Here's Looking at You : Modeling and Policy Use of Auction Price Expectations

Indexes of asset prices have been suggested as nominal anchors for monetary policy, in place of conventional monetary aggregates. This paper explores issues in modeling and policy simulations of expectations models of auction prices. Long-run (cointegrating) and short-run relationships are estimated for the prices or yields of long-term bonds, equity, and several primary commodity groups, using autoregressive approximations of agent's expectations of future interest and inflation rates. The incremental value of information of agents' inflation expectations provided by direct measurements of primary commodity prices is evaluated by stochastic simulation experiments with the FRB/MPS quarterly model of the US economy. In a set benchmark feedback rules, the price indicator is provided by a weighted index of primary commodity prices or an inflation "filter" which removes the impact of commodity-specific disturbances and policy-induced changes in interest rates from the primary commodity price index. In addition to experiments with expectations based on historical autoregressions, other simulations explore the impact of counterfactual policies on the formation of agent's expectations. Although results are quite preliminary, the simulations suggest that commodity price indicators may improve the performance of short-run stabilization policies; and the performance ranking of alternative policy rules is robust the the alternative characterizations of agents' expectations