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Working Paper
Impacts of priors on convergence and escapes from Nash inflation
Recent papers have analyzed how adaptive agents may converge to and escape from self-confirming equilibria. All of these papers have imputed to agents a particular prior about drifting coefficients. In the context of a model of monetary policy, this paper analyzes dynamics that govern both convergence and escape under a more general class of priors for the government. The authors characterize how the shape of the prior influences the dynamics in important ways. There are priors for which the E-stability condition is not enough to assure local convergence to a self-confirming equilibrium. ...
Working Paper
Optimal unemployment insurance and cyclical fluctuations
The authors study the design of optimal unemployment insurance in an environment with moral hazard and cyclical fluctuations. The optimal unemployment insurance contract balances the insurance motive to provide consumption for the unemployed with the provision of incentives to search for a job. This balance is affected by aggregate conditions, as recessions are characterized by reductions in job finding rates. We show how benefits should vary with aggregate conditions in an optimal contract. In a special case of the model, the optimal contract can be solved in closed form. We show how this ...
Working Paper
Monetary policy under uncertainty in micro-founded macroeconometric models
We use a micro-founded macroeconometric modeling framework to investigate the design of monetary policy when the central bank faces uncertainty about the true structure of the economy. We apply Bayesian methods to estimate the parameters of the baseline specification using postwar U.S. data and then determine the policy under commitment that maximizes household welfare. We find that the performance of the optimal policy is closely matched by a simple operational rule that focuses solely on stabilizing nominal wage inflation. Furthermore, this simple wage stabilization rule is remarkably ...
Conference Paper
Empirical and policy performance of a forward-looking monetary model
In this paper we consider the policy implications of a fully specified dynamic general equilibrium model, developed by Smets and Wouters (2003a). This is a relatively large-scale forward looking model, which was shown to provide a good fit to the data. However there has been little previous work analyzing monetary policy within such a model. We first re-examine the empirical performance of the model. We show that systematically accounting for prior uncertainty leads to substantially different parameter estimates. However many of the qualitative features of the model remain similar under the ...
Working Paper
The conquest of South American inflation
We infer determinants of Latin American hyperinflations and stabilizations by using the method of maximum likelihood to estimate a hidden Markov model that potentially assigns roles both to fundamentals in the form of government deficits that are financed by money creation and to destabilizing expectations dynamics that can occasionally divorce inflation from fundamentals. Our maximum likelihood estimates allow us to interpret observed inflation rates in terms of variations in the deficits, sequences of shocks that trigger temporary episodes of expectations driven hyperinflations, and ...
Journal Article
Optimal monetary policy under uncertainty: a Markov jump-linear-quadratic approach
This paper studies the design of optimal monetary policy under uncertainty using a Markov jump-linear-quadratic (MJLQ) approach. To approximate the uncertainty that policymakers face, the authors use different discrete modes in a Markov chain and take mode-dependent linear-quadratic approximations of the underlying model. This allows the authors to apply a powerful methodology with convenient solution algorithms that they have developed. They apply their methods to analyze the effects of uncertainty and potential gains from experimentation for two sources of uncertainty in the New Keynesian ...
Working Paper
Shocks and government beliefs: the rise and fall of American inflation
The authors use a Bayesian Markov chain Monte Carlo algorithm to estimate a model that allows temporary gaps between a true expectational Phillips curve and the monetary authority?s approximating nonexpectational Phillips curve. A dynamic programming problem implies that the monetary authority?s inflation target evolves as its estimated Phillips curve moves. The authors? estimates attribute the rise and fall of post-World War II inflation in the United States to an intricate interaction between the monetary authority?s beliefs and economic shocks. Shocks in the 1970s altered the monetary ...