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Working Paper
Price dispersion and inflation: new facts and theoretical implications
From a macroeconomic perspective, price rigidity is often perceived to be an important source of price dispersion, with significant implications for the dynamic properties of aggregate variables, welfare calculations, and the design of optimal policy. For instance, in standard New Keynesian models, the key cost of business cycles stems from the price dispersion resulting from firms' inability to adjust prices instantaneously. However, different macroeconomic models make conflicting predictions about the level of price dispersion, as well as about its dynamic properties and sensitivity to inflation. These contrasting predictions can help us to discriminate across alternative models. This paper examines the link between price dispersion and inflation, and the role of sales in this relationship.
AUTHORS: Sheremirov, Viacheslav
DATE: 2015-07-01

Working Paper
Financial variables and macroeconomic forecast errors
A large set of financial variables has only limited power to predict a latent factor common to the year-ahead forecast errors for real Gross Domestic Product (GDP) growth, the unemployment rate, and Consumer Price Index (CPI) inflation for three sets of professional forecasters: the Federal Reserve?s Greenbook, the Survey of Professional Forecasters (SPF), and the Blue Chip Consensus Forecasts. Even when a financial variable appears to be fairly robust across sample periods in explaining the latent factor, from an economic standpoint its contribution appears modest. Still, several financial variables retain economic significance over certain subsamples; when non-linear effects are accounted for, these variables have an improved ability to consistently predict the latent factor over the business cycle.
AUTHORS: Barnes, Michelle L.; Olivei, Giovanni P.
DATE: 2017-10-31

Working Paper
The rise and fall of consumption in the '00s
The major portion of U.S. gross domestic product (GDP) is accounted for by consumer spending, which significantly affects the business cycle. Consumer demand has been extremely volatile since 2000, especially given the booms and busts in housing values and in subprime mortgage lending. While it is well-established that housing net worth, credit availability, and household debt levels help to explain changes in consumer spending, the roles played by other potential determinants of consumption are not well identified or understood. This paper uses county-level data and a multiple-regression framework to explore how fluctuations in consumption between 2000 and 2012 are correlated with these macroeconomic variables: income, unemployment, debt, income inequality, consumer expectations, housing wealth, credit access, cash-out refinancings, and foreclosures. Four subperiods are considered: the "dot-com" recession (2001?2003), the "subprime boom" (2004?2006), the Great Recession (2007?2009), and the "tepid recovery" (2010?2012).
AUTHORS: Hryshko, Dmytro; Luengo-Prado, Maria Jose; Sorensen, Bent E.; Demyanyk, Yuliya
DATE: 2015-10-16

Working Paper
News-driven uncertainty fluctuations
We embed a news shock, a noisy indicator of the future state, in a two-state Markov-switching growth model. Our framework, combined with parameter learning, features rich history-dependent uncertainty dynamics. We show that bad news that arrives during a prolonged economic boom can trigger a ?Minsky moment??a sudden collapse in asset values. The effect is greatly amplified when agents have a preference for early resolution of uncertainty. We leverage survey recession probability forecasts to solve a sequential learning problem and estimate the full posterior distribution of model primitives. We identify historical periods in which uncertainty and risk premia were elevated because of news shocks.
AUTHORS: Song, Dongho; Tang, Jenny
DATE: 2018-01-01

Working Paper
An evaluation of the Federal Reserve estimates of the natural rate of unemployment in real time
The authors derive an estimate of the Federal Reserve's assessment of the natural rate of unemployment in real time from the Greenbook forecast of inflation. The estimated natural rate starts to rise noticeably in the second half of the mid-1970s. It stays relatively high in the 1980s, and then declines noticeably in the second half of the 1990s. They compare the Greenbook estimates with the estimates obtained in real time from simple relationships that extract information about the natural rate of unemployment from the dynamics of inflation, aggregate demand, and the functioning of the labor market. When differences between these measures and the Greenbook arise, the improvement to the Greenbook inflation forecast that would have been achieved by using a different estimate of the natural rate of unemployment is typically small.
AUTHORS: Gumbau-Brisa, Fabia; Olivei, Giovanni P.
DATE: 2013-12-18

Working Paper
Why Does the Yield-Curve Slope Predict Recessions?
Why is an inverted yield-curve slope such a powerful predictor of future recessions? We show that a decomposition of the yield curve slope into its expectations and risk premia components helps disentangle the channels that connect fluctuations in Treasury rates and the future state of the economy. In particular, a change in the yield curve slope due to a monetary policy easing, measured by the current real-interest rate level and its expected path, is associated with an increase in the probability of a future recession within the next year. In contrast, a decrease in risk premia is associated with either a higher or lower recession probability, depending on the source of the decline. In recent years, a decrease in the inflation risk premium slope has been accompanied by a heightened risk of recession, while a lower real-rate risk premium slope is a signal of diminished recession probabilities. This means that not all declines in the yield curve slope are bad news for the economy, and not all instances of steepening are good news either.
AUTHORS: Kelley, David; Chyruk, Olena; Benzoni, Luca
DATE: 2018-09-28

Working Paper
Inflation Uncertainty and Disagreement in Bond Risk Premia
This paper examines the relation between variations in perceived inflation uncertainty and bond premia. Using the subjective probability distributions available in the Survey of Professional Forecasters we construct a quarterly time series of average individual uncertainty about inflation forecasts since 1968. We show that this ex-ante measure of inflation uncertainty differs importantly from measures of disagreement regarding inflation forecasts and other proxies, such as model-based ex-post measures of macroeconomic risk. Inflation uncertainty is an important driver of bond premia, but the relation varies across inflation regimes. It is most important in the high-inflation regime early in the sample and the low-inflation regime over the last 15 years. Once the role of inflation uncertainty is accounted for, disagreement regarding inflation forecasts appears a much less important driver of bond premia.
AUTHORS: D'Amico, Stefania; Orphanides, Athanasios
DATE: 2014-01-11

Working Paper
Recession forecasting using Bayesian classification
The authors demonstrated the use of a Nave Bayes model as a recession forecasting tool. The approach has a close connection to Markov-switching models and logistic regression but also important differences. In contrast to Markov-switching models, Nave Bayes treats National Bureau of Economic Research business cycle turning points as data rather than hidden states to be inferred by the model. Although Nave Bayes and logistic regression are asymptotically equivalent under certain distributional assumptions, the assumptions do not hold for business cycle data.
AUTHORS: Smalter Hall, Aaron; Davig, Troy A.
DATE: 2016-08-01

Working Paper
The Optimal Monetary Instrument and the (Mis)Use of Causality Tests
This paper uses a New-Keynesian model with multiple monetary assets to show that if the choice of instrument is based solely on its propensity to predict macroeconomic targets, a central bank may choose an inferior policy instrument. We compare a standard interest rate rule to a k-percent rule for three alternative monetary aggregates determined within our model: the monetary base, the simple sum measure of money, and the Divisia measure. Welfare results are striking. While the interest rate dominates the other two monetary aggregate k-percent rules, the Divisia k-percent rule outperforms the interest rate rule. Next we study the ability of Granger Causality tests ? in the context of data generated from our model ? to correctly identify welfare improving instruments. All of the policy instruments considered, except for Divisia, Granger Cause both output and prices at extremely high levels of significance. Divisia fails to Granger Cause prices despite the Divisia rule stabilizing inflation better than these alternative policy instruments. The causality results are robust to using a popular version of the Sims Causality test for which we show standard asymptotics remain valid when the variables are integrated, as in our case.
AUTHORS: Keating, John W.; Smith, Andrew Lee
DATE: 2018-11-28

Working Paper
Core and 'Crust': Consumer Prices and the Term Structure of Interest Rates
We propose a no-arbitrage model that jointly explains the dynamics of consumer prices as well as the nominal and real term structures of risk-free rates. In our framework, distinct core, food, and energy price series combine into a measure of total inflation to price nominal Treasuries. This approach captures different frequencies in inflation fluctuations: Shocks to core are more persistent and less volatile than shocks to food and, especially, energy (the 'crust'). We find that a common structure of latent factors determines and predicts the term structure of yields and inflation. The model outperforms popular benchmarks and is at par with the Survey of Professional Forecasters in forecasting inflation. Real rates implied by our model uncover the presence of a time-varying component in TIPS yields that we attribute to disruptions in the inflation-indexed bond market. Finally, we find a pronounced declining pattern in the inflation risk premium that illustrates the changing nature of inflation risk in nominal Treasuries.
AUTHORS: Ajello, Andrea; Benzoni, Luca; Chyruk, Olena
DATE: 2012-12-19

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