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Working Paper
Of nutters and doves
We argue that there are conditions such that any inflation targeting regime is preferable to full policy discretion, even if long-run inflation rates are identical across regimes. The key observation is that strict inflation targeting outperforms the discretionary policy response to sufficiently persistent shocks. Under full policy discretion, inflation expectations over the medium term respond to the shock and thereby amplify its impact on output. As a result, little output stabilization is achieved at the cost of large and persistent inflation fluctuations.
Working Paper
The Perils of Nominal Targets
A monetary authority can be committed to pursuing an inflation, price-level, or nominal-GDP target yet systematically fail to achieve the prescribed goal. Con- strained by the zero lower bound on the policy rate, the monetary authority is unable to implement its objectives when private-sector expectations stray far enough from the target. Low-inflation expectations become self-fulfilling, resulting in an additional Markov equilibrium in which the monetary authority falls short of the nominal target, average output is below its efficient level, and the policy rate is typically low. Introducing ...
Working Paper
A TRACTABLE MODEL OF THE DEMAND FOR RESERVES UNDER NONLINEAR REMUNERATION SCHEMES
We propose a tractable model of the demand for reserves under nonlinear remuneration schemes that can encompass quota systems and voluntary reserve target frameworks, among other possibilities. We show how such remuneration schemes have several favorable properties regarding interest-rate control by the central bank. In particular, wider tolerance bands can reduce rate volatility due to variations in the supply of reserves, both large and small, although they may curtail trading in the interbank market.
Report
Can U.S. monetary policy fall (again) into an expectation trap?
We provide a tractable model to study monetary policy under discretion. We restrict our analysis to Markov equilibria. We find that for all parametrizations with an equilibrium inflation rate of about 2 percent, there is a second equilibrium with an inflation rate just above 10 percent. Thus, the model can simultaneously account for the low and high inflation episodes in the United States. We carefully characterize the set of Markov equilibria along the parameter space and find our results to be robust, suggesting that expectation traps are more than just a theoretical curiosity.
Working Paper
Can the U.S. monetary policy fall (again) in an expectation trap?
We provide a tractable model to study monetary policy under discretion. We focus on Markov equilibria. For all parametrizations with an equilibrium inflation rate around 2%, there is a second equilibrium with an inflation rate just above 10%. Thus the model can simultaneously account for the low and high inflation episodes in the U.S. We carefully characterize the set of Markov equilibria along the parameter space and find our results to be robust.
Working Paper
Does the time inconsistency problem make flexible exchange rates look worse than you think?
The Barro-Gordon inflation bias has provided the most influential argument for fixed exchange rate regimes. However, with low inflation rates now widespread, credibility concerns seem no longer relevant. Why give up independent monetary policy to contain an inflation bias that is already under control? We argue that credibility problems do not end with the inflation bias and they are a larger drawback for flexible exchange rates than usually thought. Absent commitment, independent monetary policy can induce expectation traps---that is, welfare ranked multiple equilibria---and perverse policy ...
Journal Article
Output gaps: uses and limitation
The concept of resource slack is central to understanding the dynamics between employment, output, and inflation. But what amount of slack is consistent with price stability? To answer this question, economists define baseline values for unemployment and output known as the natural rate of unemployment and potential output. The concepts of output and employment gaps can be useful to economists in several ways. First, they often guide the inflation forecasts of Federal Reserve staff and other researchers and market participants. Second, some economists argue that employment gaps are a useful ...
Working Paper
Sustainable monetary policy and inflation expectations
The author shows that the short-term nominal interest rate can anchor private-sector expectations into low inflation more precisely, into the best equilibrium reputation can sustain. He introduces nominal asset markets in an infinite horizon version of the Barro-Gordon model. The author then analyzes the subset of sustainable policies compatible with any given asset price system at date t = 0. While there are usually many sustainable inflation paths associated with a given set of asset prices, the best sustainable inflation path is implemented if and only if the short-term nominal bond is ...
Working Paper
On the timing of monetary policy reform
This paper argues that there is a normative case for delaying policy reform. Policy design in dynamic economies typically faces a trade-off between the policy effects in the short and long term, and possibly across future states of nature. When the economy is in an atypical state or available policies are less flexible than ideal, this trade-off can be steep enough that retaining the status-quo policy in the short term and taking on the reform at a later date is welfare improving. In a simple New Keynesian economy, I consider monetary policy reform from discretion to the optimal targeting ...
Working Paper
Rational Inattention via Ignorance Equivalence
We present a novel approach to finite Rational Inattention (RI) models based on the ignorance equivalent, a fictitious action with state-dependent payoffs that effectively summarizes the optimal learning and conditional choices. The ignorance equivalent allows us to recast the RI problem as a standard expected utility maximization over an augmented choice set called the learning-proof menu, yielding new insights regarding the behavioral implications of RI, in particular as new actions are added to the menu. Our geometric approach is also well suited to numerical methods, outperforming ...