Learning and shifts in long-run productivity growth

An extensive literature has analyzed the macroeconomic effects of shocks to the level of aggregate productivity; however, there has been little corresponding research on sustained shifts in the growth rate of productivity. In this paper, we examine the effects of shocks to productivity growth in a dynamic general equilibrium model where agents do not directly observe whether shocks are transitory or persistent. We show that an estimated Kalman filter model using real-time data describes economists’ long-run productivity growth forecasts in the United States extremely well and that filtering has profound implications for the macroeconomic effects of shifts in productivity growth.     

Monetary and Fiscal Policy Switching

A growing body of evidence finds that policy reaction functions vary substantially over different periods in the United States. This paper explores how moving to an environment in which monetary and fiscal regimes evolve according to a Markov process can change the impacts of policy shocks. In one regime monetary policy follows the Taylor principle and taxes rise strongly with debt; in another regime the Taylor principle fails to hold and taxes are exogenous. An example shows that a unique bounded non-Ricardian equilibrium exists in this environment. A computational model illustrates that because agents' decision rules embed the probability that policies will change in the future, monetary and tax shocks always produce wealth effects. When it is possible that fiscal policy will be unresponsive to debt at times, active monetary policy (like a Taylor rule) in one regime is not sufficient to insulate the economy against tax shocks in that regime and it can have the unintended consequence of amplifying and propagating the aggregate demand effects of tax shocks. The paper also considers the implications of policy switching for two empirical issues.     

Optimal sustainable monetary policy

In recent monetary policy literature, optimal commitment policy and its variant from a timeless perspective have been studied with emphasis on welfare gains from policy commitment. These policies, however, involve a time-consistency problem called a stabilization bias in forward-looking models. We analyze Chari and Kehoe's [1990. Sustainable plans. Journal of Political Economy 98, 783-802] sustainable equilibrium and examine optimal sustainable policy, i.e. a policymaker's strategy in the best sustainable equilibrium. This paper shows that such a policy becomes consistent with the optimal commitment policy in sufficiently later periods. It also shows that whether the optimal sustainable policy can attain the Ramsey equilibrium outcome depends on the magnitude of shocks hitting the model economy. Moreover, the paper finds a sustainable policy that attains higher social welfare than discretionary policy does.     

Habit formation and the persistence of monetary shocks

The dynamic effects and relative importance of monetary shocks in the US business cycle are studied using a sticky-price dynamic stochastic general equilibrium model with habit formation and capital adjustment costs. The model is estimated via maximum likelihood using data on output, real money balances, and the nominal interest rate. Econometric results indicate that the model has a strong internal propagation mechanism that can explain the persistent and hump-shaped response of US output and consumption to monetary shocks.     

Credit and Banking in a DSGE Model of the Euro Area

This paper studies the role of credit supply factors in business cycle fluctuations using a dynamic stochastic general equilibrium (DSGE) model with financial frictions enriched with an imperfectly competitive banking sector. Banks issue collateralized loans to both households and firms, obtain funding via deposits, and accumulate capital out of retained earnings. Loan margins depend on the banks' capital‐to‐assets ratio and on the degree of interest rate stickiness. Balance‐sheet constraints establish a link between the business cycle, which affects bank profits and thus capital, and the supply and cost of loans. The model is estimated with Bayesian techniques using data for the euro area. The analysis delivers the following results. First, the banking sector and, in particular, sticky rates attenuate the effects of monetary policy shocks, while financial intermediation increases the propagation of supply shocks. Second, shocks originating in the banking sector explain the largest share of the contraction of economic activity in 2008, while macroeconomic shocks played a limited role. Third, an unexpected destruction of bank capital may have substantial effects on the economy.     

Equilibrium Indeterminacy and Asset Price Fluctuation in Japan: A Bayesian Investigation

This paper investigates sources of asset price fluctuation in Japan using an estimated financial accelerator model. For explicit treatment of expectational beliefs characterized by sunspots, the model is analyzed over the parameter space where the equilibrium can be indeterminate. We show that indeterminacy arises if the financial accelerator effect is sufficiently large. According to our Bayesian estimation results, Japan's economy was affected by sunspot shocks; however, the contribution of the sunspots to asset price volatility was low. Rather, net worth and cost shocks drove the asset price fluctuation. We find, however, that the sunspots substantially affected capital investment.     

Consumption, the persistence of shocks, and asset price volatility

In a general equilibrium setting, a temporary component in consumption introduces a wedge between the volatility of equity returns and the volatility of consumption growth. This paper explores the asset pricing consequences of this property in a model in which consumption is the sum of a permanent and a transitory component. Permanent shocks are assumed to be rare events, while transitory shocks follow a diffusion process. When calibrated to US annual data, the model matches first and second moments of equity and bond returns for preference parameters within acceptable bounds. Permanent and transitory shocks together explain the equity premium, while transitory shocks alone explain the excess volatility of returns.     

Unemployment and the business cycle

This paper presents a dynamic general equilibrium model where labor effort is imperfectly observable and there is unemployment in equilibrium. In contrast to shirking models in the efficiency wage literature, detected shirkers are not dismissed. Instead, they face a monetary punishment because they forgo an increase in their compensation. Estimated versions of the model can generate the high variation in employment and low variation of real wages observed over the business cycle, and are consistent with existing qualitative evidence about the responses of the economy to fiscal policy shocks.     

Inflation dynamics: A cross-country investigation

We document that “persistent and lagged” inflation (with respect to output) is a world-wide phenomenon in that these short-run inflation dynamics are highly synchronized across countries. In particular, the average cross-country correlation of inflation is significantly and systematically stronger than that of output, while the cross-country correlation of money growth is essentially zero. We investigate whether standard monetary models driven by monetary shocks are consistent with the empirical facts. We find that neither the new Keynesian sticky-price model nor the sticky-information model can fully explain the data. An independent contribution of the paper is to provide a simple solution technique for solving general equilibrium models with sticky information.     

Monetary Policy and Price Responsiveness to Aggregate Shocks under Rational Inattention

This paper studies a general equilibrium model that is consistent with recent empirical evidence showing that the U.S. price level and inflation are much more responsive to aggregate technology shocks than to monetary policy shocks. Specifically, we show that the fact that aggregate technology shocks are more volatile than monetary policy shocks induces firms to pay more attention to the former than to the latter. However, most important, this work adds to the literature by analytically showing how monetary policy feedback rules affect the incentives faced by firms in allocating attention. A policy rule responding more actively to inflation fluctuations induces firms to pay relatively more attention to more volatile shocks, helping to rationalize the observed behavior of prices in response to technology and monetary policy shocks.     

A quantitative analysis of oil-price shocks, systematic monetary policy, and economic downturns

Are the recessionary consequences of oil-price shocks due to oil-price shocks themselves or to the monetary policy that responds to them? We investigate this question in a calibrated general equilibrium model in which oil use is tied to capital utilization. The response to an oil-price shock is examined under a variety of monetary policy specifications. Under our benchmark calibration, which approximates the Federal Reserve's behavior since 1979, monetary policy contributes about 40 percent to the drop in output following a rise in oil prices. Moreover, none of the commonly proposed policies we examine completely offsets the recessionary consequences of oil shocks.     

Risk Premium Shocks and the Zero Bound on Nominal Interest Rates

Quantitative dynamic stochastic general equilibrium (DSGE) models often admit that the zero bound on nominal interest rates does not constrain (optimal) monetary policy. Recent economic events, however, have reinforced the relevance of the zero bound. This paper sheds some light on this disconnect by studying a broad range of shocks within a standard DSGE model. In contrast to earlier studies, we find that risk premium shocks are key to building quantitative models where the zero bound is relevant for monetary policy design. Other commonly included shocks, such as productivity, government spending, and money demand shocks, are unable to push nominal rates close to zero.     

Can News Be a Major Source of Aggregate Fluctuations? A Bayesian DSGE Approach

We examine whether the news shocks, as explored in Beaudry and Portier (2004) , can be a major source of aggregate fluctuations. For this purpose, we extend a standard dynamic stochastic general equilibrium model of Christiano, Eichenbaum, and Evans (2005) and Smets and Wouters (2003, 2007) by allowing news shocks on the total factor productivity (TFP), and estimate the model using Bayesian methods. Estimation results on the U.S. and Japanese economies suggest that (i) news shocks play a relatively more important role in the United States than in Japan, (ii) a news shock with a longer forecast horizon has larger effects on nominal variables, and (iii) the overall effect of the TFP on hours worked becomes ambiguous in the presence of news shocks.     

Where is the GE? Consumption Dynamics in DSGEs

We offer a partial equilibrium perspective on the behavior of consumption in dynamic stochastic general equilibrium (DSGE) models. We consider a benchmark dynamic general equilibrium model and show that a standard calibration implies that the real interest rate is essentially fixed. One manifestation of this feature is that, with separable preferences, the reaction of consumption to total factor productivity (TFP) shocks is flat: the random‐walk permanent income hypothesis holds almost exactly, pretty much as in a partial equilibrium consumption‐savings problem. These results help explain the prominent role of aggregate demand, and how it is achieved, in modern DSGE analysis.     

The variability of velocity of money in a search model

We construct a dynamic equilibrium model where there is costly search in the goods market and the labor market. Incorporating shocks to money growth and productivity, we calibrate the model to the US time series data to examine the model's quantitative predictions on aggregate variables and, in particular, on the variability of consumption velocity of money. Despite the fact that money is the only asset, the model captures most of the variability of velocity in the data. It also generates realistic predictions on the moments of other variables and provides persistent propagation of the shocks. The model generates these results largely because costly search gives an important role to the extensive margin of trade.     

Uncertainty,Financial Frictions,and Nominal Rigidities: A Quantitative Investigation

Are uncertainty shocks a major source of business cycle fluctuations? This paper studies the effect of a mean preserving shock to the variance of aggregate total factor productivity (macro‐uncertainty) and to the dispersion of entrepreneurs' idiosyncratic productivity (micro‐uncertainty) in a financial accelerator dynamic stochastic general equilibrium model with sticky prices. It explores the different mechanisms through which uncertainty shocks are propagated and amplified. The time‐series properties of macro‐ and micro‐uncertainty are estimated using U.S. aggregate and firm‐level data, respectively. While surprise increases in micro‐uncertainty have a larger impact on total output than macro‐uncertainty, these can only account for a small (but nontrivial) share of output volatility.     

Resuscitating the wage channel in models with unemployment fluctuations

Higher wages all else equal translate into higher inflation. More rigid wages imply a weaker response of inflation to shocks. This view of the wage channel is deeply entrenched in central banks’ views and models of their economies. In this paper, we present a model with equilibrium unemployment which has three distinctive properties. First, using a search and matching model with right-to-manage wage bargaining a proper wage channel obtains. Second, accounting for fixed costs associated with maintaining an existing job greatly magnifies profit fluctuations for any given degree of wage fluctuations, which allows the model to reproduce the fluctuations of unemployment over the business cycle. And third, the model implies a reasonable elasticity of steady state unemployment with respect to changes in benefits. The calibration of the model implies low profits, but does not require a small gap between the value of working and the value of unemployment for the worker.     

House Prices and Government Spending Shocks

We show that dynamic stochastic general equilibrium (DSGE) models with housing and collateralized borrowing predict a fall in house prices following positive government spending shocks. By contrast, we show that house prices in the United States rise persistently after identified positive government spending shocks. We clarify that the incorrect house price response is due to a general property of DSGE models—approximately constant shadow value of housing—and that modifying preferences and production structure cannot help in obtaining the correct house price response. Properly accounting for the empirical evidence on government spending shocks and house prices using a DSGE model therefore remains a significant challenge.     

The Quantitative Importance of News Shocks in Estimated DSGE Models

We estimate a dynamic stochastic general equilibrium (DSGE) model with several frictions and both unanticipated and news shocks, using quarterly U.S. data from 1954 to 2004 and Bayesian methods. We find that unanticipated shocks dominate news shocks in accounting for the unconditional variance of output, consumption, and investment growth, interest rate, and the relative price of investment. The unanticipated shock to the marginal efficiency of investment is the dominant shock, accounting for over 45% of the variance in output growth. News shocks account for less than 15% of the variance in output growth. Within the set of news shocks, nontechnology sources of news dominate technology news, with wage markup news shocks accounting for about 60% of the variance share of both hours and inflation. We find that in the estimated DSGE model (i) the presence of endogenous countercyclical price and wage markups due to nominal frictions substantially diminishes the importance of news shocks relative to a model without these frictions, and (ii) while there is little change in the estimated contributions of technology news when we restrict wealth effects on labor supply, the contributions of nontechnology news shocks are relatively more sensitive.     

Is the technology-driven real business cycle hypothesis dead? Shocks and aggregate fluctuations revisited

This paper re-examines recent empirical evidence that positive technology shocks lead to short-run declines in hours. Building on Galí's [1999. Technology, employment, and the business cycle: do technology shocks explain aggregate fluctuations. American Economic Review 89, 249-271] work, which uses long-run restrictions to identify technology shocks, we analyze whether the identified shocks can be plausibly interpreted as technology shocks. We first examine the validity of the identification assumption in a DGE model with several possible sources of permanent shocks. We then empirically assess the plausibility of the shocks using a variety of tests. After finding that the shocks pass all of the tests, we present two examples of modified DGE models that match the facts.