Financial Intermediaries, Markets, and Growth

We build a model in which financial intermediaries provide insurance to households against idiosyncratic liquidity shocks. Households can invest in financial markets directly if they pay a cost. In equilibrium, the ability of intermediaries to share risk is constrained by the market. From a growth perspective, this can be beneficial because intermediaries invest less in the productive technology when they provide more risk-sharing. Our model predicts that bank-oriented economies can grow more slowly than more market-oriented economies, which is consistent with some recent empirical evidence.     

Optimal Monetary Policy in a Small Open Economy with Home Bias

We analyze optimal monetary policy in a small open economy characterized by home bias in consumption. Peculiar to our framework is the application of a Ramsey-type analysis to a model of the recent open-economy New Keynesian literature. We show that home bias in consumption is a sufficient condition for inducing the monetary policymaker of an open economy to deviate from a strategy of strict markup stabilization and contemplate some (optimal) degree of exchange rate stabilization. We focus on the optimal setting of policy both in the case of firms setting prices one period in advance and in a gradual fashion subject to adjustment costs. While the first setup allows us to analytically highlight home bias as an independent source of equilibrium markup variability, the second setup allows to study the effects of future expectations on the optimal policy problem and the effect of home bias on optimal inflation volatility. The latter, in particular, is shown to be related to the degree of trade openness in a U-shaped fashion, whereas exchange rate volatility is monotonically decreasing in openness.     

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.     

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.     

Private Sector Influences on Monetary Policy in the United States

I examine the extent to which the Federal Reserve's monetary policy actions are correlated with the expressed wishes of private sector lobbying groups. I update and extend work by Havrilesky (1990, 1993) regarding the effect of signals from the banking industry through the Federal Advisory Council (FAC). I also construct a new database containing statements from non-financial interest groups. I find that monetary policy actions are correlated with signals from non-financial groups before 1979 but not after, and are correlated with signals from the FAC after 1979 but not before. I also find that the Fed's policy stance more closely matches the preferred stance of the banking industry after 1979.     

Model Uncertainty and Delegation: A Case for Friedman's k-Percent Money Growth Rule?

Model uncertainty affects the monetary policy delegation problem. If there is uncertainty with regards to the determination of the delegated objective variables, the central bank will want robustness against potential model misspecifications. We show that with plausible degree of model uncertainty, delegation of the Friedman rule of increasing the money stock by k percent to the central bank will outperform commitment to the social loss function (flexible inflation targeting). The reason is that the price paid for robustness under flexible inflation targeting outweighs the inefficiency of money growth targeting. Imperfect control of money growth does not change this conclusion.     

Inflation Band Targeting and Optimal Inflation Contracts

In this paper we provide a theoretical treatment of how inflation target ranges cope with the time-inconsistency problem arising from incentives for the monetary policymaker to exploit the short-run trade-off between employment and inflation to pursue short-run employment objectives, as in a Barro-Gordon (1983) model. Inflation band targets are able to achieve many of the benefits that arise under practically less attractive solutions such as the conservative central banker and optimal inflation contracts. Our theoretical model also shows how an inflation targeting range should be set and how it should respond to changes in the nature of shocks to the economy.     

Re-Examining the Consumption–Wealth Relationship: The Role of Model Uncertainty

This paper discusses the consumption–wealth relationship. We use data on consumption, assets, and labor income and a vector error correction framework. This framework defines a set of models that differ in the number of co-integrating vectors, the form of deterministic components and lag length. Further models can be defined through parametric restrictions and, in particular, interest centers on a weak exogeneity restriction that says that the co-integrating residuals do not affect consumption and income directly. Key results in previous work relate to the roles of permanent and transitory shocks in driving wealth and how consumption responds to these shocks. We investigate the robustness of these results to model uncertainty and argue for the use of Bayesian model averaging. We find that there is a large degree of model uncertainty. Whether this uncertainty has important empirical implications depends on the researcher's attitude toward the theory used to motivate a co-integrating relationship between consumption, assets and income. If we work with models consistent with this theory and impose the weak exogeneity restriction, we find precisely estimated results that show that permanent shocks have only a small role in driving assets and that the predominant transitory shocks have little effect on consumption. These findings are consistent with the previous literature. However, if we work with a broader set of models and let the data speak, we find that the exact magnitude of the role of permanent shocks is hard to estimate precisely. Thus, although some support exists for the view that their role is small, we cannot rule out the possibility that they have a substantive role to play.     

Financial Crisis, Fiscal Policy, and the 1995 GDP Contraction in Mexico

In 1995 Mexico experienced its largest contraction of gross domestic product (GDP) since the early twentieth century. I propose a simple mechanism to partially account for the contraction: the effects of changes in fiscal policy. The contraction of GDP was preceded by a financial crisis. The government responded by raising taxes and reducing spending. Using a model with taxation and government consumption, and the business cycle accounting methodology, I measure the impact of fiscal policy. Fiscal policy accounts for 20.7% of the fall in output.     

Asymmetric price adjustment in the small

Analyses of a large retail scanner price data set reveal a new and surprising regularity - small price increases occur more frequently than small price decreases for price changes of up to 10¢. That is, we find asymmetric price adjustment “in the small.” Furthermore, it turns out that inflation offers only a partial explanation for the finding. Indeed, substantial proportion of the asymmetry remains unexplained, even after accounting for the inflation. For example, the asymmetry holds also after excluding periods of inflation from the data, and even for products whose price had not increased. The findings hold for different aggregate and disaggregate measures of inflation and also after allowing for lagged price adjustments.