BoE paper takes DSGE approach to deflation probabilities
DSGE model simulations can help pick out causality, researchers say
A staff working paper, published by the Bank of England on November 4, tries to tease out the reasons why people may view monetary policy as more likely to be constrained by the zero lower bound.
Authors Alex Haberis, Riccardo Masolo and Kate Reinold compare simulations from a dynamic stochastic general equilibrium (DSGE) model, estimated on different measures of deflation probability – the survey of economic forecasts, financial market option prices and BoE Monetary Policy Committee forecasts.
By varying the assumptions underlying the DSGE model on the likelihood of the central bank being able to offset disinflationary shocks, the researchers say it is easier to pick out the possible drivers of inflation probabilities.
Their results imply the deflation probability measures observed during the 2008 crisis do not "embody a perception" that monetary policy was particularly constrained.
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