Very interesting conclusion that the market will push the Fed to do 50bp today, and very elegant way of deriving it. I strongly recommend reading it.
I'm not sure I agree with the line of argument however - on normative grounds. If the central bank in every decision makes sure it doesn't disappoint the market - a kind of central bank put writ large - then this stores up trouble for the future as it creates moral hazard: the financial sector will take bigger and bigger risks knowing the central bank will not want to upset the apple cart.
** Nerds only: in the model, the result is due to the one shot nature of the game in a Barro-Gordon-type setup; in fact it should lead to a suboptimal equilibrium like the inflation bias in BG (1983), where you get too much market volatility as the central bank can't commit [Stefan please correct me if I'm wrong as I'm rusty on all this grad school macro] **
If this is how the central bank behaves, the end result is financial dominance: the central bank must deliver whatever the market, or the financial sector, needs.
Very interesting conclusion that the market will push the Fed to do 50bp today, and very elegant way of deriving it. I strongly recommend reading it.
I'm not sure I agree with the line of argument however - on normative grounds. If the central bank in every decision makes sure it doesn't disappoint the market - a kind of central bank put writ large - then this stores up trouble for the future as it creates moral hazard: the financial sector will take bigger and bigger risks knowing the central bank will not want to upset the apple cart.
** Nerds only: in the model, the result is due to the one shot nature of the game in a Barro-Gordon-type setup; in fact it should lead to a suboptimal equilibrium like the inflation bias in BG (1983), where you get too much market volatility as the central bank can't commit [Stefan please correct me if I'm wrong as I'm rusty on all this grad school macro] **
If this is how the central bank behaves, the end result is financial dominance: the central bank must deliver whatever the market, or the financial sector, needs.
A related problem is that of communication: I'm of the view that central banks shouldn't issue guidance but in exceptional cases (e.g. lower bound), see here: https://open.substack.com/pub/thinicemacroeconomics/p/the-ecb-should-resist-the-forward?r=1oa8fn&utm_campaign=post&utm_medium=web
Jeremy Stein has a great paper on this whole conundrum which I link to in my post.
Thank you for the stimulating read Stefan Gerlach.