77. Informal Observations on Deposit and Credit Dollarization, presented to conference to celebrate the 25th anniversary of the Armenian Dram, prepared with Husnu Dalgic and Armen Nurbekyan.
76. Discouraging Deviant Behavior in Monetary Economics, with Yuta Takahashi. Slides.
75. Does the New Keynesian Model Have a Uniqueness Problem?, with Martin Eichenbaum and Ben Johannsen.
74. Discussion of Aoki, Benigno and Kiyotaki, “Monetary and Financial Policies in Emerging Markets”
73. On DSGE Models, with Martin Eichenbaum and Mathias Trabandt.
71. Financialization in Commodity Markets, with VV Chari.
69. Interview on DSGE models, International Monetary Fund, summer 2015.
67. Discussion of Acemoglu-Akcigit-Kerr.
66. Discussion of Barsky, Basu and Lee Macroeconomics Annual Paper.
65. Discussion of “Land-price Dynamics and Macroeconomic Fluctuations,’’ by Zheng Liu, Pengfei Wang and Tao Zha (Econometrica, 2013).
64. Understanding the Great Recession, with Eichenbaum and Trabandt, American Economic Journal: Macroeconomics, 2015
63. Discussion of Boissay-Collard-Smets.
60. Discussion of Giavazzi-McMahon, “The Household Effects of Government Spending”.
59. Comment on Saki Bigio, “Financial Risk Capacity”.
58. Risk Shocks, with Roberto Motto and Massimo Rostagno, American Economic Review, 2014..
57. Notes on Linear Approximations, Equilibrium Multiplicity and E-learnability in the Analysis of the Zero Lower Bound, with Martin Eichenbaum.
56. Comment on Cogley, Sargent and Surico, ‘The Return of the Gibson Paradox’.
54. Monetary Policy, 1982 to the Present, remarks presented to conference, “A Return to Jekyll Island: The Origins, History, and Future of the Federal Reserve”, November 5-6, 2010.
53. Government Policy, Credit Markets and Economic Activity, with Daisuke Ikeda.
52. Remarks on Unconventional Monetary Policy Presented at International Journal of Central Banking Conference Hosted by Bank of Japan, September 15, 2010
51. Monetary Policy and Stock Market Booms, with Cosmin Ilut, Roberto Motto and Massimo Rostagno (revision of paper presented for August 2010 Jackson Hole symposium).
49. Discussion of Eggertsson, What Fiscal Policy Is Effective at Zero Interest Rates?
47. Comment on Gertler and Kiyotaki.
46. Involuntary Unemployment in a Business Cycle Model, with Mathias Trabandt and Karl Walentin (slides, technical appendix).
44. Introducing Financial Frictions and Unemployment into a Small Open Economy Model, with Mathias Trabandt and Karl Walentin (appendix).
43. Financial Factors in Business Cycles, with Motto and Rostagno.
We augment a standard monetary DSGE model to include financial markets, and fit the model to EA and US data. The empirical results draw attention to a new shock and to an important new nominal rigidity. The new shock originates in the financial sector and accounts for a significant portion of business cycle fluctuations. We do a detailed study of the role of this shock in the boom-bust of the late 1990s and early 2000s. The new nominal friction corresponds to the fact that lending contracts are typically denominated in nominal terms. Consistent with Fisher (1933), we show that the distributional consequences of this nominal rigidity play an important role in the propagation of shocks. Finally, we exploit the existence of financial variables in our model to investigate the consequences of adopting a monetary policy which reacts to the stock market or to a broad monetary aggregate.
42. Rules and Discretion, Remarks at a conference in honor of John Taylor.
41. Two Reasons Why Money and Credit May be Useful in Monetary Policy, with Roberto Motto and Massimo Rostagno.
Abstract: We describe two examples which illustrate in different ways how money and credit may be useful in the conduct of monetary policy. Our first example shows how monitoring money and credit can play a useful role in anchoring private sector expectations about inflation. The second example shows that a monetary policy that focuses too narrowly on inflation may inadvertently contribute to welfare-reducing boom-bust cycles in real and financial variables. The example is of some interest because it is based on a monetary policy rule fit to aggregate data. In the example, a policy of monetary tightening when credit growth is strong can attenuate this unintended consequence of stabilizing inflation. Powerpoint presentation.
40. ‘Shocks, Structures or Monetary Policies? The EA and US After 2001, with Roberto Motto and Massimo Rostagno.
Abstract: We describe a model we have estimated using US and Euro Area data, and use it to address a recent controversy. The US Federal Reserve cut interest rates much more vigorously in the recent recession than the European Central Bank did. By comparison with the Fed, it is claimed, the ECB stood by passively as the EA economy slumped. According to our analysis, passivity at the ECB is not useful for understanding the different experiences of the EA and US in recent years. On the contrary, we find that - because there is greater inertia in the ECB's policy rule - the policy actions of the ECB actually had a greater stabilizing effect than did those of the Fed. The ECB's policy shocks converted what would have been a severe recession in the EA into what turned out to be only an economic growth slowdown, without compromising the ECB's inflation objective. Other factors that account for the different economic outcomes in the EA and US include differences in shocks and differences in the degree of wage and price flexibility.
39. Work in progress on the behavior of different firms over the business cycle.
38. Signals: Implications for Business Cycles and Monetary Policy, with Cosmin Ilut, Roberto Motto and Massimo Rostagno. We fit a Bayesian DSGE model to US data and find that anticipations about the future for monetary policy matter a lot in business cycle dynamics. We then also show that the presence of such signals matter for monetary policy as well. Signals induce substantial movements in the natural rate of interest, and standard interest rate targeting rules for monetary policy induce inefficient booms as a result. An earlier draft of this paper is: Monetary Policy and Stock Market Boom-Bust Cycles, with Cosmin Ilut, Roberto Motto and Massimo Rostagno.
Using ‘business cycle accounting’ (BCA), Chari, Kehoe and McGrattan (2006) (CKM) conclude that models of financial frictions which create a wedge in the intertemporal Euler equation are not promising avenues for modeling business cycle dynamics. There are two reasons that this conclusion is not warranted. First, small changes in the implementation of BCA overturn CKM’s conclusions. Second, one way that shocks to the intertemporal wedge impact on the economy is by their spillover effects onto other wedges. This potentially important mechanism for the transmission of intertemporal wedge shocks is not identified under BCA. CKM potentially understate the importance of these shocks by adopting the extreme position that spillover effects are zero.
36. Discussion of ‘On the Fit of New-Keynesian Models’, by Marco Del Negro, Frank Schorfheide, Frank Smets and Raf Wouters.
35. The Optimal Monetary Response to a Financial Crisis, with Fabio Braggion and Jorge Roldos.
We describe a model in which the optimal monetary policy response to a financial crisis is to raise the interest rate immediately, and then reduce it sharply. This pattern is consistent with what actually happened in the Asian crisis episodes.
34. VARs as a Guide to Estimating Dynamic General Equilibrium Models, with Martin Eichenbau and Rob Vigfusson.
33. Firm-Specific Capital, Nominal Rigidities and the Business Cycle, with David Altig, Martin Eichenbaum and Jesper Linde.
Macroeconomic and microeconomic data paint conflicting pictures of price behavior. Macroeconomic data suggest that inflation is inertial. Microeconomic data indicate that firms change prices frequently. We formulate and estimate a model which resolves this apparent micro - macro conflict. Our model is consistent with post-war U.S. evidence on inflation inertia even though firms re-optimize prices on average once every 1.5 quarters. The key feature of our model is that capital is firm-specific and pre-determined within a period.
32. Firm-Specific Capital and Aggregate Inflation Dynamics in Woodford's Model. This note exposits Woodford’s method for computing the reduced form coefficients governing aggregate inflation dynamics in Woodford’s, Interest and Prices, Chapter 5. The MATLAB code, inflation.m, implements the calculations. To run this software using an example, execute computegamma.m in the software found here.
31. Discussion of Chari, Kehoe and McGrattan, ‘Are Structural VARs Useful Guides for Developing Business Cycle Theories?’. Presented at ‘3rd Banco de Portugal Conference on Monetary Policy’, Lisbon, June 2004.
I consider the example analyzed in Eggertsson and Woodford (2003a,b), which shows that the zero lower bound on the nominal rate of interest, in conjunction with a low-inflation policy by the central bank, can cause output to collapse in response to certain shocks. I show that with investment, the problem is less severe, though not ruled out under the parameter values suggested by Woodford (2003). However, the parameters in Woodford (2003) imply a very high Frisch elasticity of labor supply. When I use a more standard elasticity, the lower bound no longer binds, even for very large shocks.
We evaluate the Friedman-Schwartz hypothesis that a more accommodative monetary policy could have greatly reduced the severity of the Great Depression. To do this, we first estimate a dynamic, general equilibrium model using data from the 1920s and 1930s. Although the model includes eight shocks, the story it tells about the Great Depression turns out to be a simple and familiar one. The contraction phase was primarily a consequence of a shock that induced a shift away from privately intermediated liabilities, such as demand deposits and liabilities that resemble equity, and towards currency. The slowness of the recovery from the Depression was due to a shock that increased the market power of workers.
We identify a monetary base rule which responds only to the money demand shocks in the model. We solve the model with this counterfactual monetary policy rule. We then simulate the dynamic response of this model to all the estimated shocks. Based on the model analysis, we conclude that if the counterfactual policy rule had been in place in the 1930s, the Great Depression would have been relatively mild.
The Great Depression and the Friedman-Schwartz Hypothesis, joint with Roberto Motto and Massimo Rostagno .
We investigate what happens to hours worked after a positive shock to technology, using the aggregate technology series computed in Basu, Fernald, and Kimball (1999). We conclude that hours worked rise after such a shock.
The Response of Hours to a Technology Shock: Evidence Based on Direct Measures of Technology, joint with Martin Eichenbaum and Robert Vigfusson.
This paper examines the economic impact of permanent shocks to technology. We argue that a positive technology shock drives hours worked up. This contrasts sharply with results in the literature. The evidence suggests that those results are an artifact of specification error.
More generally, we find that positive technology shocks have qualitative effects that students of real business cycle models would anticipate: in addition to driving hours worked up, they also lead to increases in productivity, output, consumption and investment, while generating a decline in inflation. Nevertheless, we find that technology shocks play a relatively small role in business fluctuations. Their importance is greater in the lower frequency components of the data.
What Happens After a Technology Shock? joint with Martin Eichenbaum and Rob Vigfusson.
We characterize the change in the nature of the money growth-inflation and unemployment-inflation relationships between the first and second halves of the 20th century. The changes are substantial, and we discuss some of the implications for modeling inflation dynamics.
Inflation and Monetary Policy in the 20th Century, joint with Terry Fitzgerald.
What are the economic effects of an interest rate cut when an economy is in the midst of a financial crisis? Under what conditions will a cut stimulate output and employment, and raise welfare? Under what conditions will a cut have the opposite effects? We answer these questions in a general class of open economy models, where a financial crisis is modeled as a time when collateral constraints are suddenly binding. We find that when there are frictions in adjusting the level of output in the traded good sector and in adjusting the rate at which that output can be used in other parts of the economy, then a cut in the interest rate is most likely to result in a welfare-reducing fall in output and employment. When these frictions are absent, a cut in the interest rate improves asset positions and promotes a welfare-increasing economic expansion.
Monetary Policy in a Financial Crisis, joint with Christopher Gust and Jorge Roldos.
Using a series of examples, we review the various ways in which a monetary policy characterized by the Taylor rule can inject volatility into the economy. In the examples, a particular modification to the Taylor rule can reduce or even entirely eliminate the problems. Under the modified policy, the central bank monitors the money growth rate and commits to abandoning the Taylor rule in favor of a money growth rule in case money growth passes outside a particular monitoring range.
Money Growth Monitoring and the Taylor Rule, joint with Massimo Rostagno.
We present a model embodying moderate amounts of nominal rigidities which accounts for the observed inertia in inflation and persistence in output.
Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy, joint with Martin Eichenbaum and Charles Evans.
22. Abstract: We analyze two monetary economies - a cash-credit good model and a limited participation model. In our models, monetary policy is made by a benevolent policymaker who cannot commit to future policies. We define and analyze Markov equilibrium in these economies. We show that there is no time inconsistency problem for a wide range of parameter values.
How Severe is the Time Inconsistency Problem in Monetary Policy?, with Stefania Albanesi and V.V. Chari.
21. Abstract: Why is it that inflation is persistently high in some periods and persistently low in other periods? We argue that lack of commitment in monetary policy may bear a large part of the blame. We show that, in a standard equilibrium model, absence of commitment leads to multiple equilibria, or expectation traps, even in the absence of trigger strategies. In these traps, expectations of high or low inflation lead the public to take defensive actions which then make it optimal for the monetary authority to validate those expectations.
Expectation Traps and Monetary Policy, with Stefania Albanesi and V.V. Chari.
20. Abstract: 'No'. So says one model that is broadly consistent with postwar US seasonal and business cycle data.
We review the fiscal theory of the price level. We place special emphasis on the theory's implications for the feasibility and desirability of price stability.
Understanding the Fiscal Theory of the Price Level, with Terry J. Fitzgerald.
We explore a hypothesis about the take-off in inflation that occurred in the early 1970s. According to the expectations trap hypothesis, the Fed was pushed into producing the high inflation out of a fear of violating the public’s inflation expectations. We compare this hypothesis with the Phillips curve hypothesis, according to which the Fed produced the high inflation as an unfortunate by-product of a conscious decision to jump-start a weak economy. Which hypothesis is more plausible has important implications for what needs to be done to prevent other inflation flare-ups.
The Expectations Trap Hypothesis, with Christopher Gust.
There is a worry that low interest rates interfere with a central bank's ability to conduct stabilization policy. With rates low, the fed cannot cut them further in the case of a bad shock. McCallum argues that these concerns are overblown on the grounds that a central bank has a second tool for stabilizing the economy: it can manipulate the exchange rate. According to McCallum this is possible even if the central bank has lost control over the interest rate because it has hit its zero lower bound. I offer a critical assessment of this proposition. I go on to describe another worry about low interest rates - that they prevent the central bank from fighting 'confidence crises'. These possibilities are ruled out from McCallum's model. But, they need to be addressed too, in an overall evaluation of the policy implications of a low interest rate. I sketch a model that incorporates these concerns.
Comment on McCallum's 'Theoretical Analysis Regarding a Zero Lower Bound on Nominal Interest Rates'.
We explore two models of the take-off in inflation in the early 1970s: a sticky price model and a limited participation model. The latter has the virtue that it also accounts for the weak economic conditions (i.e., stagflation) of the early 1970s.
Our limited participation model incorporates the monetary policy rule estimated for the 1970s by Clarida, Gali and Gertler. The model has an equilibrium in which a bad technology shock drives up expected inflation which the Fed accommodates with higher money growth. The Fed also raises the interest rate, which has the effect of exacerbating the depressive effects of the bad technology shock. We argue that the model provides a useful stylized representation of the events of the early 1970s. We explore the implications of our analysis for the policy changes needed to ensure that a 1970s-style stagflation does not happen again.
The Great Inflation of the 1970s (very preliminary!), with Christopher Gust.
We introduce two modifications into the standard real business cycle model: habit persistence preferences and limitations on intersectoral factor mobility. The resulting model is consistent with the observed mean equity premium, mean risk free rate and Sharpe ratio on equity. With respect to the conventional measures of business cycle volatility and comovement, the model does roughly as well as the standard real business cycle model. On four other dimensions its business cycle implications represent a substantial improvement. It accounts for (i) persistence in output, (ii) the observation that employment across different sectors moves together over the business cycle, (iii) the evidence of `excess sensitivity' of consumption growth to output growth, and (iv) the `inverted leading indicator property of interest rates,' that high interest rates are negatively correlated with future output.
Habit Persistence, Asset Returns and the Business Cycle, joint with Michele Boldrin and Jonas Fisher.
We consider a real business cycle model with an externality in production. Depending on parameter values, the model has sunspot equilibria, cyclical and chaotic equilibria, and equilibria with deterministic or stochastic regime switching. We study the implications of this model environment for automatic stabilizer tax systems.
Chaos, Sunspots and Automatic Stabilizers, joint with Sharon Harrison.
We construct a model that can account for the observed procylical behavior of stock prices and countercyclical behavior of investment good prices. We then examine the model's business cycle and asset pricing implications. It does as well as previous business cycle models on asset prices and standard business cycle statistics. It makes significant progress on two aspects of business cycles that have traditionally received less attention. In particular, our model accounts for the observed comovement across sectors in employment, output and investment. In addition, the model accounts for the so-called inverted leading indicator property of interest rates: interest rates (real or nominal) lead low output. The latter observation is often interpreted as reflecting the business cycle role of monetary policy shocks. Since ours is a model in which there are only real shocks, our analysis suggests that observations conventionally attributed to monetary policy shocks may, to some extent at least, also reflect the effects of real shocks.
Stock Market and Investment Good Prices: Implications for Macroeconomics, joint with Jonas Fisher.
Would the 1930s have looked very different if the collapse in M1 had been avoided? 'No', according to a model of Chris Sims.
Discussion of Christopher Sims, `The Role of Interest Rate Policy in the Generation and Propagation of Business Cycles: What Has Changed Since the 30s?'
11. Abstract :
I present an undetermined coefficients method for obtaining a linear approximating to the solution of a class of dynamic, rational expectations models. The method is illustrated using several examples. I also show how the solution can be used to compute a model's implications for impulse response functions and for second moments.
The Levin-Wieland-Williams paper finds that a Taylor-style monetary policy for setting short-term interest rates works well in several large scale macroeconomic models. We examine the robustness of their results in a small, limited participation macroeconomic model with money. Our analysis underscores several reasons to be cautious in designing an interest rate targetting rule. If not tuned carefully, such a rule could be counterproductive and lead to excessive volatility.
Discussion of Andrew Levin, Volker Wieland and John C. Williams, `Are Simple Monetary Policy Rules Robust to Model Uncertainty.', joint with Christopher Gust.
This paper reviews recent research that grapples with the question: What happens after an exogenous shock to monetary policy? We argue that this question is interesting because it lies at the center of a particular approach to assessing the empirical plausibility of structural economic models that can be used to think about systematic changes in monetary policy institutions and rules. The literature has not yet converged on a particular set of assumptions for identifying the effects of an exogenous shock to monetary policy. Nevertheless, there is considerable agreement about the qualitative effects of a monetary policy shock in the sense that inference is robust across a large subset of the identification schemes that have been considered in the literature. We document the nature of this agreement as it pertains to key economic aggregates.
Monetary Policy Shocks: What Have We Learned and to What End?, joint with Martin Eichenbaum and Charles Evans.
We develop a dynamic model with optimizing private agents and a benevolent, optimizing monetary authority who cannot commit to future policies. We characterize the set of sustainable equilibria and discuss the implications for institutional reform. We show that there are equilibria in which the monetary authority pursues inflationary policies, because that is what private agents expect. We call such equilibria expectation traps. Alternative institutional arrangements for the conduct of monetary policy which impose limited forms of commitment on the policymaker can eliminate expectations traps.
Expectation Traps and Discretion, with V.V. Chari and Martin Eichenbaum.
We describe and compare several algorithms for approximating the solution to a model in which inequality constraints occasionally bind. Their performance is evaluated and compared using various parameterizations of the one sector growth model with irreversible investment. We develop parameterized expectation algorithms which, on the basis of speed, accuracy and convenience of implementation, appear to dominate the other algorithms.
Algorithms for Solving Dynamic Models with Occasionally Binding Constraints, with Jonas Fisher.
The 'ideal' band pass filter can be used to isolate the component of a time series that lies within a particular band of frequencies. However, applying this filter requires a dataset of infinite length. In practice, some sort of approximation is needed. Using projections, we derive approximations that are optimal when the time series representations underlying the raw data have a unit root, or are stationary about a trend. We identify one approximation which, though it is only optimal for one particular time series representation, nevertheless works well for standard macroeconomic time series.
To illustrate the use of this approximation, we use it to characterize the change in the nature of the Phillips curve and the money-inflation relation before and after the 1960s. We find that there is surprisingly little change in the Phillips curve and substantial change in money growth-inflation relation.
5. The Business Cycle: It's Still a Puzzle, with Terry Fitzgerald.
We illustrate the use of various frequency domain tools for estimating and testing dynamic, stochastic general equilibrium models. Our substantive results confirm other findings which suggest that time-to-plan in the investment technology has a potentially useful role to play in business cycle models.
Maximum Likelihood in the Frequency Domain: The Importance of Time-to-Plan, with Rob Vigfusson.
2. Technical Appendix to Modeling Money, with Eichenbaum and Evans.
1. The Effects of Monetary Policy Shocks: Evidence from the Flow of Funds, with Martin Eichenbaum and Charles Evans.