Financial system procyclicality and optimal capital requirement policy: Revisiting countercyclical responses (with Solikin M. Juhro) -- version: 18 September 2026; Appendix
Abstract: This paper analyzes the optimal interaction between monetary and capital requirement (CR) policies in an estimated medium-scale DSGE model with financial frictions and a wide array of shocks. Rather than imposing countercyclical CR policy, we allow the optimal response to credit conditions to be either countercyclical or procyclical. We find that the welfare-maximizing CR response is procyclical for a majority of individual shocks and remains procyclical when all shocks are considered jointly, with non-trivial welfare gains in some cases even when monetary policy is already optimized. The optimal orientation, however, is not determined by the shock alone. For a bank-capital shock, the response switches from procyclical to countercyclical as the bank-capital friction becomes sufficiently strong. Our analysis identifies nominal price rigidity and the associated relative-price distortion as a key source of the procyclical policy incentive. More generally, the desirable cyclicality of CR policy depends on the interaction between the shocks affecting the economy and the distortions through which they propagate. There is therefore no unconditional welfare rationale for making capital requirements countercyclical.
The slope of the Phillips curve and the optimal average inflation targeting window -- Australian Economic Review, Policy Forum, September 2024; WP version; Appendix
Abstract: The slope of the Phillips curve has been shown to be flatter in recent years, including in Australia. How does this impact the optimal targeting window for a central bank conducting an average inflation targeting policy? This paper shows that in the face of the flattening of the Phillips curve, it is desirable to increase the targeting window. Doing so would lead to lower inflation fluctuations and to a non-trivial welfare gain. In a persistently higher-than-target inflation, high interest-rate environment, this implies that the central bank should keep the nominal interest rate higher for longer.
Changes in the Inflation Target and the Comovement between Inflation and the Nominal Interest Rate (with Yunjong Eo) -- Economic Record Vol. 101, Issue 332, 3-40 (lead article), March 2025; WP (accepted) version
Abstract: Would raising the inflation target require an increase in the nominal interest rate in the short run? We answer this policy question, first analytically in a small-scale New Keynesian model with backward-looking components where a closed-form solution exists, and then in a medium-scale model of Smets and Wouters (2007) calibrated to the U.S. economy. Our analysis shows that the short-run comovement between inflation and the nominal interest rate conditional on changes in the inflation target is more likely to be positive, all else equal, as the monetary authority reacts less aggressively to the deviation of inflation from its target. Meanwhile, features of the model that enhance backward-looking behavior, such as backward price indexation and habit formation in consumption, are shown to reduce the likelihood of the positive comovement. However, our investigations reveal that in both models, this positive comovement or so-called Neo-Fisherism is prevalent across a wide-range of empirically plausible parameter values. Using the Smets and Wouters model with a zero lower bound (ZLB) constraint on the nominal interest rate, we show that raising the inflation target could be an effective alternative policy framework to reduce the possibility of a binding ZLB constraint and to mitigate the potentially large output loss.
Money velocity, digital currency, and inflation dynamics in Indonesia (with Danny Hermawan, Aryo Sasongko and Richard Yusan) -- Bulletin of Indonesian Economic Studies Vol. 60(3), 2024
Abstract: This paper empirically investigates the impact of transaction–cost-induced variations in the velocity of money on inflation dynamics in Indonesia, using a structural New Keynesian Phillips curve incorporating an explicit money-velocity term. The effect of money velocity arises from the role of money, both physical and digital, in reducing aggregate transaction costs and facilitating the purchase of goods and services. We find a non-trivial aggregate impact on the Indonesian economy: our benchmark estimates suggest that a 10% decrease in money velocity due to the issuance of a new digital currency (for example, a central bank digital currency [CBDC]), would reduce the inflation rate by 0.6%–1.7%, all else being equal. We show that shocks to the velocity of money are an important driver of aggregate fluctuations by incorporating these estimates into a small-scale New Keynesian dynamic stochastic general equilibrium model calibrated to the Indonesian economy. The model’s simulation shows that a CBDC issuance equivalent to about 5% of nominal GDP in Indonesia in 2023 would permanently increase real GDP by almost 1% and lower the inflation rate by nearly 1%. Both nominal and real interest rates would also be permanently lower. Our findings suggest that central banks could use CBDCs as an additional tool for stabilisation policy by influencing money velocity.
An estimated open-economy DSGE model for the evaluation of central bank policy mix (with Solikin M. Juhro and Aryo Sasongko) -- Bulletin of Monetary Economics and Banking Vol. 26(3), November 2023 (WP version)
Implications of State-Dependent Pricing for DSGE Model-Based Policy Analysis in Indonesia -- Economic Analysis and Policy Vol. 71(C), 2021 (WP version)
Average Inflation Targeting and Interest-Rate Smoothing (with Yunjong Eo) -- Economics Letters Vol. 189, March 2020 (WP version)
The Role of Inflation Target Adjustment in Stabilization Policy (with Yunjong Eo) -- Journal of Money, Credit and Banking Vol. 52(8), December 2020 (WP version)
Observed Inflation-Target Adjustments in an Estimated DSGE Model for Indonesia: Do They Matter for Aggregate Fluctuations? -- (WP version) -- Economic Papers Vol. 38(4), December 2019, Special Issue on Understanding Indonesia's Economic and Financial Systems
State-Dependent Pricing and Optimal Monetary Policy -- version: August 2019
Time-Varying Trend Inflation and the New Keynesian Phillips Curve in Australia (with Anirudh Yadav) -- Economic Record Vol. 93, Issue 300, 42-66, March 2017 (WP version)
Comments on "Trend Inflation, Indexation, and Inflation Persistence in the New Keynesian Phillips Curve" (with Fabia Gumbau-Brisa) -- version: May 2015
Straightforward Approximate Stochastic Equilibria for Nonlinear Rational Expectations Models (with Michael K. Johnston and Robert G. King) -- version: August 2014
Note: these (newer) codes impose restrictions on equations (as in Appendix A) and compute solutions up to a 3rd-order approximation.
Note: these (older) codes impose restrictions on variables and only compute solutions up to a 2nd-order approximation.
Estimation of Forward-Looking Relationships in Closed Form: An Application to the New Keynesian Phillips Curve (with Michelle Barnes, Fabia Gumbau-Brisa, and Giovanni Olivei) -- version: June 2011
Note: this paper is a revised version of "Closed-Form Estimates of the New Keynesian Phillips Curve with Time-Varying Trend Inflation," Federal Reserve Bank of Boston WP 09-15.