In light of the current low-interest-rate environment, we reconsider the merits of strict money growth targeting (MGT) relative to conventional inflation targeting (IT) and to price level targeting (PLT). We evaluate these policies in terms of social welfare through the lens of a New Keynesian model and accounting for a zero lower bound (ZLB) constraint on the nominal interest rate. Although MGT makes monetary policy vulnerable to money demand shocks, MGT contributes to achieving price level stationarity and significantly reduces the incidence and severity of the ZLB relative to both IT and PLT. Furthermore, MGT lessens the need for fiscal expansions to supplement monetary policy in fighting recessions.

We study how a central bank in a small open economy should conduct monetary policy if it fears that its model is misspecified. Using a new-Keynesian model of a small open economy, we solve analytically for the optimal robust policy rule and the equilibrium dynamics, and we separately analyze the consequences of central bank robustness against misspecification concerning the determination of inflation, output, and the exchange rate. We show that an increase in the preference for robustness makes the central bank respond more aggressively or more cautiously to shocks, depending on the type of shock and the source of misspecification. r 2008 Elsevier B.V. All rights reserved. JEL classification: E52; E58; F41

In an article published in the American Economic Review, Jón Steinsson (2008) argues that two sticky price models driven by real shocks can explain the observed persistence, volatility, and hump-shaped impulse response function of the real exchange rate. This comment shows, first, that correcting an error in one of Steinsson's models leads to substantially lower persistence and volatility of the real exchange rate; second, that Steinsson's models cannot match real exchange rate volatility relative to output; and, third, that reasonable variations of the model calibration or specification all lead to lower real exchange rate persistence and volatility (or both). (JEL F41, F44, E52)

Although I am myself a member of the Executive Board of the Riksbank, it is hardly a secret that I see major problems with Swedish monetary policy. In a shorter-run perspective one can note that both CPI and CPIF inflation are now significantly below the inflation target of 2 per cent, and that unemployment is way above a reasonable long-run sustainable rate. There is no doubt that monetary policy has contributed to this, in that it has been too tight since the Riksbank began raising the policy rate in the summer of 2010. This may of course sound strange given that the policy rate is at a historically low level. But both short and long nominal and real interest rates have shown a negative trend since the mid-1990s and have fallen in Sweden and the rest of the world. This makes it misleading to now make direct historical comparisons of the level of the policy rate. The fact that monetary policy has been and still is too tight becomes clearer when one sees that the policy rate and the short real rates in Sweden have been raised since 2010, and then have been kept high in comparison with policy rates and the short real rates in the euro area, the United Kingdom and the United States. This is despite the fact that inflation in Sweden is significantly lower than in these economies while unemployment is about as high as in the United Kingdom and the United States (Figures 1-3). After having been close to the target in early 2010, CPIF inflation in Sweden has also since trended downwards to a rate of one per cent or below.

We use an estimated monetary business cycle model with search and matching frictions in the labor market and nominal price and wage rigidities to study four countries (the U.S., the U.K., Sweden, and Germany) during the financial crisis and the Great Recession. We estimate the model over the period prior to the financial crisis and use the model to interpret movements in GDP, unemployment, vacancies, and wages in the period from 2007 until 2011. We show that contractionary financial factors and reduced efficiency in labor market matching were largely responsible for the experience in the U.S. Financial factors were also important in the U.K., but less so in Sweden and Germany. Reduced matching effi ciency was considerably less important in the U.K. and Sweden than in the U.S., but matching efficiency improved in Germany, helping to keep unemployment low. A counterfactual experiment suggests that unemployment in Germany would have been substantially higher if the German labor market had been more similar to that in the U.S.

We use an estimated monetary business cycle model with search and matching frictions in the labor market and nominal price and wage rigidities to study three countries (the U.S., the U.K., and Sweden) during the financial crisis and the Great Recession. We estimate the model over the period prior to the financial crisis and use the model to interpret movements in GDP, unemployment and vacancies in the period from 2007 until 2011. We show that contractionary financial factors and reduced efficiency in labor market matching were largely responsible for the experience in the U.S. Financial factors were also important in the U.K. and (to a lesser extent) in Sweden, while reduced matching efficiency was considerably less important in the European countries than in the U.S.

Sweden’s economy has grown dramatically following a severe downturn (Figure 1). GDP is now more or less back to the level it was at three years ago (Figure 2). Since the summer of 2010, the majority on the Executive Board of the Riksbank has tightened monetary policy by raising the repo rate. According to the Riksbank’s forecasts for the years ahead, CPI inflation will be higher than the target of 2 per cent over the next few years (Figure 3). However, the fact that CPI inflation is higher than the target is due to the Riksbank’s own reporate increases. If we instead measure inflation using the CPIF index, which adjusts for the effects of these repo-rate increases, the forecast is on average lower than 2 per cent. The rate of unemployment will also continue to be high in the years ahead (Figure 4). Is increasing the repo rate and tightening monetary policy therefore the right thing to do? It means that CPIF inflation will be lower and further from the target and that unemployment will continue to be unnecessarily high compared to what it would be with a lower repo rate and a more expansionary monetary policy.

We use a standard quantitative business cycle model with nominal price and wage rigidities to estimate two measures of economic inefficiency in recent U.S. data: the output gap: the gap between the actual and efficient levels of output -- and the labor wedge -- the wedge between households' marginal rate of substitution and firms' marginal product of labor. We establish three results. (i ) The output gap and the labor wedge are closely related, suggesting that most inefficiencies in output are due to the inefficient allocation of labor. (ii ) The estimates are sensitive to the structural interpretation of shocks to the labor market, which is ambiguous in the model. (iii ) Movements in hours worked are essentially exogenous, directly driven by labor market shocks, whereas wage rigidities generate a markup of the real wage over the marginal rate of substitution that is acyclical. We conclude that the model fails in two important respects: it does not give clear guidance concerning the efficiency of business cycle fluctuations, and it provides an unsatisfactory explanation of labor market and business cycle dynamics.

We use a standard quantitative business cycle model with nominal price and wage rigidities to estimate two measures of economic inefficiency in recent U.S. data: the output gap—the gap between the actual and efficient levels of output—and the labor wedge—the wedge between households’ marginal rate of substitution and firms’ marginal product of labor. We establish three results. (i) The output gap and the labor wedge are closely related, suggesting that most inefficiencies in output are due to the inefficient allocation of labor. (ii) The estimates are sensitive to the structural interpretation of shocks to the labor market, which is ambiguous in the model. (iii) Movements in hours worked are essentially exogenous, directly driven by labor market shocks, whereas wage rigidities generate a markup of the real wage over the marginal rate of substitution that is acyclical. We conclude that the model fails in two important respects: it does not give clear guidance concerning the efficiency of business cycle fluctuations, and it provides an unsatisfactory explanation of labor market and business cycle dynamics.

We estimate a monetary business cycle model on post-war U.S. data. We first show that an i.i.d. shock to the labor market is better interpreted as measurement error, while a persistent labor market shock is the main driver of hours. We then study the behavior of the potential level of output and the output gap, and show that the estimated gap is very sensitive to the structural interpretation of the persistent labor market shock: two observationally equivalent interpretations of the model generate very different behavior of the output gap, and therefore have very different implications for the welfare costs of business cycles and the design of optimal monetary policy. Finally, we demonstrate that the dynamics of the output gap are closely related to the dynamics of hours and the “labor wedge,” that is, the wedge between consumers’ marginal rate of substitution between leisure and consumption and firms’ marginal product of labor. We conclude that the interpretation of labor market fluctuations is crucial when using models in this class for welfare analysis or to design optimal monetary policy.

I revisit the potential costs and benefits for Sweden of joining the Economic and Monetary Union (EMU) of the European Union. I first show that the Swedish business cycle since the mid-1990s has been closely correlated with the Euro area economies, suggesting that common shocks have been an important driving force of business cycles in Europe. However, evidence from an estimated model of the Swedish economy instead suggests that country-specific shocks have been important for fluctuations in the Swedish economy since 1993, implying that EMU membership could be costly. The model also indicates that the exchange rate has to a large extent acted to destabilize, rather than stabilize, the Swedish economy, pointing to the costs of independent monetary policy with a flexible exchange rate. Finally, counterfactual simulations of the model suggest that Swedish inflation and GDP growth might have been slightly higher if Sweden had been a member of EMU since the launch in 1999, but also that GDP growth might have been more volatile. The evidence is therefore not conclusive about whether or not participation in the monetary union would be advantageous for Sweden.

Robust control allows policymakers to formulate policies that guard against model misspecification. The principal tools used to solve robust control problems are state-space methods (see Hansen and Sargent, 2006, and Giordani and Soderlind, 2004). In this paper we show that the structural-form methods developed by Dennis (2006) to solve control problems with rational expectations can also be applied to robust control problems, with the advantage that they bypass the task, often onerous, of having to express the reference model in statespace form. Interestingly, because state-space forms and structural forms are not unique the two approaches do not necessarily return the same equilibria for robust control problems. We apply both state-space and structural solution methods to an empirical New Keynesian business cycle model and find that the differences between the methods are both qualitatively and quantitatively important. In particular, with the structural-form solution methods the specification errors generally involve changes to the conditional variances in addition to theconditional means of the shock processes.

We develop a structural model of a small open economy with gradual exchange rate pass-through and endogenous inertia in inflation and output. We then estimate the model by matching the implied impulse responses with those obtained from a VAR model estimated on Swedish data. Although our model is highly stylized it captures very well the responses of output, domestic and imported inflation, the interest rate, and the real exchange rate. However, in order to account for the observed persistence in the real exchange rate and the large deviations from UIP, we need a large and volatile premium on foreign exchange.