inertia that is built into the backward-looking model is displayed by the Mankiw and Reis model.
Note also that or these parameters, a monetary policy shock in the Mankiw and Reis model has its maximum impact on inflation after seven quarters. It is equally sufficient to note that, compared to the Christiano-Eichenbaum-Evans model, the impulse response function for the Mankiw and Reis model is far more consistent as well as correlates positively with the conventional views about the effect of monetary policy. The long lags inherent in macroeconomic policy have been emphasized by many economists in the past. In particular, most central bankers do accept or are convinced on the validity of the long lag between monetary policy actions and inflation -- a fact that have been equally confirmed by most econometric studies.
Note that while Mankiw and Reis model can explain with reasonable precision a long lag between monetary policy shocks and inflation, the Christiano-Eichenbaum-Evans model cannot. To promote a better understanding of these results, it is worth taking a brief look at the impulse functions. In the Christiano-Eichenbaum-Evans model, output falls for a while and inflation falls immediately before it starts to rise again whenever the economy experiences a contractionary monetary shock. Thus, prior to coinciding with the rising inflation for a long period, the low output first of all coincides first with the falling inflation. This scenario generates a small but negative correlation.
By contrast, in the Mankiw and Reis model, inflation adjusts slowly to a monetary shock. When the output is lowered by a contractionary shock, the effect will be a prolonged period of falling inflation. This scenario will, in turn, generate a positive correlation between output and the change in inflation ( Mankiw and Reis, 1-34).
Having presented a comparative analysis of the Christiano-Eichenbaum-Evans and Mankiw-Reis models in this section, I will proceed to conclude the paper.
Any model that is designed to be used for monetary policy analysis should have three main features. First, it should be closely related to the underlying objectives of both the consumers and firms. Second, it should explicitly model expectations. Third, it should have the capability of capturing the dynamic interactions among all the variables that are exhibited in the data. In this paper, I examined and analyzed two models of monetary policy that satisfies these qualities, namely the Christiano-Eichenbaum-Evans and Mankiw-Reis Models. I equally made a succinct comparative analysis of these models.
Christiano Lawrence J., Martin Eichenbaum, & Charles Evans. "Nominal Rigidities and the Dynamic Effects of A Shock to Monetary Policy." Federal Reserve Bank of Cleveland Working Paper May 2001: 5-50.
DiCecio, Riccardo, Edward Nelson." An Estimated DSGE Model for the United Kingdom." Federal Reserve Bank of St. Louis Review July/August 2007. http://research.stlouisfed.org/publications/review/07/07/DiCecio.pdf
Fischer, Stanley. "Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule." Journal of Political…[continue]
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