The future of central banking
By
👤ECB
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New Keynesian DSGE models, fashionable with central banks, have too long ignored the insights of the Information Economics Revolution to which Joseph Stiglitz made seminal contributions. Further, these models have failed to assimilate important research insights from encompassing alternative theories, model selection and the implications of structural breaks, to which econometric literature David Hendry is a key contributor. This paper summarises the critique. After responding to a recent counter-attack on critics of New Keynesian DSGE models, it shows how evidence-based research can improve quantitative policy models allowing central banks to have a better understanding of financial stability, and to improve inflation models and forecasts. In particular, household sector equation systems for consumption, balances sheets and asset prices are able to explain the amplification mechanisms that put some countries at greater risk of financial instability. And new evidence from forecasting US core inflation suggests that with appropriate controls, a stable relationship between unemployment and inflation is revealed, though not between the policy rate and inflation. This empirical evidence is consistent with arguments advanced in recent years by the ECB’s retiring Vice President Vítor Constâncio.
By
👤ECB
