R&D Shocks and News Shocks

Most of the theoretical work in the news shock literature abstracts away from structural explanations, assuming instead that news is a pure signal giving agents advance notice that aggregate technology will undergo exogenous change at some future point. This paper proposes that a surprise improvement in sector‐specific productivity in the research and development sector can be seen as news about aggregate productivity. I not only offer a deeper explanation for the news but also show that the model performs modestly better in matching empirical facts than a standard, one‐sector neoclassical growth model augmented with exogenous news shocks does.     

Asset Prices,Liquidity, and Monetary Policy in an Exchange Economy

I formulate a model in which money coexists with equity shares on a risky aggregate endowment. Agents can use equity as a means of payment, so shocks to equity prices translate into aggregate liquidity shocks that disrupt the mechanism of exchange. I characterize a family of optimal monetary policies and find that the resulting equity prices are independent of monetary considerations. I also study a perturbation of the family of optimal policies that targets a positive constant nominal interest rate and find that in this case the real equity return includes a liquidity return that depends on monetary considerations.     

Household Debt and Income Inequality, 1963–2003

I construct an economy with heterogeneous agents that mimics the time-series behavior of the earnings distribution in the United States from 1963 to 2003. Agents face aggregate and idiosyncratic shocks and accumulate real and financial assets. I estimate the shocks that drive the model using data on income inequality, aggregate income, and measures of financial liberalization. I show how the model economy can replicate two empirical facts: the trend and cyclical behavior of household debt and the diverging patterns in consumption and wealth inequality over time. While business cycle fluctuations can account for the short-run changes in household debt, its prolonged rise of the 1980s and the 1990s can be quantitatively explained only by the concurrent increase in income inequality.     

The Elastic Provision of Liquidity by Private Agents

I study a model of investment by financially constrained firms that are heterogeneous with respect to their exposure to an aggregate liquidity shock. A firm that is susceptible to the shock will mitigate its exposure by purchasing claims issued by a firm that is not. Liabilities of an unaffected firm may earn a liquidity premium due to their fungibility, and because they are backed by productive investment, their supply is elastic to the demand. This segmentation implies that an aggregate liquidity shock has different consequences across sectors of the economy.     

Optimal monetary policy with durable consumption goods

We document that the durable goods sector is much more interest-sensitive than the nondurables sector, and then investigate the implications of these sectoral differences for monetary policy. We formulate a two-sector general equilibrium model that is calibrated both to match the sectoral responses to a monetary shock derived from our empirical VAR and to imply an empirically realistic degree of sectoral output volatility and comovement. While the social welfare function involves sector-specific output gaps and inflation rates, the performance of the optimal policy rule can be closely approximated by a simple rule that targets a weighted average of aggregate wage and price inflation. In contrast, a rule that stabilizes a more narrow measure of final goods price inflation performs poorly in terms of social welfare.     

Business cycles with staggered prices and international trade in intermediate inputs

International trade in intermediate inputs and, increasingly, in goods produced at multiple stages of processing has been widely studied in the real trade literature. We assess the role of this feature of modern world trade in accounting for some stylized facts about international business cycles. Our model with staggered prices and trade in intermediates across four stages of processing does well in explaining the observed international correlations in aggregate quantities, and it performs much better than a single-stage model with no trade in intermediates. The model in itself does not provide a full account of the cyclical behavior of the real exchange rate, but, compared to the single-stage model, it moves in the right direction.     

Fixed‐ and Variable‐Rate Mortgages,Business Cycles,and Monetary Policy

This paper studies how the proportion of fixed‐ and variable‐rate mortgages affects business cycles and welfare. I develop and solve a New Keynesian dynamic stochastic general equilibrium model with a housing market and a group of constrained individuals who need housing collateral to obtain loans. The model predicts that with mostly variable‐rate mortgages, an exogenous interest rate shock has larger effects on borrowers than in a fixed‐rate economy. For plausible parameterizations, aggregate differences are muted by wealth effects on labor supply and by the presence of savers. For given monetary policy, a high proportion of fixed‐rate mortgages is welfare enhancing.     

International price dispersion in state-dependent pricing models

Menu-cost models predict a hump-shaped relationship between real and nominal exchange rate volatility. The hump occurs at higher values of nominal exchange rate volatility, the higher trade costs and lower international substitution elasticities are. These predictions accord well with the negative relationship between relative price and nominal exchange rate volatility I document using a data set of prices collected in Eastern Europe in a volatile environment. In contrast, trade costs must be sufficiently high or international substitution elasticities low in order for the model to account for the positive correlation between real and nominal exchange rate volatility in the aggregate data.     

Individual and Aggregate Labor Supply with Coordinated Working Times

I analyze two extensions to the standard model of life‐cycle labor supply that feature operative choices along both the intensive and extensive margin. One assumes that individuals face continuous wage‐hours schedules, while the other assumes that all work must be coordinated across individuals. Though similar qualitatively, the two models have very different implications for aggregate labor supply responses to tax policy. In the first model, curvature in the individual utility from leisure function plays relatively little role, but in the second model, it is of first‐order importance. The second model also has important implications for what data are best able to provide evidence on the extent of curvature in the utility from leisure function.     

Interpreting Permanent Shocks to Output When Aggregate Demand May Not Be Neutral in the Long Run

This paper studies a popular statistical model of permanent and transitory shocks to output using a set of arguably more plausible structural assumptions. One way to structurally interpret the model is by assuming aggregate demand has no long‐run output effect. However, many economic theories are inconsistent with that assumption. Instead, we reinterpret the statistical model assuming a positive shock to aggregate supply lowers the price level and in the long run raises output while a positive shock to aggregate demand raises the price level. Under these assumptions, a puzzling finding from the empirical literature implies that a positive aggregate demand shock had a long‐run positive effect on output in pre–World War I economies.     

TRADER EXPLOITATION OF ORDER FLOW INFORMATION DURING THE LTCM CRISIS

By using a unique data set of audit trail transactions, I examine the trading behavior of market makers in the Treasury-bond futures market during the Long-Term Capital Management (LTCM) crisis in 1998. I find strong evidence that during the crisis market makers in the aggregate engaged in anticipatory trading against customer orders from a particular clearing firm (coded PI7) that closely match various features of LTCM's trades through Bear Stearns. I also show that a significant percentage of market makers made abnormal profits during the crisis. Their aggregate abnormal profits, however, were more than offset by abnormal losses following the recapitalization of LTCM.     

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.     

The expectations theory works for monetary policy shocks

In practice, the expectations theory of the term structure is employed extensively in monetary policy analysis despite its empirical failure. This paper performs a conditional test of the theory that is directly relevant to monetary theory and policy. It finds that the theory holds quite well conditional on identified monetary policy shocks, but fails conditional on aggregate supply shocks that prompt an immediate jump in prices. It also finds that policy responses to movements in the term structure play an important role in uncovering evidence for the theory as predicted by McCallum [1994. Monetary policy and the term structure of interest rates. NBER Working Paper Series, no. 4938].     

Cross-sectional heterogeneity and the persistence of aggregate fluctuations

The microevidence indicates that small firms grow faster than big firms. I argue that this relationship between the expected growth rate of a firm and its size may provide a microfoundation for the well-known high degree of persistence of shocks to aggregate output. The logic goes as follows. Almost any shock tends to temporarily alter firms' incentive to invest in growth thereby leading to a reallocation of firms across size categories. If small firms grow faster than big ones, the impact effect of the shock on aggregate output is gradually absorbed. But, as fast growing small firms become big and start to grow at the lower rate of big firms, the rate at which the shock is absorbed decreases over the adjustment path. As a result, shocks are absorbed, yet at a very low decreasing rate which induces long memory in aggregate output. I argue that this transmission mechanism may reconcile the microevidence with the observed degree of aggregate persistence. It requires changes in neither the number of firms in the market nor the rate of technological progress. It is merely the result of the cross-sectional heterogeneity that we observe in real economies.     

Alternative central bank credit policies for liquidity provision in a model of payments

I explore alternative central bank policies for liquidity provision in a model of payments. I use a mechanism design approach so that agents’ incentives to default are explicit and contingent on the credit policy designed. In the first policy, the central bank invests in costly enforcement and charges an interest rate to recover costs. I show that the second-best solution is not distortionary. In the second policy, the central bank requires collateral. If collateral does not bear an opportunity cost, then the solution is first best. Otherwise, the second best is distortionary because collateral serves as a binding credit constraint.     

Deep Habits in the New Keynesian Phillips Curve

We derive and estimate a New Keynesian Phillips Curve (NKPC) in a model with deep habits. Habits are deep in that they apply to individual consumption goods instead of aggregate consumption. This alters the NKPC in a fundamental manner since it introduces consumption growth and future demand terms into the NKPC equation. We construct the driving process in the deep habits NKPC by using the model's optimality conditions to impute time series for unobservable variables. The resulting series is considerably more volatile than unit labor cost. Generalized methods of moments estimation shows an improved fit and a much lower degree of indexation compared to the standard NKPC.     

Unemployment insurance and capital accumulation

In this paper, I examine a model economy with production, search, and unemployment insurance. The introduction of capital into the economy of Wang and Williamson (J. Monetary Econom. 49(7)(2001)1337) generates the result that optimal replacement ratios are always zero. The result arises from the decline in aggregate activity caused by unemployment insurance: both capital and labor inputs to production fall when benefits rise. Unlike most of the literature, I compute explicitly the cost of the transition path; agents are made better off by switching to a steady state with no unemployment insurance, but the welfare gain is approximately cut in half. Only the very poor and unemployed suffer welfare losses along the transition path. I then briefly investigate the implications of negative replacement ratios.     

A quantitative exploration of the opportunistic approach to disinflation

Under a conventional policy rule, a central bank adjusts its policy rate linearly according to the gap between inflation and its target, and the gap between output and its potential. Under “the opportunistic approach to disinflation” a central bank controls inflation aggressively when inflation is far from its target, but concentrates more on output stabilization when inflation is close to its target, allowing supply shocks and unforeseen fluctuations in aggregate demand to move inflation within a certain band. We use stochastic simulations of a small-scale rational expectations model to contrast the behavior of output and inflation under opportunistic and linear rules.     

Monetary Policy in a Forward-Looking Input–Output Economy

This paper examines the implications for monetary policy of sticky prices in both final and intermediate goods in a New Keynesian model. Both optimal policy under commitment and discretionary policy under simple loss functions are studied. Household utility losses under alternative loss functions are compared; additionally, the robustness of policy performance to model and shock misperceptions and parameter uncertainty is examined. Targeting inflation in both consumer and intermediate goods performs better than targeting inflation in one sector; targeting price levels of both final and intermediate goods performs significantly better. Moreover, targeting price levels in both sectors yields superior robustness properties.     

Investment Adjustment Costs: An Empirical Assessment

We evaluate the empirical evidence for costs that penalize changes in investment using U.S. industry data. In aggregate models, such investment adjustment costs have been introduced to help account for a variety of business cycle and asset market phenomena. So far no attempt has been made to estimate these costs directly at a disaggregated level. We consider an industry model with investment adjustment costs and estimate its parameters using generalized methods of moments. The findings indicate small costs associated with changing the flow of investment at the industry level. The weighted average of the industry elasticities with respect to the shadow price of capital, which depends inversely on the adjustment cost parameter, is eight times larger than the largest estimate reported in Levin et al. (2006) . We examine a variety of factors that may account for this discrepancy, but a substantial part of it remains unexplained. Our results therefore suggest that more caution is needed when giving policy advice that hinges on a structural interpretation of large investment adjustment costs.