Endogenous business cycles and stabilization policies

The paper reports results on the effects of stylized stabilization policies on endogenously created fluctuations. A simple monetary model with intertemporally optimizing agents is considered. Fluctuations in output may occur due to fluctuations in labor supply which are again caused by volatile expectations which are ``self fulfilling'', i.e. correct given the model. It turns out that stabilization policies that are sufficiently countercyclical in the sense that government spending (on transfers or demand) depends sufficiently strongly negatively on GNP-increases can stabilize the economy at a monetary steadystate for an arbitrarily low degree of distortion of that steady state. Such stabilization has unambiguously good welfare effects and can be achieved without features such as positive lump sum taxation or negative income taxation as part of the stabilization policy.

Stable sunspot equilibria in a cash-in-advance economy

We analyze a monetary model with flexible labor supply, cash-inadvance constraints and seigniorage-financed government deficits. If the intertemporal elasticity of substitution of labor is greater than one, there are two steady states, one determinate and the other indeterminate. If the elasticity is less than one, there is a unique steady state, which can be indeterminate. Only in the latter case do there exist sunspot equilibria that are stable under adaptive learning. A sufficient reduction in government purchases can in many cases eliminate the sunspot equilibria while raising consumption/labor taxes even enough to balance the budget may fail to achieve determinacy.

Recurrent hyperinflations and learning

This paper uses a model of boundedly rational learning to accountfor the observations of recurrent hyperinflations in the lastdecade. We study a standard monetary model where the fullyrational expectations assumption is replaced by a formaldefinition of quasi-rational learning. The model under learningis able to match remarkably well some crucial stylized factsobserved during the recurrent hyperinflations experienced byseveral countries in the 80's. We argue that, despite being asmall departure from rational expectations, quasi-rationallearning does not preclude falsifiability of the model and itdoes not violate reasonable rationality requirements.

Labor markets and monetary policy: A new-Keynesian model with unemployement

We construct a utility-based model of fluctuations, with nominal rigidities andunemployment, and draw its implications for the unemployment-inflation trade-off and for the conduct of monetary policy.We proceed in two steps. We first leave nominal rigidities aside. We show that,under a standard utility specification, productivity shocks have no effect onunemployment in the constrained efficient allocation. We then focus on theimplications of alternative real wage setting mechanisms for fluctuations in un-employment. We show the role of labor market frictions and real wage rigiditiesin determining the effects of productivity shocks on unemployment.We then introduce nominal rigidities in the form of staggered price setting byfirms. We derive the relation between inflation and unemployment and discusshow it is influenced by the presence of labor market frictions and real wagerigidities. We show the nature of the tradeoff between inflation and unemployment stabilization, and its dependence on labor market characteristics. We draw the implications for optimal monetary policy.

The role of interbank markets in monetary policy: A model with rationing

This paper analyses the impact of asymmetric information in the interbankmarket and establishes its crucial role in the microfoundations of the monetarypolicy transmission mechanism. We show that interbank market imperfectionsinduce an equilibrium with rationing in the credit market. This has two majorimplications: first, it reconciles the irresponsiveness of business investment to theuser cost of capital with the large impact of monetary policy (magnitude effect)and, second, it shows that banks liquidity positions condition their reaction tomonetary policy (Kashyap and Stein liquidity effect).

On the identification of monetary (and other) shocks

The purpose of this paper is twofold. First, we construct a DSGE model which spells out explicitly the instrumentation of monetary policy. The interest rate is determined every period depending on the supply and demand for reserves which in turn are affected by fundamental shocks: unforeseeable changes in cash withdrawal, autonomous factors, technology and government spending. Unexpected changes in the monetary conditions of the economy are interpreted as monetary shocks. We show that these monetary shocks have the usual effects on economic activity without the need of imposing additional frictions as limited participation in asset markets or sticky prices. Second, we show that this view of monetary policy may have important consequences for empirical research. In the model, the contemporaneous correlations between interest rates, prices and output are due to the simultaneous effect of all fundamental shocks. We provide an example where these contemporaneous correlations may be misinterpreted as a Taylor rule. In addition, we use the sign of the impact responses of all shocks on output, prices and interest rates derived from the model to identify the sources of shocks in the data.

Endogenous capacity utilization and the asymmetric effects of monetary policy

This paper investigates the role of variable capacity utilization as a source of asymmetries in the relationship between monetary policy and economic activity within a dynamic stochastic general equilibrium framework. The source of the asymmetry is directly linked to the bottlenecks and stock-outs that emerge from the existence of capacity constraints in the real side of the economy. Money has real effects due to the presence of rigidities in households' portfolio decisions in the form of a Luces-Fuerst 'limited participation' constraint. The model features variable capacity utilization rates across firms due to demand uncertainty. A monopolistic competitive structure provides additional effects through optimal mark-up changes. The overall message of this paper for monetary policy is that the same actions may have different effects depending on the capacity utilization rate of the economy.

The Role of model uncertainty and learning in the U.S. postwar policy response to oil prices

This paper studies optimal monetary policy in a framework that explicitly accounts for policymakers' uncertainty about the channels of transmission of oil prices into the economy. More specfically, I examine the robust response to the real price of oil that US monetary authorities would have been recommended to implement in the period 1970 2009; had they used the approach proposed by Cogley and Sargent (2005b) to incorporate model uncertainty and learning into policy decisions. In this context, I investigate the extent to which regulator' changing beliefs over different models of the economy play a role in the policy selection process. The main conclusion of this work is that, in the specific environment under analysis, one of the underlying models dominates the optimal interest rate response to oil prices. This result persists even when alternative assumptions on the model's priors change the pattern of the relative posterior probabilities, and can thus be attributed to the presence of model uncertainty itself.

How does monetary policy change? evidence on inflation targeting countries

We examine the evolution of monetary policy rules in a group of inflation targeting countries (Australia, Canada, New Zealand, Sweden and the United Kingdom) applying moment- based estimator at time-varying parameter model with endogenous regressors. Using this novel flexible framework, our main findings are threefold. First, monetary policy rules change gradually pointing to the importance of applying time-varying estimation framework. Second, the interest rate smoothing parameter is much lower that what previous time-invariant estimates of policy rules typically report. External factors matter for all countries, albeit the importance of exchange rate diminishes after the adoption of inflation targeting. Third, the response of interest rates on inflation is particularly strong during the periods, when central bankers want to break the record of high inflation such as in the U.K. or in Australia at the beginning of 1980s. Contrary to common wisdom, the response becomes less aggressive after the adoption of inflation targeting suggesting the positive effect of this regime on anchoring inflation expectations. This result is supported by our finding that inflation persistence as well as policy neutral rate typically decreased after the adoption of inflation targeting.

Macroeconomic shocks and the business cycle: evidence from a structural factor model

We use a dynamic factor model to provide a semi-structural representation for 101 quarterly US macroeconomic series. We find that (i) the US economy is well described by a number of structural shocks between two and six. Focusing on the four-shock specification, we identify, using sign restrictions, two non-policy shocks, demand and supply, and two policy shocks, monetary and fiscal. We obtain the following results. (ii) Both supply and demand shocks are important sources of fluctuations; supply prevails for GDP, while demand prevails for employment and inflation. (ii) Policy matters, Both monetary and fiscal policy shocks have sizeable effects on output and prices, with little evidence of crowding out; both monetary and fiscal authorities implement important systematic countercyclical policies reacting to demand shocks. (iii) Negative demand shocks have a large long-run positive effect on productivity, consistently with the Schumpeterian "cleansing" view of recessions.

A fractionally integrated approach to monetary policy and inflation dynamics

This paper relaxes the standard I(0) and I(1) assumptions typically stated in the monetary VAR literature by considering a richer framework that encompasses the previous two processes as well as other fractionally integrated possibilities. First, a timevarying multivariate spectrum is estimated for post WWII US data. Then, a structural fractionally integrated VAR (VARFIMA) is fitted to each of the resulting time dependent spectra. In this way, both the coefficients of the VAR and the innovation variances are allowed to evolve freely. The model is employed to analyze inflation persistence and to evaluate the stance of US monetary policy. Our findings indicate a strong decline in the innovation variances during the great disinflation, consistent with the view that the good performance of the economy during the 80’s and 90’s is in part a tale of good luck. However, we also find evidence of a decline in inflation persistence together with a stronger monetary response to inflation during the same period. This last result suggests that the Fed may still play a role in accounting for the observed differences in the US inflation history. Finally, we conclude that previous evidence against drifting coefficients could be an artifact of parameter restriction towards the stationary region. Keywords: monetary policy, inflation persistence, fractional integration, timevarying coefficients, VARFIMA. JEL Classification: E52, C32

On optimal monetary and fiscal policy interactions in open economies

This paper studies monetary and fiscal policy interactions in a two country model, where taxes on firms sales are optimally chosen and the monetary policy is set cooperatively.It turns out that in a two country setting non-cooperative fiscal policy makers have an incentive to change taxes on sales depending on shocks realizations in order to reduce output production. Therefore whether the fiscal policy is set cooperatively or not matters for optimal monetary policy decisions. Indeed, as already shown in the literature, the cooperative monetary policy maker implements the flexible price allocation only when special conditions on the value of the distortions underlying the economy are met. However, if non-cooperative fiscal policy makers set the taxes on firms sales depending on shocks realizations, these conditions cannot be satisfied; conversely, when fiscal policy is cooperative, these conditions are fulfilled. We conclude that whether implementing the flexible price allocation is optimal or not depends on the fiscal policy regime.

Monetary policy rules and macroeconomic stability: Evidence and some theory

We estimate a forward-looking monetary policy reaction function for thepostwar United States economy, before and after Volcker's appointmentas Fed Chairman in 1979. Our results point to substantial differencesin the estimated rule across periods. In particular, interest ratepolicy in the Volcker-Greenspan period appears to have been much moresensitive to changes in expected inflation than in the pre-Volckerperiod. We then compare some of the implications of the estimated rulesfor the equilibrium properties of inflation and output, using a simplemacroeconomic model, and show that the Volcker-Greenspan rule is stabilizing.

Monetary policy with signal extraction from the bond market

Monetary policy is conducted in an environment of uncertainty. This paper sets upa model where the central bank uses real-time data from the bond market togetherwith standard macroeconomic indicators to estimate the current state of theeconomy more efficiently, while taking into account that its own actions influencewhat it observes. The timeliness of bond market data allows for quicker responsesof monetary policy to disturbances compared to the case when the central bankhas to rely solely on collected aggregate data. The information content of theterm structure creates a link between the bond market and the macroeconomythat is novel to the literature. To quantify the importance of the bond market asa source of information, the model is estimated on data for the United Statesand Australia using Bayesian methods. The empirical exercise suggests that thereis some information in the US term structure that helps the Federal Reserve toidentify shocks to the economy on a timely basis. Australian bond prices seemto be less informative than their US counterparts, perhaps because Australia is arelatively small and open economy.