Endogenous capacity utilization and macroeconomic persistence

This paper presents a monetary dynamic general equilibrium model featuring a strong internal propagation mechanism. Limited short-run factor substitutability and idiosyncratic demand uncertainty play a prominent role in the results. Firms are ex post heterogeneous and a well defined distribution of capacity utilization rates characterizes the equilibrium of the model. The economy responds gradually to aggregate shocks since firms with excess capacity can raise production without experiencing large increases in their marginal costs. The modeling framework presented in this paper offers a plausible microeconomic interpretation for reduced form mark-up shocks typically considered in the “new Keynesian” literature.     

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.     

U.S. domestic money, inflation and output

Recent empirical research documents that the strong short-term relationship between U.S. monetary aggregates on one side and inflation and real output on the other has mostly disappeared since the early 1980s. Using the direct estimate of flows of U.S. dollars abroad we find that domestic money (currency corrected for the foreign holdings of dollars) contains valuable information about future movements of U.S. inflation and real output. Statistical evidence suggests that the Friedman-Schwartz stylized facts can be reestablished once the focus of analysis is back on the correct measure of domestic monetary aggregates.     

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.     

The effect of banking market structure on the lending channel: Evidence from emerging markets

This paper analyses the extent to which the level of bank competition influences monetary policy transmission. Using a large panel dataset of 978 banks from 55 countries, and employing the Lerner index model as a measure of market structure, our results show that an increase in banking sector competition weakens the effectiveness of monetary policy on bank lending. The findings are robust to a broad array of sensitivity checks including control of alternative measurements of the Lerner index, different samples and different methodological specifications. By extension, these results have important policy implications for regulators in assessing the effectiveness of monetary policy transmission mechanisms.     

External Constraints on Monetary Policy and the Financial Accelerator

We develop a small open economy macroeconomic model where financial conditions influence aggregate behavior. Our goal is to explore the connection between the exchange rate regime and financial distress. We first show that a calibrated version of the model captures well the behavior of the Korean economy during its financial crisis period of 1997–98. In particular, the model accounts for the sharp increase in lending rates and the large drop in output, employment, investment, and measured productivity. The financial market frictions play an important role, further, explaining roughly half the decline in overall economic activity. We then perform some counterfactual exercises to illustrate how the fixed exchange rate regime likely exacerbated the crisis by tying the hands of monetary policy.     

Macroeconomic Sources of Risk in the Term Structure

We develop a new way of modeling time variation in term premia, based on the stochastic discount factor model of asset pricing. The joint distribution of excess U.S. bond returns of different maturity and the observable fundamental macroeconomic factors is modeled using multivariate GARCH with conditional covariances in the mean to capture the term premia. By testing the assumption of no arbitrage we derive a specification test of our model. We estimate the contribution made to the term premia at different maturities through real and nominal sources of risk. From the estimated term premia we recover the term structure of interest rates and examine how it varies through time. Finally, we examine whether the reported failures of the rational expectations hypothesis can be attributed to an omitted time-varying term premium.     

Modeling the dynamics of Chinese spot interest rates

Using the daily data of Chinese 7-day repo rates from January 1, 1997 to December 31, 2008, this paper tests a variety of popular spot rate models, including single-factor diffusion, GARCH, Markov regime-switching and jump-diffusion models. We document that Chinese spot rates are subject to both market forces and administrative forces. GARCH, regime-switching and jump-diffusion models capture some important features of the dynamics of Chinese spot rates, but all models under study are overwhelmingly rejected. We further explore possible sources of model misspecification using diagnostic tests.     

Uncovering the US term premium: An alternative route

The estimates of the US term premium crucially depend upon the ex-ante decision on whether the short-term rate is either an I(0) or an I(1) process. In this paper we estimate a fractionally integrated (I(d)) model which simultaneously determines both the order of integration of the short-term rate and the associated term premium. We show that the term premium experienced a sharp increase from essentially zero in mid-2007 to almost 3% in 2009. We also show that unemployment and term premium dynamics exhibit a very significant positive co-movement.     

The Dynamic (In)Efficiency of Monetary Policy by Committee

This paper develops a model where the value of the monetary policy instrument is selected by a heterogenous committee engaged in a dynamic voting game. Committee members differ in their institutional power, and in certain states of nature, they also differ in their preferred instrument value. Preference heterogeneity and concern for the future interact to generate decisions that are dynamically inefficient and inertial around the previously agreed instrument value. This model endogenously generates autocorrelation in the policy variable and helps explain the empirical observation that the distribution of actual interest rate changes has a mode of zero.     

Monetary policy and distribution

A segmented markets model of monetary policy is constructed, in which a novel feature is goods market segmentation, and its relationship to conventional asset market segmentation. The implications of the model for the response of prices, interest rates, consumption, labor supply, and output to monetary policy are determined. As well, optimal monetary policy is studied, as are the costs of inflation. The model features persistent nonneutralities of money, relative price effects of increases in the money supply, persistent liquidity effects, and a negative Fisher effect from a money supply increase. A Friedman rule is in general suboptimal.     

Does inflation targeting really make a difference? Evaluating the treatment effect of inflation targeting in seven industrial countries

We evaluate the treatment effect of inflation targeting in seven industrial countries that adopted this policy in the 1990s. To address the self-selection problem of policy adoption, we make use of a variety of propensity score matching methods recently developed in the treatment effect literature. Our results show that inflation targeting has no significant effects on either inflation or inflation variability in these seven countries. Further evidence from long-term nominal interest rates and income velocity of money also supports the window-dressing view of inflation targeting.     

Determinacy, Learnability, and Monetary Policy Inertia

We show how monetary policy inertia can help alleviate problems of indeterminacy and non-existence of stationary equilibrium observed for some commonly studied monetary policy rules. We also find that inertia promotes learnability of equilibrium. The context is a simple, forward-looking model of the macroeconomy widely used in the rapidly expanding literature in this area. We conclude that this might be an important reason why central banks in the industrialized economies display considerable inertia when adjusting monetary policy in response to changing economic conditions.     

Efficient monetary allocations and the illiquidity of bonds

We construct a monetary economy with heterogeneity in discounting and consumption risk. Agents can insure against this risk with money and nominal government bonds, but all trades must be monetary. We demonstrate that a deflationary policy à la Friedman cannot sustain the constrained-efficient allocation as no-arbitrage imposes too stringent a bound on the return money can pay. The constrained-efficient allocation can be sustained when bonds have positive yields and, under certain conditions, only if they are illiquid. Illiquidity, meaning that bonds cannot be transformed into consumption as easily as cash, is necessary to eliminate arbitrage opportunities due to disparities in shadow interest rates.     

Information variables for monetary policy in an estimated structural model of the euro area

A small scale new keynesian model for the euro area is estimated with maximum likelihood under the assumptions of imperfect information and discretionary monetary policy. The estimated parametrization of this widely used dynamic stochastic model unveils the monetary authorities’ objectives and the information content of two indicator variables: monetary aggregates and real unit labour costs. The results highlight a significant policy concern about interest-rate smoothing and inflation; almost no concern for output gap stabilization emerges. Regarding indicator variables, unit labour costs provide information on potential output that is helpful for stabilization policy; no useful information role emerges for monetary aggregates.     

How much inflation is necessary to grease the wheels?

Tobin's proposition that inflation “greases” the wheels of the labor market is studied using a simple dynamic stochastic general equilibrium model with asymmetric wage adjustment costs. The simulated method of moments is used to estimate the nonlinear model based on its second-order approximation. Optimal inflation is determined by a benevolent government that maximizes the households’ welfare. Econometric results indicate that nominal wages are downwardly rigid and that the optimal level of grease inflation for the U.S. economy is about 0.35% per year, with a 95% confidence interval ranging from 0.04% to 0.87%.     

Interest rate corridors and reserves

This paper evaluates reserves regimes versus interest rate corridors, which have become competing frameworks for monetary policy implementation. Rate corridors, relying on lending and deposit facilities to create ceilings and floors for overnight interest rates, evince mixed results on controlling volatility. Reserve requirements allow period-average smoothing of interest rates but, even if remunerated, are subject to reserve avoidance activities. A system of voluntary, period-average reserve commitments could offer equivalent rate-smoothing advantages. If central banks created symmetric opportunity costs of meeting or falling short of period-average reserve requirements (or commitments), they could achieve flat reserve demand on settlement day.     

Dollarization and currency exchange

We use a dual currency money search model to study dollarization. Agents hold portfolios consisting of two currencies, one of which is risky. We use numerical methods to solve for the steady-state distributions of currency portfolios, transaction patterns, and value functions. As risk increases, agents increasingly use the safe currency as a medium of exchange—dollarization occurs. Furthermore, the safe currency trades for multiple units of the risky currency. This type of currency exchange, and the corresponding nominal exchange rate, are often observed in black market or unofficial currency exchange markets in developing countries. Due to decentralized trading, a distribution of exchange rates arises, whose mean and variance change in predictable ways when currency risk increases.     

Deposit rate ceilings and monetary transmission in the US

Establishing the existence and nature of changes in the conduct and transmission of monetary policy is key in understanding the remarkable macroeconomic performance of the US since the mid-1980s. This paper presents evidence on a phenomenon of disintermediation occurring during the major recessions in the 1960s and 1970s, but absent ever since, and shows that disintermediation is closely linked to the existence of deposit rate ceilings under regulation Q. In a monetary DSGE model that incorporates deposit rate ceilings as occasionally binding constraints, the regulation alters the behavior of money aggregates and exacerbates the drop in economic activity following a monetary tightening. The results of a threshold VAR lend support to the main theoretical predictions of the model.