Papers by Michael Hatcher
This paper presents a DSGE model in which long run inflation risk matters for social welfare. Opt... more This paper presents a DSGE model in which long run inflation risk matters for social welfare. Optimal indexation of long-term government debt is studied under two monetary policy regimes: inflation targeting (IT) and price-level targeting (PT). Under IT, full indexation is optimal because long run inflation risk is substantial due to base-level drift, making indexed bonds a much better store of value than nominal bonds. Under PT, where long run inflation risk is largely eliminated, optimal indexation is substantially lower because nominal bonds become a better store of value relative to indexed bonds. These results are robust to the PT target horizon, imperfect credibility of PT and model calibration, but the assumption that indexation is lagged is crucial. From a policy perspective, a key finding is that accounting for optimal indexation has important welfare implications for comparisons of IT and PT.
This paper presents a DSGE model where the inflation risk premium has a closed-form solution. If ... more This paper presents a DSGE model where the inflation risk premium has a closed-form solution. If monetary policy is imperfectly credibledefined as the belief that monetary policy will revert to a high inflation risk regime with positive probabilitythe inflation risk premium rises. This finding may help to explain why DSGE models have struggled to match the magnitude of inflation risk premia in the data in the absence of high risk aversion. There are also implications for empirical studies which rely on decompositions of break-even inflation rates, since the standard decomposition used in the literature is no longer valid.
This paper presents a general equilibrium model in which nominal government debt pays an inflatio... more This paper presents a general equilibrium model in which nominal government debt pays an inflation risk premium. The model predicts that the inflation risk premium will be higher in economies which are exposed to unanticipated inflation through nominal asset holdings. In particular, the inflation risk premium is higher when government debt is primarily nominal, steady-state inflation is low, and when cash and nominal debt account for a large fraction of consumers' retirement portfolios. These channels do not appear to have been highlighted in previous models or tested empirically. Numerical results suggest that the inflation risk premium is comparable in magnitude to standard representative agent models. These findings have implications for management of government debt, since the inflation risk premium makes it more costly for governments to borrow using nominal rather than indexed debt. Simulations of an extended model with Epstein-Zin preferences suggest that increasing the share of indexed debt would enable governments to permanently lower taxes by an amount that is quantitatively non-trivial.
This paper presents a DSGE model in which long run inflation risk matters for social welfare. Agg... more This paper presents a DSGE model in which long run inflation risk matters for social welfare. Aggregate and welfare effects of long run inflation risk are assessed under two monetary regimes: inflation targeting (IT) and price-level targeting (PT). These effects differ because IT implies base-level drift in the price level, while PT makes the price level stationary around a target price path. Under IT, the welfare cost of long run inflation risk is equal to 0.35 per cent of aggregate consumption. Under PT, where long run inflation risk is largely eliminated, it is lowered to only 0.01 per cent. There are welfare gains from PT because it raises average consumption for the young and lowers consumption risk substantially for the old. These results are strongly robust to changes in the PT target horizon and fairly robust to imperfect credibility, fiscal policy, and model calibration. While the distributional effects of an unexpected transition to PT are sizeable, they are short-lived and not welfare-reducing. for helpful comments. Email address for correspondence: [email protected]. 2 4 Berg and Jonung (1999) argue that PT was adopted in Sweden during the Great Depression, but this is disputed by Straumann and Woitek (2009). 5 The issue of whether optimal policy in the New Keynesian model implies base drift is controversial. Negative results include Steinsson (2003), Levin et al. (2010) and Amano, Ambler and Shukayev (forthcoming). 6 This work is surveyed in Ambler (2009), Crawford, Meh and Terajima (2009) and Bank of Canada (2011).
Bank of England Working Paper 440, Oct 2011
This paper analyses the conduct of monetary policy in an environment where households' desire to ... more This paper analyses the conduct of monetary policy in an environment where households' desire to amass precautionary savings is influenced by fluctuations in the volatilities of disturbances that hit the economy. It uses a simple New Keynesian model with external habit formation that is augmented with demand and supply disturbances whose volatilities vary over time. If volatility fluctuations are ignored by policy, interest rates are set at a suboptimal level. The extent of 'policy bias' is relatively small but of greater importance the higher the degree of habit formation. The reason is that habit-forming preferences raise risk aversion, increasing the importance of the precautionary savings channel through which volatility fluctuations impact upon inflation and output.
This paper provides a detailed survey of the economic literature comparing inflation and pricelev... more This paper provides a detailed survey of the economic literature comparing inflation and pricelevel targeting as macroeconomic stabilisation policies. Its contributions relative to past surveys are as follows. First, rather than focusing on any particular topic, the survey gives equal emphasis to all key areas of the literature. Second, the paper discusses "new results" in several areas, including the zero lower bound on nominal interest rates; the long-term impact of pricelevel targeting; and financial market considerations. Finally, the survey is written in such a way that it can be understood by economists with little or no prior knowledge of price-level targeting and the related academic literature. The survey concludes that whilst price-level targeting has a number of potential advantages, further research is needed to accurately quantify its costs and benefits and to test robustness. Potential obstacles to the introduction of price-level targeting in practice include: concerns about its credibility; lack of public understanding; and lack of prior experience with price-level targeting regimes.
Economic and Labour Market Review, Sep 2008
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Papers by Michael Hatcher