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Working Paper
Optimal time-consistent government debt maturity
The current literature on a government's optimal debt maturity structure contends that by purchasing short-term assets and selling long-term debt, it is possible to fully insulate the economy against fiscal shocks. The required short and long positions are large relative to GDP and constant. The market value of debt adjusts automatically and the constant debt positions and fluctuating bond prices insulate against potential shocks. However, achieving the goal of averting future shocks depends on the government perfectly committing to the future fiscal policy, for without this sustained ...
Working Paper
The macroeconomic effect of external pressures on monetary policy
Central banks, whether independent or not, may occasionally be subject to external pressures to change policy objectives. We analyze the optimal response of central banks to such pressures and the resulting macroeconomic consequences. We consider several alternative scenarios regarding policy objectives, the degree of commitment and the timing of external pressures. The possibility to adopt " more liberal" objectives in the future increases current inflation through an accommodation effect. Simultaneously, the central bank tries to anchor inflation by promising to be even " more ...
Working Paper
Optimal Credit Market Policy
We study optimal credit market policy in a stochastic, quantitative, general equilibrium, infinite-horizon economy with collateral constraints tied to housing prices. Collateral constraints yield a competitive equilibrium that is Pareto inefficient. Taxing housing in good states and subsidizing it in recessions leads to a Pareto-improving allocation for borrowers and savers. Quantitatively, the welfare gains afforded by the optimal tax are significant. The optimal tax reduces the covariance of collateral prices with consumption, and, by doing so, it increases asset prices on average, thus ...
Working Paper
Interest Rate Surprises: A Tale of Two Shocks
Interest rate surprises around FOMC announcements reveal both the surprise in the monetary policy stance (the pure policy shock) and interest rate movements driven by exogenous information about the economy from the central bank (the information shock). In order to disentangle the effects of these two shocks, we use interest rate changes on days of macroeconomic data releases. On these release dates, there are no pure policy shocks, which allows us to identify the impact of information shocks and thereby distill pure policy shocks from interest rate surprises around FOMC announcements. Our ...
Working Paper
Do central banks’ forecasts take into account public opinion and views?
The Federal Reserve through the Federal Open Market Committee (FOMC) regularly releases macroeconomic forecasts to the general public and the US congress with the purpose of explaining the likely evolution of the economy and the appropriate stance of monetary policy. Immediately before doing so, the FOMC receives a forecast produced by the Federal Reserve staff which remains private for five years. The literature has pointed out that, despite the informational advantage of the FOMC, its forecast differs from and is not always more accurate than the staff forecast. This finding has raised ...
Working Paper
Interest Rate Surprises: A Tale of Two Shocks
Interest rate surprises around FOMC announcements reveal both the surprise in the monetary policy stance (the pure policy shock) and interest rate movements driven by exogenous information about the economy from the central bank (the information shock). In order to disentangle the effects of these two shocks, we use interest rate changes on days of macroeconomic data releases. On these release dates, there are no pure policy shocks, which allows us to identify the impact of information shocks and thereby distill pure policy shocks from interest rate surprises around FOMC announcements. Our ...
Working Paper
Simple monetary rules under fiscal dominance
This paper asks whether an aggressive monetary policy response to inflation is feasible in countries that suffer from fiscal dominance, as long as monetary policy also responds to fiscal variables. We find that if nominal interest rates are allowed to respond to government debt, even aggressive rules that satisfy the Taylor principle can produce unique equilibria. But following such rules results in extremely volatile inflation. This leads to very frequent violations of the zero lower bound on nominal interest rates that make such rules infeasible. Even within the set of feasible rules the ...
Working Paper
Designing a simple loss function for the Fed: does the dual mandate make sense?
Variable and high rates of price inflation in the 1970s and 1980s led many countries to delegate the conduct of monetary policy to "instrument-independent" central banks and to give their central banks a clear mandate to pursue price stability and instrument independence to achieve it. Advances in academic research supported a strong focus on price stability as a means to enhance the independence and credibility of monetary policymakers. An overwhelming majority of these central banks also adopted an explicit inflation target to further strengthen credibility and facilitate accountability. ...
Working Paper
Political disagreement, lack of commitment and the level of debt
We analyze how public debt evolves when successive policymakers have different policy goals and cannot make credible commitments about their future policies. We consider several cases to be able to disentangle and quantify the respective effects of imperfect commitment and political disagreement. Absent political turnover, imperfect commitment drives the long-run level of debt to zero. With political disagreement, debt is a sizeable fraction of GDP and increasing in the degree of polarization among parties, no matter the degree of commitment. The frequency of political turnover does not ...
Working Paper
Monetary regime switches and unstable objectives
Monetary policy objectives and targets are not necessarily stable over time. The regime switching literature has typically analyzed and interpreted changes in policymakers' behavior through simple interest rate rules. This paper analyzes policy regime switches explicitly modeling policymakers' behavior and objectives. We show how current monetary policy is affected and should optimally respond to alternative regimes. We also show that changes in the parameters of simple rules do not necessarily correspond to changes in policymakers' preferences. In fact, capturing and interpreting regime ...