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Working Paper
Discretionary monetary policy and the zero lower bound on nominal interest rates
Ignoring the existence of the zero bound on nominal interest rates one considerably understates the value of monetary commitment in New Keynesian models. A stochastic forward-looking model with an occasionally binding lower bound, calibrated to the U.S. economy, suggests that low values for the natural rate of interest lead to sizeable output losses and deflation under discretionary monetary policy. The fall in output and deflation are much larger than in the case with policy commitment and do not show up at all if the model abstracts from the existence of the lower bound. The welfare losses ...
Working Paper
Distortionary fiscal policy and monetary policy goals
We study interactions between monetary policy, which sets nominal interest rates, and fiscal policy, which levies distortionary income taxes to finance public goods, in a standard, sticky-price economy with monopolistic competition. Policymakers? inability to commit in advance to future policies gives rise to excessive inflation and excessive public spending, resulting in welfare losses equivalent to several percent of consumption each period. We show how appointing a conservative monetary authority, which dislikes inflation more than society does, can considerably reduce these welfare losses ...
Working Paper
Monetary conservatism and fiscal policy
Does an inflation conservative central bank la Rogoff (1985) remain desirable in a setting with endogenous fiscal policy? To provide an answer we study monetary and fiscal policy games without commitment in a dynamic stochastic sticky price economy with monopolistic distortions. Monetary policy determines nominal interest rates and fiscal policy provides public goods generating private utility. We find that lack of fiscal commitment gives rise to excessive public spending. The optimal inflation rate internalizing this distortion is positive, but lack of monetary commitment robustly generates ...
Working Paper
Optimal monetary policy under commitment with a zero bound on nominal interest rates
We determine optimal monetary policy under commitment in a forward-looking New Keynesian model when nominal interest rates are bounded below by zero. The lower bound represents an occasionally binding constraint that causes the model and optimal policy to be nonlinear. A calibration to the U.S. economy suggests that policy should reduce nominal interest rates more aggressively than suggested by a model without lower bound. Rational agents anticipate the possibility of reaching the lower bound in the future and this amplifies the effects of adverse shocks well before the bound is reached. ...
Working Paper
Stock Market Volatility and Learning
Consumption-based asset pricing models with time-separable preferences can generate realistic amounts of stock price volatility if one allows for small deviations from rational expectations. We consider rational investors who entertain subjective prior beliefs about price behavior that are not equal but close to rational expectations. Optimal behavior then dictates that investors learn about price behavior from past price observations. We show that this imparts momentum and mean reversion into the equilibrium behavior of the price-dividend ratio, similar to what can be observed in the data. ...