Should We Be Puzzled by Forward Guidance?
Although a growing literature argues output is too sensitive to future interest rates in standard macroeconomic models, little empirical evidence has been put forth to evaluate this claim. In this paper, we use a range of vector autoregression models to answer the central question of how much output responds to changes in interest rate expectations following a monetary policy shock. Despite distinct identification strategies and sample periods, we find surprising agreement regarding this elasticity across empirical models. We then show that in a standard model of nominal rigidity estimated ...
Uncertainty shocks in a model of effective demand
This paper examines the role of uncertainty shocks in a one-sector, representative-agent dynamic stochastic general equilibrium model. When prices are flexible, uncertainty shocks are not capable of producing business cycle comovements among key macro variables. With countercyclical markups through sticky prices, however, uncertainty shocks can generate fluctuations that are consistent with business cycles. Monetary policy usually plays a key role in offsetting the negative impact of uncertainty shocks. If the central bank is constrained by the zero lower bound, then monetary policy can no ...
Do federal funds futures need adjustment for excess returns? a state-dependent approach
This paper utilizes a Markov-switching framework to model excess returns in federal funds futures contracts. This framework identifies a high-volatility state where excess returns are large, positive, and volatile and a low-volatility state where excess returns have a lower volatility and are small in absolute value. Federal funds futures rates require adjustment for excess returns only in the high-volatility state. Intermeeting rate cuts of the federal funds rate target always correspond with the high-volatility regime and can explain much of the variation in excess returns. This paper also ...
From Deviations to Shortfalls: The Effects of the FOMC’s New Employment Objective
The Federal Open Market Committee (FOMC) recently revised its interpretation of its maximum employment mandate. In this paper, we analyze the possible effects of this policy change using a theoretical model with frictional labor markets and nominal rigidities. A monetary policy that stabilizes employment “shortfalls” rather than “deviations” of employment from its maximum level leads to higher inflation and more hiring at all times due to firms’ expectations of more accommodative future policy. Thus, offsetting only shortfalls of employment results in higher inflation, employment, ...
Uncertainty Shocks in a Model of Effective Demand: Reply
de Groot, Richter, and Throckmorton (2018) argue that the model in Basu and Bundick (2017) can match the empirical evidence only because the model assumes an asymptote in the economy?s response to an uncertainty shock. In this Reply, we provide new results showing that our model?s ability to match the data does not rely either on assuming preferences that imply an asymptote nor on a particular value of the intertemporal elasticity of substitution. We demonstrate that shifting to preferences that are not vulnerable to the Comment?s critique does not change our previous conclusions about the ...
Does Communicating a Numerical Inflation Target Anchor Inflation Expectations? Evidence & Bond Market Implications
High-frequency empirical evidence suggests that inflation expectations in the United States became better anchored after the Federal Reserve began communicating a numerical inflation target. Using an event-study approach, we find that forward measures of inflation compensation became unresponsive to news about current inflation after the adoption of an explicit inflation target. In contrast, we find that forward measures of nominal compensation in Japan continued to drift with news about current inflation, even after the Bank of Japan adopted a numerical inflation target. These empirical ...
Did the Federal Reserve Break the Phillips Curve? Theory and Evidence of Anchoring Inflation Expectations
In a macroeconomic model with drifting long-run inflation expectations, the anchoring of inflation expectations manifests in two testable predictions. First, expectations about inflation far in the future should no longer respond to news about current inflation. Second, better-anchored inflation expectations weaken the relationship between unemployment and inflation, flattening the reduced-form Phillips curve. We evaluate both predictions and find that communication of a numerical inflation objective better anchored inflation expectations in the United States but failed to anchor expectations ...
Estimating the Monetary Policy Rule Perceived by Forecasters
Brent Bundick examines whether the FOMC?s implicit monetary policy rule, as perceived by professional forecasters, changed when the federal funds rate reached its effective lower bound. The article is summarized in The Macro Bulletin.