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Papers by Stephen Murchison

The authors provide a detailed technical description of the Terms-of-Trade Economic Model (ToTEM)... more The authors provide a detailed technical description of the Terms-of-Trade Economic Model (ToTEM), which replaced the Quarterly Projection Model (QPM) in December 2005 as the Bank's principal projection and policy-analysis model for the Canadian economy. ToTEM is an open-economy, dynamic stochastic general-equilibrium model that contains producers of four distinct finished products: consumption goods and services, investment goods, government goods, and export goods. ToTEM also contains a commodity-producing sector. The behaviour of almost all key variables in ToTEM is traceable to a set of fundamental assumptions about the underlying structure of the Canadian economy. This greatly improves the model's ability to tell coherent, internally consistent stories about the current evolution of the Canadian economy and how it is expected to evolve in the future. In addition, ToTEM's multiple-goods approach enables the Bank to gain insight into a much wider variety of shocks, in...

The authors develop a small open-economy dynamic stochastic general-equilibrium (DSGE) model in a... more The authors develop a small open-economy dynamic stochastic general-equilibrium (DSGE) model in an attempt to understand the dynamic relationships in Canadian macroeconomic data. The model differs from most recent DSGE models in two key ways. First, for prices and wages, the authors use the time-dependent staggered contracting model of Dotsey, King, and Wolman (1999) and Wolman (1999), rather than the Calvo (1983) specification. Second, to model investment, the authors adopt Edge's (2000a, b) framework of time-to-build with ex-post inflexibilities. The model's parameters are chosen to minimize the distance between the structural model's impulse responses to interest rate, demand (consumption), and exchange rate shocks and those from an estimated vector autoregression (VAR). The majority of the model's theoretical impulse responses fall within the 5 and 95 per cent confidence intervals generated by the VAR.

The authors assess the performance of the Canadian economy under a variety of interest rate rules... more The authors assess the performance of the Canadian economy under a variety of interest rate rules when the zero bound on nominal interest rates can bind. Their assessment is based on numerical simulations of a dynamic stochastic general-equilibrium model in a stochastic environment. Consistent with the literature, the authors find that the probability and consequences of the zero bound depend strongly on the targeted rate of inflation and that price-level targeting generally leads to better outcomes. Their results show that a non-linear rule is preferable to a linear rule under both inflation and price-level targeting, because of the zero-bound issue. This suggests that central banks should be pre-emptive and adopt an aggressive monetary policy when expected inflation falls below its desired level. The authors' results also show that the monetary authority must be much more forward looking under price-level targeting than under inflation targeting.

This report provides a detailed technical description of an updated version of the Terms-of-Trade... more This report provides a detailed technical description of an updated version of the Terms-of-Trade Economic Model (ToTEM II), which replaced ToTEM (Murchison and Rennison 2006) in June 2011 as the Bank of Canada's quarterly projection model for Canada. ToTEM has been improved along a number of dimensions, with important changes to the model structure, including: (i) multiple interest rates, (ii) sector-specific demand specifications for consumption, housing investment and inventory investment, (iii) a role for financial wealth in household consumption, and (iv) rule-of-thumb price and wage setters. These new features remove some of the restrictions on model dynamics implied by assumptions in ToTEM, making ToTEM II more general and flexible than its predecessor. Furthermore, most of ToTEM II's parameters are now formally estimated using full information estimation techniques, leading to significantly improved in-sample goodness of fit. The report discusses the model's esti...

For central banks, conducting policy in an environment of uncertainty is a daily fact of life. Th... more For central banks, conducting policy in an environment of uncertainty is a daily fact of life. This uncertainty can take many forms, ranging from incomplete knowledge of the correct economic model and data to future economic and geopolitical events whose precise magnitudes and effects cannot be known with certainty. The objective of this paper is to summarize and compare the main results that have emerged in the literature on optimal monetary policy under uncertainty with actual central bank behaviour. To this end, three examples are studied in which uncertainty played a significant role in the Bank of Canada's policy decision, to see how closely they align with the predictions from the literature. Three principles emerge from this analysis. First, some circumstances—such as when the policy rate is at risk of being constrained by the effective lower bound—should lead the central bank to be more pre-emptive in moving interest rates, whereas others can rationalize more of a wait-a...

SSRN Electronic Journal, 1998

This paper seeks, through the estimation of central bank reaction functions for 19 OECD countries... more This paper seeks, through the estimation of central bank reaction functions for 19 OECD countries in a panel setting, to examine the relationship between certain key target variables and an instrument of monetary policy, namely short-term interest rates. A rolling, reduced form, vector autoregression (VAR) of interest rates, unemployment, and inflation is employed to mimic a central bank's information set. Each "roll" updates this information set by one observation while eliminating the first. The one-step ahead forecast error is then modeled in the reaction function to test the extent to which the policy instrument reacts to unemployment and inflation innovations. We also consider the role of professional forecasts in central bank reactions. In addition to forecast errors, we also examine the reaction of interest rates as a function of how unemployment diverges from a newly proposed estimate of trend unemployment. Alternatively, we also apply the Hodrick-Prescott filter and consider other assumptions about the trend unemployment rate. We examine the possibility that central banks react asymmetrically to positive and negative shocks. Furthermore, where relevant, we include deviations from published inflation target "bands" to capture the recent commitment by some central banks to formally target inflation. Finally, we also examine the influence of political variables, such as election timing and partisan changes in government, on our chosen instrument of monetary policy. In addition, several definitions of central bank autonomy and exchange rate regimes are included as control variables to capture institutional effects on monetary policy formation. The results of this study suggest that central banks react in a predictable manner to unemployment and inflation innovations. Furthermore, deviations from trend unemployment appear to generate compensating movements in interest rates. Evidence confirming the possibility of threshold effects, however, is less conclusive. Moreover, there is little evidence of political influence on monetary policy, regardless of the time period examined. Indexes of central bank independence account for little of the cross sectional variation in interest rates among OECD countries. However, when the group of inflation targeting countries are separately considered, the reaction functions are much more informative about both central bank and government motives.

Studies evaluating the e¢ cacy of monetary policy rules and regimes are often based a benchmark n... more Studies evaluating the e¢ cacy of monetary policy rules and regimes are often based a benchmark new Keynesian model where the parameters are assumed to be policy invariant. It is possible, however, that some key parameters may not be invariant to changes in monetary policy. In this paper, we use a hybrid new Keynesian Phillips curve to examine the in‡ation versus price-level targeting debate when the proportion of rule-of- thumb price setters is allowed to change endogenously with the monetary regime. Although there are other factors that may also be endogenous, we focus on in‡ation inertia since it has been identi…ed in the literature as a crucial parameter aecting the performance of monetary policy. � This paper was prepared for the Bank of Canada's annual conference entitled "New Frontiers in Monetary Policy Design," to be held November 12 and 13, 2009. The views expressed are the authors'and do not necessarily re‡ect those of the Bank of Canada or its sta¤.

This article examines another strategy in the Bank's approach to dealing with an uncertain wo... more This article examines another strategy in the Bank's approach to dealing with an uncertain world: the use of carefully articulated models to produce economic forecasts and to examine the implications of the various risks to those forecasts. Economic models are deliberate simplifications of a complex world that allow economists to make predictions that are reasonably accurate and that can be easily understood and communicated. By using several models, based on competing paradigms, the Bank minimizes policy errors that could result from relying on one view of the world and one philosophy of model design. The authors review some of the models currently used at the Bank, as well as the role of judgment in the projection process.

Journal of Monetary Economics, 2009

This paper studies the steady-state costs of inflation in a general-equilibrium model with real p... more This paper studies the steady-state costs of inflation in a general-equilibrium model with real per capita output growth and staggered nominal price and wage contracts. Our analysis shows that trend inflation has important effects on the economy when combined with nominal contracts and real output growth. Steady-state output and welfare losses are quantitatively important even for low values of trend inflation. Further, we show that nominal wage contracting is quantitatively more important than nominal price contracting in generating these losses. This important result does not arise from price dispersion per se but from an effect of nominal output growth on the optimal markup of monopolistically competitive labour suppliers. We also demonstrate that accounting for productivity growth is important for calculating the welfare costs of inflation. Indeed, the presence of two percent productivity growth increases the welfare costs of inflation in our benchmark specification by a factor of four relative to the no-growth case.

Applied Economics Letters, 1999

ABSTRACT evidence not presented here is contained in a separate appendix available from the secon... more ABSTRACT evidence not presented here is contained in a separate appendix available from the second author. Comments by a referee on an earlier draft We propose a proxy for trend unemployment derived from the cointegration property between unemployment rates and world oil prices. Evidence from a sample of OECD countries is presented in support of the hypothesis. We argue that our empirical proxy is superior from an economic perspective to at least one popular empirical alternative and may be especially useful in cross-country type studies

This is the first of three papers describing NAOMI1, a new quarterly forecasting model developed ... more This is the first of three papers describing NAOMI1, a new quarterly forecasting model developed in the Economic Analysis and Forecasting Division at the Department of Finance. NAOMI’s intended purpose is twofold. First, it is capable of producing reliable, judgement-free macroeconomic forecasts on a timely basis. Second, it can accurately quantify the level of uncertainty associated with each forecast while ensuring this uncertainty is minimised. Jointly achieving these two objectives represents a formidable task and necessitates a somewhat unique approach to the model building exercise. This paper outlines the model building strategy used to create NAOMI. The proposed approach differs from existing methods in that its sole objective is to minimise forecast uncertainty. We demonstrate that the high level of forecast imprecision typically associated with multi-equation forecasting models such as vector autoregressions stems from the large number of free parameters embodied in such s...

SSRN Electronic Journal, 1998

Journal of Monetary Economics, 2009

Applied Economics Letters, 1999