Search Results
Report
How to escape a liquidity trap with interest rate rules
I study how central banks should communicate monetary policy in liquidity trap scenarios in which the zero lower bound on nominal interest rates is binding. Using a standard New Keynesian model, I argue that the key to anchoring expectations and preventing self-fulfilling deflationary spirals is to promise to keep nominal interest rates pegged at zero for a length of time that depends on the state of the economy. I derive necessary and sufficient conditions for this type of state-contingent forward guidance to implement the welfare-maximizing equilibrium as a globally determinate (that is, ...
Report
An interest rate rule to uniquely implement the optimal equilibrium in a liquidity trap
We propose a new interest rate rule that implements the optimal equilibrium and eliminates all indeterminacy in a canonical New Keynesian model in which the zero lower bound on nominal interest rates (ZLB) is binding. The rule commits to zero nominal interest rates for a length of time that increases in proportion to how much past inflation has deviated?either upward or downward?from its optimal level. Once outside the ZLB, interest rates follow a standard Taylor rule. Following the Taylor principle outside the ZLB is neither necessary nor sufficient to ensure uniqueness of equilibria. ...
Working Paper
Behavioral Economics and Macroeconomic Models
Over the past 20 years, macroeconomists have incorporated more and more results from behavioral economics into their models. We argue that doing so has helped fixed deficiencies with standard approaches to modeling the economy--for example, the counterfactual absence of inertia in the standard New Keynesian model of economic fluctuations. We survey efforts to use behavioral economics to improve some of the underpinnings of the New Keynesian model--specifically, consumption, the formation of expectations and determination of wages and employment that underlie aggregate supply, and the ...
Working Paper
Monetary Policy Interactions: The Policy Rate, Asset Purchases and Optimal Policy with an Interest Rate Peg
We study monetary policy in a New Keynesian model with a variable credit spread and scope for central bank asset purchases to matter. A novel financial and labor market interaction generates an endogenous cost-push channel in the Phillips curve and a credit wedge in the IS curve. These channels arise due to a liquidity premium to long-term debt present in our model. The “divine coincidence” holds with the nominal short rate and central bank balance sheet available as policy tools—dual-instrument policy. Targeting the liquidity premium using balance sheet policy provides a determinate ...
Working Paper
The Chicago Fed DSGE Model: Version 2
The Chicago Fed dynamic stochastic general equilibrium (DSGE) model is used for policy analysis and forecasting at the Federal Reserve Bank of Chicago. This guide describes its specification, estimation, dynamic characteristics, and how it is used to forecast the U.S. economy. In many respects the model resembles other medium-scale New Keynesian frameworks, but there are several features which distinguish it: the monetary policy rule includes anticipated future deviations, productivity is driven by both neutral and investment specific technical change, multiple price and wage indices identify ...
Working Paper
Trade Costs and Inflation Dynamics
We study how trade cost shocks influence inflation. Using bilateral trade flows from detailed global input-output data and a gravity framework, we estimate trade cost shocks and their effects on CPI inflation. Higher trade costs for final goods cause large but short-lived inflation spikes, while increased costs for intermediate inputs trigger more persistent inflation. A multi-country model of inflation with trade in final goods and intermediate inputs replicates these patterns. We show that trade cost shocks and tariffs on imported inputs transmit through global value chains and worsen ...
Working Paper
Inflation Expectations and Monetary Policy Design: Evidence from the Laboratory
Using laboratory experiments within a New Keynesian framework, we explore the interaction between the formation of inflation expectations and monetary policy design. The central question in this paper is how to design monetary policy when expectations formation is not perfectly rational. Instrumental rules that use actual rather than forecasted inflation produce lower inflation variability and reduce expectational cycles. A forward-looking Taylor rule where a reaction coefficient equals 4 produces lower inflation variability than rules with reaction coefficients of 1.5 and 1.35. Inflation ...
Working Paper
Trade Costs and Inflation Dynamics
We explore how shocks to trade costs affect inflation dynamics in the global economy. We exploit bilateral trade flows of final and intermediate goods together with the structure of static trade models that deliver gravity equations to identify exogenous changes in trade costs between countries. We then use a local projections approach to assess the effects of trade cost shocks on consumer price (CPI) inflation. Higher trade costs of final goods lead to large but short-lived increases in inflation, while increases in trade costs of intermediate goods generate small but persistent increases in ...
Working Paper
Fiscal Implications of Interest Rate Normalization in the United States
This paper studies the fiscal implications of interest rate normalization from the zero lower bound (ZLB) in the United States. At the ZLB, the decline in tax revenues and the real bond price drives up government debt. During normalization, interest payments continue to rise higher than they would have had rates not reached the ZLB, potentially increasing government debt even as output and tax revenues recover. We find that against the yardstick of ability to pay, interest rate normalization is unlikely to pose an immediate threat to debt sustainability at the current net federal debt level ...
Working Paper
Global Robust Bayesian Analysis in Large Models
This paper develops a tool for global prior sensitivity analysis in large Bayesian models. Without imposing parametric restrictions, the methodology provides bounds for posterior means or quantiles given any prior close to the original in relative entropy, and reveals features of the prior that are important for the posterior statistics of interest. The author develops a sequential Monte Carlo algorithm and uses approximations to the likelihood and statistic of interest to implement the calculations. Applying the methodology to the error bands for the impulse response of output to a monetary ...