Analytical Toolkit
Our monetary policy analytical framework is a suite of models including a “workhorse” Core Quarterly Production Model, supplemented by a series of satellite models that focus on specific aspects of the economy (e.g. effects of fiscal policy, external shocks, etc.).
While not necessarily an innovation of FPAS Mark II, additional satellite models will provide a further analytical toolkit to better understand the implications of policy-relevant risks. These include a Mixed-Frequency Model, which blends near-term forecasts and medium-term policy projections. This model incorporates high-frequency data (almost real-time) along with large amounts of metadata (which would not necessarily be limited to quantitative observations).
Additional models deal with understanding specific shocks and linkages. These kinds of models help motivate the nonlinear relationship between policy and the achievement of its objectives via the short-run output-inflation trade-off in a practical and intuitive way. The development and implementation of non-linear approaches to analysis, as well as the discussion of the role of central bank's credibility in the process of developing policy scenarios, have been particularly emphasized within our analytical framework. In this regard, our Endogenous credibility model contains three novel features relevant to quarterly projection models:
- Endogenous policy credibility, where the central bank can gain or lose credibility based on its performance in regard to its monetary policy objective. Credibility is thought of as being equivalent to the reputation that the central bank has developed based on whether or not it has been able to achieve the inflation target on average over time. Policymakers may build credibility over time, such that public expectations of inflation only converge gradually to the target, or lose credibility, if the public begins to doubt their commitment to achieving the inflation target.
- Number of nonlinearities, including the specification of both convexity in Phillips curve and in the process through which credibility is gained or lost.
Loss function for monetary policy, meaning that our quarterly workhorse model is built to recognize the costs of deviations of inflation (from the target) and output (from potential), along with the costs of fluctuations in interest rates.