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Working Paper
A Comment on 'Wealth Inequality and Endogenous Growth' by Byoungchan Lee
How does wealth inequality affect economic growth? Byoungchan Lee answers this question by developing a heterogeneous-agent model and augmenting it with endogenous firm innovation. The novel channel is that rising wealth concentration reduces aggregate demand, which gives firms a disincentive to spend on R&D and therefore leads to slower productivity growth. In this discussion, we first explain the difference in calibration strategy between Lee’s approach and the common approach in the literature, and then discuss its quantitative implications for the effect of rising inequality on ...
Working Paper
Average Inflation Targeting: Time Inconsistency And Intentional Ambiguity
We study the implications of the Fed's new policy framework of average inflation targeting (AIT) and its ambiguous communication. We show that AIT improves the trade-off between inflation and real activity by tilting the Phillips curve in a favorable way. To fully utilize this feature and maximize social welfare, the central bank has the incentive to deviate from AIT and implement inflation targeting ex post. Next, we rationalize the central bank's ambiguous communication about the horizon over which it averages inflation. Ambiguous communication, together with uncertainty about economic ...
Working Paper
Rising Skill Supply, Technological Changes, and Innovation: A Quantitative Exploration of China
Can the expansion of higher education lead to firm productivity growth? In this paper, we examine how China's college expansion program contributes to the rapid growth of firms' R&D expenditure and productivity. In our model, heterogeneous firms make endogenous R&D decisions, requiring them to allocate skilled workers between production and R&D. We structurally estimate the model using firm-level data on the level and distribution of R&D, as well as macro-level data on skill prices and sectoral allocation. Quantitative analysis reveals that between 2004 and 2018, the combination of the ...
Journal Article
Average Inflation Targeting in a Low-Rate Environment
One significant change in the US economy in the last 20 years is the trend decline in real interest rates that pushes the policy rate near the effective lower bound (ELB) and puts downward pressure on inflation. This environment leaves conventional monetary policy tools less effective in accommodating adverse shocks. To better achieve the Federal Reserve’s dual mandate at the ELB, the FOMC adopted a new framework called average inflation targeting (AIT). In this Commentary, I demonstrate that AIT is a better policy in a low-rate environment because of its ability to anchor inflation ...
Working Paper
Asymmetric Information, Two-Way Learning, and the Fed Information Effect
How important is the information effect of monetary policy? We first show analytically that the reduced-form method of regressing forecast revisions on monetary policy surprises leads to a biased estimation, due to the correlation between monetary policy surprises and the unobserved shocks. We then develop a New Keynesian model in which asymmetric information originates from a two-way learning mechanism: the central bank learns from lagged aggregate inflation and output, and firms learn from individual marginal costs and the interest rate. We calibrate our model parameters to match ...
Working Paper
How Important Is the Information Effect of Monetary Policy?
Is the "information effect" of monetary policy quantitatively important? We first use a simple model to show that under asymmetric information, monetary policy surprises are correlated with the unobserved state of the economy. This correlation implies that monetary policy surprises provide information about the state of the economy, and at the same time, explains why the estimation of the information effect may be biased. We then develop a New Keynesian DSGE model under asymmetric information and calibrate model parameters to match macroeconomic dynamics in the US and forecasting accuracy in ...
Journal Article
Forward Guidance during the Pandemic: Has It Changed the Public’s Expectations?
In responding to the COVID-19 crisis, the Federal Reserve has both lowered the federal funds rate and provided forward guidance. We study whether the forward guidance given with the April and June 2020 FOMC meetings altered the public’s expectations of future policy rates, GDP growth, and inflation. We find that forward guidance was effective in altering the public’s expectations about future policy rates if it was accompanied by an SEP but not expectations about economic fundamentals. We suggest that the difference might be explained by FOMC statements being interpretable in two ...
Working Paper
The Informational Effect of Monetary Policy and the Case for Policy Commitment
I study how the informational effect of monetary policy changes the optimal conduct of monetary policy. In my model, the private sector extracts information about unobserved shocks from the central bank's interest rate decisions. The central bank optimally changes the informational effect of the interest rate by committing to a state-contingent policy rule, in which case the Phillips curve becomes endogenous to the central bank's optimization problem. In a dynamic model, the optimal policy rule overshoots the natural-rate shock and gradually responds to the cost-push shock, which makes the ...
Journal Article
Monetary Policy since the Onset of the COVID-19 Pandemic: A Path-Dependent Interpretation
Some argue that the Fed underreacted to rising inflation in 2021 after the US economy started to recover from the COVID-19 crisis. By using data from the Summary of Economic Projections (SEP), we surmise that the FOMC expected to keep the federal funds rate near zero by the end of 2021, but at the same time, the committee also expected to make the policy rate catch up to inflation over the next two years. We then argue that the Fed chose this gradual approach in response to the negative demand shock that pushed the policy rate to its effective zero lower bound. Economic literature on optimal ...
Journal Article
Financial Markets’ Perceptions of the FOMC’s Data-Dependent Monetary Policy
Over the past ten years, the Federal Open Market Committee (FOMC) has repeatedly emphasized that future policy is data dependent. In this Economic Commentary, we investigate how financial markets expected future interest rates to change with the release of new data on inflation and labor market conditions. We find that the surprises in economic indicators have a stronger effect on the 2-year Treasury yield than on the expected federal funds rate to be set in the next FOMC meeting. This implies that markets understand that under the data-dependent approach, policy decisions do not heavily rely ...