Stabilizing and destabilizing mechanisms: A new perspective to understand business cycles

Economists believe that economic fluctuations can be smoothed by stabilization mechanisms, such as price adjustment, embedded in the economy. While price adjustment can be seen as a stabilization mechanism, are there mechanisms that can destabilize an economy? We find that as early as 1939, Harrod discussed a destabilization mechanism, the firm's investment adjustment, illustrated in his knife-edge puzzle. We build a macro-dynamic model with investment and price as the core macroeconomic variables. Our analysis shows that the interaction between the stabilization mechanism (price adjustment) and the destabilization mechanism (investment adjustment) generates fluctuations and cycles. However, due to price stickiness, the price adjustment mechanism may not be enough to stabilize the economy. In this case, a government stabilization policy is necessary for further stabilization. As this paper also addresses the microfoundations of Keynesian quantity theory, including the choice of output and investment in optimization, it can be related to traditional Keynesian economics, with a new perspective to understand business cycles.     

Asymmetry,Complementarities, and State Dependence in Federal Reserve Forecasts

Forecasts are a central component of policymaking; the Federal Reserve's forecasts are published in a document called the Greenbook. Previous studies of the Greenbook's inflation forecasts have found them to be rationalizable but asymmetric if considering particular subperiods, for example, before and after the Volcker appointment. In these papers, forecasts are analyzed in isolation, assuming policymakers value them independently. We analyze the Greenbook forecasts in a framework in which the forecast errors for different variables are allowed to interact. We find that allowing the losses to interact makes the unemployment forecasts virtually symmetric, the output forecasts symmetric prior to the Volcker appointment, and the inflation forecasts symmetric after the onset of the Great Moderation.     

Seven Fallacies Concerning Milton Friedman's “The Role of Monetary Policy”

This paper analyzes Milton Friedman's (1968a) article “The Role of Monetary Policy,” via a discussion of seven fallacies concerning the article. These fallacies are as follows: (i) “The Role of Monetary Policy” was Friedman's first public statement of the natural rate hypothesis. (ii) The Friedman–Phelps Phillips curve was already present in Samuelson and Solow's (1960) analysis. (iii) Friedman's specification of the Phillips curve was based on perfect competition and no nominal rigidities. (iv) Friedman's (1968a) account of monetary policy in the Great Depression contradicted the Monetary History’s version. (v) Friedman (1968a) stated that a monetary expansion will keep the unemployment rate and the real interest rate below their natural rates for two decades. (vi) The zero lower bound on nominal interest rates invalidates the natural rate hypothesis. (vii) Friedman's (1968a) treatment of an interest-rate peg was refuted by the rational expectations revolution. The discussion lays out the reasons why each of these seven items is a fallacy and infers key aspects of the framework underlying Friedman's (1968a) analysis.     

Monetary Policy Transmission with Interbank Market Fragmentation

This paper shows how interbank market fragmentation disrupts the transmission of monetary policy. Fragmentation is the fact that banks, depending on their country of location, have different probabilities of default on their interbank borrowings. Once fragmentation is introduced into standard theoretical models of monetary policy implementation, excess liquidity arises endogenously. This leads short-term interest rates to depart from the central bank policy rates. Using data on monetary policy operations, I show that this mechanism has been at work in the euro area since 2008. The model is used to analyze conventional and unconventional monetary policy measures.     

Money,Asset Prices,and the Liquidity Premium

This paper examines the effect of monetary policy on the market value of the liquidity services that financial assets provide, known as the liquidity premium. The theory predicts that money supply and nominal interest rates have positive effects on the liquidity premium, but asset supply has a negative effect. The empirical analysis with U.S. data confirms the theoretical predictions. The theory also proposes that the liquidity properties of assets can cause negative nominal yields when the money holding cost is low and liquid assets are scarce. The suggestive empirical findings in Switzerland to support this theoretical result are presented.     

A Welfare-Based Analysis of International Monetary Policy Spillovers at the Zero Lower Bound

We study the welfare effects of international monetary policy spillovers at the zero lower bound, focusing on the effects of forward guidance in a large economy (“foreign”) on its smaller trading partner (“home”) in scenarios motivated by the global financial crisis. We find that foreign forward guidance has an overall prosper-thy-neighbor effect on the home economy as long as it increases foreign welfare. This finding holds under alternative assumptions about exchange rate pass-through or the degree of international financial integration. However, foreign forward guidance may worsen the trade-off between the stabilization objectives of home monetary policy.     

Monetary Policy Uncertainty and the Response of the Yield Curve to Policy Shocks

This paper studies the nonlinear response of the term structure of interest rates to monetary policy shocks and presents a new stylized fact. We show that uncertainty about monetary policy changes the way the term structure responds to monetary policy. A policy tightening leads to a significantly smaller increase in long-term bond yields if policy uncertainty is high at the time of the shock. We also look at the decomposition of bond yields into expectations about future policy and the term premium. The weaker response of yields is driven by the fall in term premia, which fall more strongly if uncertainty about policy is high. Conditional on a monetary policy shock, higher uncertainty about monetary policy tends to make securities with longer maturities relatively more attractive to investors. As a consequence, investors demand even lower term premia. These findings are robust to the measurement of monetary policy uncertainty, the definition of the monetary policy shock, and to changing the model specification.     

Sourcing patterns of export‐platform foreign affiliates: The case of Japanese affiliates in Mexico

This study investigates the sourcing patterns of Japanese export‐platform foreign affiliates in Mexico, which mainly export to the United States and Canada. We propose a novel approach to estimate intermediate input elasticities of exports by sourcing country. We find that, on average, Japanese export‐platform foreign affiliates in Mexico source intermediate inputs from third countries, including the United States and Canada, rather than from Japan and Mexico, suggesting that Japanese export‐platform foreign affiliates in Mexico are mainly integrated into the vertical production networks back and forth between Mexico, the United States and Canada. In turn, Japanese foreign affiliates selling domestically in Mexico source intermediate inputs not only within the North American Free Trade Agreement countries but also from Japan. In addition, we find that export‐platform foreign affiliates in Mexico use more labour‐intensive production than do foreign affiliates selling domestically in Mexico. This suggests that saving labour costs is one of the motives for export‐platform foreign direct investment in Mexico.     

Population ageing and inflation with endogenous money creation

This paper models a mechanism through which population ageing may induce a deflationary process. We propose an overlapping-generations model (OLG) with money created by credits (inside money) and intergenerational trade. The model links demographic factors, such as fertility rates and longevity, to prices. We show that lower fertility rates lead to smaller demand for credit and lower money creation, which in turn cause a decline in prices. Changes in longevity affect prices through real savings and the capital market. Furthermore, a few links between interest rates and inflation are addressed; they arise in the general equilibrium and are not thoroughly discussed in literature. Long-run results are derived analytically; short-run dynamics are simulated numerically.