Research Discussion Papers, Bank of Finland
No 13/1998:
Macroeconomic Effects of Looming Policy Shifts: Non-falsified Expectations and Peso Problems
Jouko Vilmunen ()
Abstract: Using a standard model as a basis, we analyse the rational
expectations macroeconomic equilibrium for an open economy with flexible
exchange rates, in which expectations are affected by a perceived
possibility of discrete shifts in monetary policy. These discrete shifts
are modelled as possible jumps in the money supply process, which is
otherwise a smooth random walk. Two such jump models are analysed. In
equilibrium, the distribution of endogenous variables is (apparently
systematically) affected by peso problems (premia), which reflect
distributional peculiarities associated with expectations of possible
future policy shifts. It turns out that the macroeconomic effects of peso
premia accord closely with intuition regarding the effects of poor
credibility of a policy regime: the output gap widens; the levels of real
interest rates and domestic prices rise; and the domestic currency
appreciates in real terms due to anticipated expansionary shifts in the
money supply. Moreover, the key macro-aggregates become more volatile. The
effects of peso premia on the nominal interest rate and the exchange rate
turn out to be ambiguous.
Keywords: poisson process; policy shifts; peso problem; rational expectations; (follow links to similar papers)
48 pages, July 2, 1998
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