Excess Reserves and Monetary Policy Implementation
In response to the Great Recession, the Federal Reserve resorted to several unconventional policies that drastically altered the landscape of the federal funds market. The current environment, in which depository institutions are flush with excess reserves, has forced policymakers to design a new operational framework for monetary policy implementation. We provide a parsimonious model that captures the key features of the current federal funds market along with the instruments introduced by the Federal Reserve to implement its target for the federal funds rate. We use this model to analyze ...
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 ...
Rational Inattention via Ignorance Equivalence
We introduce the concept of the ignorance equivalent to effectively summarize the payoff possibilities in a finite Rational Inattention problem. The ignorance equivalent is a unique fictitious action that is weakly preferable to all existing learning strategies and yet generates no new profitable learning opportunities when added to the menu of choices. We fully characterize the relationship between the ignorance equivalent and the optimal learning strategies. Agents with heterogeneous priors self-select their own ignorance equivalent, which gives rise to an expected-utility analogue of the ...
Does the U.S. trade more widely than it appears?
Given the importance of international trade for economic growth, why in any given year do few U.S. firms export their wares, and why are most U.S. goods not traded with most countries? Roc Armenter presents some intriguing evidence suggesting the U.S. does export most of its products to most countries, just not very often.
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 ...
A Model of the Federal Funds Market: Yesterday, Today, and Tomorrow
The landscape of the federal funds market changed drastically in the wake of the Great Recession as large-scale asset purchase programs left depository institutions awash with reserves, and new regulations made it more costly for these institutions to lend. As traditional levers for implementing monetary policy became less effective, the Federal Reserve introduced new tools to implement the target range for the federal funds rate, changing this landscape even more. In this paper, we develop a model that is capable of reproducing the main features of the federal funds market, as observed ...
Fraud deterrence in dynamic Mirrleesian economies
Social and private insurance schemes rely on legal action to deter fraud and tax evasion. This observation guides the authors to introduce a random state verification technology in a dynamic economy with private information. With some probability, an agent's skill level becomes known to the planner, who prescribes a punishment if the agent is caught misreporting. The authors show how deferring consumption can ease the provision of incentives. As a result, the marginal benefit may be below the marginal cost of investment in the constrained-efficient allocation, suggesting a subsidy on savings. ...
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 ...
Endogenous productivity and development accounting
Cross-country data reveal that the per capita incomes of the richest countries exceed those of the poorest countries by a factor of thirty-five. We formalize a model with embodied technical change in which newer, more productive vintages of capital coexist with older, less productive vintages. A reduction in the cost of investment raises both the quantity and productivity of capital simultaneously. The model induces a simple relationship between the relative price of investment goods and per capita income. Using cross-country data on the prices of investment goods, we find that the model does ...
On the use of market-based probabilities for policy decisions
This paper seeks to delimit conditions so that market-based probabilities provide all the information the policymaker needs to arrive at the best possible decision. Although there are practical considerations regarding how to derive market-based probabilities from financial prices, the author confines the discussion to a theoretical analysis that assumes no impediment to obtaining the market-based probabilities.