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Working Paper
Monetary policy in a financial crisis
What are the economic effects of an interest rate cut when an economy is in the midst of a financial crisis? Under what conditions will a cut stimulate output and employment, and raise welfare? Under which will it have the opposite effects? The authors answer these questions in a general class of open-economy models, modeling a financial crisis as a time when collateral constraints are suddenly binding. They find that when there are frictions in adjusting the level of output in the traded goods sector and the rate at which that output can be used in other parts of the economy, a cut in the ...
Working Paper
Monetary policy in a financial crisis
What are the economic effects of an interest rate cut when an economy is in the midst of a financial crisis? Under what conditions will a cut stimulate output and employment, and raise welfare? Under what conditions will a cut have the opposite effects? We answer these questions in a general class of open economy models, where a financial crisis is modeled as a time when collateral constraints are suddenly binding. We find that when there are frictions in adjusting the level of output in the traded good sector and in adjusting the rate at which that output can be used in other parts of the ...
Working Paper
International competition and inflation: a New Keynesian perspective
We develop and estimate an open economy New Keynesian Phillips curve (NKPC) in which variable demand elasticities give rise to changes in desired markups in response to changes in competitive pressure from abroad. A parametric restriction on our specification yields the standard NKPC, in which the elasticity is constant, and there is no role for foreign competition to influence domestic inflation. By comparing the unrestricted and restricted specifications, we provide evidence that foreign competition plays an important role in accounting for the behavior of inflation in the traded goods ...
Working Paper
Trade integration, competition, and the decline in exchange-rate pass-through
Over the past twenty years, U.S. import prices have become less responsive to the exchange rate. We propose that a significant portion of this decline is a result of increased trade integration. To illustrate this effect, we develop an open economy DGE model in which trade occurs along both the intensive and extensive margins. The key element we introduce into this environment is strategic complementarity in price setting. As a result, a firm's pricing decision depends on the prices set by its competitors. This feature implies that a foreign exporter finds it optimal to vary its markup in ...
Working Paper
Monetary Policy, Incomplete Information, and the Zero Lower Bound
In the context of a stylized New Keynesian model, we explore the interaction between imperfect knowledge about the state of the economy and the zero lower bound. We show that optimal policy under discretion near the zero lower bound responds to signals about an increase in the equilibrium real interest rate by less than it would when far from the zero lower bound. In addition, we show that Taylor-type rules that either include a time-varying intercept that moves with perceived changes in the equilibrium real rate or that respond aggressively to deviations of inflation and output from their ...
Working Paper
Short-term Planning, Monetary Policy, and Macroeconomic Persistence
This paper uses aggregate data to estimate and evaluate a behavioral New Keynesian (NK) model in which households and firms plan over a finite horizon. The finite-horizon (FH) model outperforms rational expectations versions of the NK model commonly used in empirical applications as well as other behavioral NK models. The better fit of the FH model reflects that it can induce slow-moving trends in key endogenous variables which deliver substantial persistence in output and inflation dynamics. In the FH model, households and firms are forward-looking in thinking about events over their ...
Working Paper
Can long-run restrictions identify technology shocks?
Gali's innovative approach of imposing long-run restrictions on a vector autoregression (VAR) to identify the effects of a technology shock has become widely utilized. In this paper, we investigate its reliability through Monte Carlo simulations of several relatively standard business cycle models. We find it encouraging that the impulse responses derived from applying the Gali methodology to the artificial data generally have the same sign and qualitative pattern as the true responses. However, we highlight the importance of small-sample bias in the estimated impulse responses and show that ...
Working Paper
Entry dynamics and the decline in exchange-rate pass-through
The degree of exchange-rate pass-through to import prices is low. An average pass-through estimate for the 1980s would be roughly 50 percent for the United States implying that, following a 10 percent depreciation of the dollar, a foreign exporter selling to the U.S. market would raise its price in the United States by 5 percent. Moreover, substantial evidence indicates that the degree of pass-through has since declined to about 30 percent. ; Gust, Leduc, and Vigfusson (2010) demonstrate that, in the presence of pricing complementarity, trade integration spurred by lower costs for importers ...
Working Paper
The power of long-run structural VARs
Are structural vector autoregressions (VARs) useful for discriminating between macro models? Recent assessments of VARs have shown that these statistical methods have adequate size properties. In other words, in simulation exercises, VARs will only infrequently reject the true data generating process. However, in assessing a statistical test, we often also care about power: the ability of the test to reject a false hypothesis. Much less is known about the power of structural VARs. ; This paper attempts to fill in this gap by exploring the power of long-run structural VARs against a set of ...