Bianca De Paoli
Bianca De Paoli Bianca De Paoli Bianca De Paoli
Curriculum Vitae Curriculum Vitae
New Keynesian framework:
"Monetary Policy and Welfare in a Small Open Economy": Journal of International Economics, Vol.77, No.1, February 2009. Earlier version available as:
CEP Discussion Papers
no.0639, May 2004.
This paper analyzes optimal monetary policy in a small open economy featuring monopolistic competition and nominal rigidities. It shows that the utility-based loss function for this economy can be written as a quadratic expression of domestic inflation, output gap and real exchange rate. The presence of an internal monopolistic distortion and a terms of trade externality drives optimal policy away from domestic inflation targeting and affects the optimal level of exchange rate volatility. When domestic and foreign goods are close substitutes for each other, the optimal policy rule implies lower real exchange rate volatility than a domestic inflation targeting regime. The reverse is true when the elasticity of substitution between goods is low.
CEP Discussion Papers no.0923, April 2009.
Can the structure of asset markets change the way monetary policy should be conducted in open economies? The debate surrounding optimal monetary policy in open economies has been extensive over the past decade. Many works have studied the role of the exchange rate in monetary policy and examined how trade balance dynamics can affect the analysis. However, technical difficulties have restricted the attention given to the capital account, net foreign asset positions and the structure of international asset markets in general. This study finds that, while price stability is suboptimal regardless of the configuration of asset markets, the performance of standard monetary policy rules is significantly affected by this configuration. Whereas under complete markets an exchange rate peg can outperform an inflation targeting regime if domestic and foreign goods are close substitutes to each other, the opposite holds when markets are incomplete.
"Asset Pricing Implications of a New Keynesian Model" (with Alastair Scott and Olaf Weeken), Journal of Economic Dynamics and Control, forthcoming. Also available as:
Bank of England Working Paper no.326, June 2007.
To match the stylised facts of goods and labour markets, the canonical New Keynesian model augments the optimising neoclassical growth model with nominal and real rigidities. We ask what the implications of this type of model are for asset prices. Using a second-order approximation, we examine bond and equity returns, the equity risk premium, and the behaviour of the real and nominal term structure. We catalogue the factors that are most important for determining the size of risk premia and the slope and level of the yield curve. In a world of technology shocks only, increasing the degree of real rigidities raises risk premia and increasing nominal rigidities reduces risk premia. In a world of monetary policy shocks only, both real and nominal rigidities raise risk premia. The results indicate that the implications of the New Keynesian model for average asset returns depend critically on the characterisation of shocks hitting the model economy.
This paper analyses the international dimension of fiscal policy in a small open economy framework. In our model, the fiscal authority finances government spending by levying distortionary taxation and issuing non-state-contingent debt. Our analysis identifies the presence of a real exchange rate externality and show that, once this open economy aspect of the policy problem is considered, it is no longer optimal to smooth taxes following idiosyncratic shocks. The paper also examines the implication of such externality for the optimal fiscal and monetary policy mix. We demonstrate that while in a closed economy case the introduction of nominal rigidities tends to increase the volatility of taxes relative to inflation, in an open economy, this is not necessarily the case.
"A Bayesian approach to optimal monetary policy with parameter and model uncertainty", (with Tim Cogley, Christian Matthes, Kalin Nikolov and Tony Yates). Journal of Economic Dynamics and Control, forthcoming.
This paper undertakes a Bayesian analysis of optimal monetary policy for theU.K. We estimate a suite of monetary-policy models that include both forwardandbackward-looking representations as well as large- and small-scale models.We find an optimal simple Taylor-type rule that accounts for both model and parameter uncertainty. For the most part, backward-looking models are highly fault tolerant with respect to policies optimized for forward-looking representations, while forward-looking models have low fault tolerance with respect to policies optimized for backward-looking representations. In addition, backward-looking models often have lower posterior probabilities than forwardlooking models. Bayesian policies therefore have characteristics suitable for inflation and output stabilization in forward-looking models.
"Why risk premia vary over time?", (with Pawel Zabczyk), Macroeconomic Dynamics, forthcoming. Also available as
Bank of England Working Paper no.361, February 2009.
Empirical evidence suggests that risk premia are higher at business cycle troughs than they are at peaks. Existing asset pricing theories ascribe moves in risk premia to changes in volatility or risk aversion. Nevertheless, in a simple general equilibrium model, risk premia can be procyclical even though the volatility of consumption is constant and despite a countercyclically varying risk aversion coefficient. We show that agentsí expectations about future prospects also influence premium dynamics. In order to generate countercyclically varying premia, as found in the data, one requires a combination of hump shaped consumption dynamics or highly persistent shocks and habits. Our results, thus, suggest that factors which help match activity data may also help along the asset pricing dimension.
"Costs of sovereign default", (with Glenn Hoggarth and Victoria Saporta), in Sovereign Debt: From Safety to Default (Robert W. Kolb Series). Earlier versions available as:
Bank of England Working Paper no.362, February 2009.
Quarterly Bulletin, Bank of England, July 2006.
Bank of England FS Paper no. 1, July 2006.
Over the past quarter of a century, emerging market economies (EMEs) have defaulted on their sovereign debts frequently. This article assesses the size and types of costs that have been associated with these defaults. It emphasises that costs, measured by the fall in output, are particularly large when default is combined with banking and/or currency crises. Output losses also seem to increase the longer that countries stay in arrears or take to restructure their debts. The paper concludes with a number of policy suggestions to improve debt crisis prevention and management and the role played by the IMF.
' Foreign exchange rate risk in a small open economy', (with Jens Sondergaard), Bank of England Working Paper no.365, March 2009.
The forward premium anomaly refers to the empirical observation that high interest rate currencies tend to appreciate rather than depreciate as the risk-neutral uncovered interest rate parity (UIP) would imply. Part of the literature have attributed the failure of UIP to the existence of time varying foreign exchange risk premia. But resolving the forward premium puzzle requires a volatile FX risk premium that covaries negatively with the depreciation rate. This paper shows that a canonical general equilibrium small open economy model with consumption based external habit formation can only generate such a FX premium under certain assumptions namely: Households need to have slow-moving habits as well as incur very persistent output shocks. The results are shown to be independent of the origin of shocks. Moreover, the introduction of mechanisms that increase exchange rate volatility also help reconcile such puzzle.
Using an endogenous portfolio choice model, this paper examines how different monetary policy regimes can lead to different foreign currency positions by changing the cyclical properties of the nominal exchange rate. We find that strict inflation targeting regimes are associated with a short position in foreign currency, while the opposite is true for non-inflation targeting regimes. We also explore how these different external positions affect the international transmission of monetary shocks through the valuation channel. When central banks follow inflation targeting Taylor-type rules, valuation effects of monetary expansions are beggar-thy-self, but they are beggar-thy-neighbour in a money growth targeting regime (or when monetary policy puts weight on output stabilization)
"Uncertainty and Monetary Policy: the Role of Precautionary Saving", (with Pawel Zabczyk), Bank of England working papers, forthcoming.
This paper analyzes the conduct of monetary policy in an environment in which cyclical swings in risk appetite affect households' propensity to save. It uses a New-Keynesian model featuring external habit formation to show that taking note of precautionary saving motives justifies an accommodative policy bias in the face of persistent, adverse disturbances. Equally, policy should be more restrictive -- i.e. `lean against the wind' -- following positive shocks. Since the size of these `risk-adjustments' is increasing in the degree of macroeconomic volatility, ignoring this channel could lead to larger policy errors in turbulent times -- with good luck translating into good policy.