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Working Paper
Welfare-enhancing inflation and liquidity premia
The Friedman rule recommends eliminating liquidity premia on nominally risk-free government debt and following a deflationary monetary policy. The desirability of this prescription in a broad class of monetary models contrasts sharply with observation. In reality, the average rate of inflation is almost always positive and long-dated government securities are–as a matter of policy–allowed to trade at a discount relative to cash, even when these securities represent risk-free claims to cash. Our paper identifies a set of empirically-plausible conditions under which a strictly positive ...
Working Paper
Why Does the Yield Curve Predict GDP Growth? The Role of Banks
We provide evidence on the effect of the slope of the yield curve on economic activity through bank lending. Using detailed data on banks’ lending activities coupled with term premium shocks identified using high-frequency event study or instrumental variables, we show that a steeper yield curve associated with higher term premiums (rather than higher expected short rates) boosts bank profits and the supply of bank loans. Intuitively, a higher term premium represents greater expected profits on maturity transformation, which is at the core of banks’ business model, and therefore ...
Working Paper
Why Does the Yield Curve Predict GDP Growth? The Role of Banks
We provide evidence on the effect of the slope of the yield curve on economic activity through bank lending. Using detailed data on banks' lending activities coupled with term premium shocks identified using high-frequency event study or instrumental variables, we show that a steeper yield curve associated with higher term premiums (rather than higher expected short rates) boosts bank profits and the supply of bank loans. Intuitively, a higher term premium represents greater expected profits on maturity transformation, which is at the core of banks' business model, and therefore incentivizes ...
Working Paper
Downward Nominal Rigidities and Bond Premia
We develop a parsimonious New Keynesian macro-finance model with downward nominal rigidities to understand secular and cyclical movements in Treasury bond premia. Downward nominal rigidities create state-dependence in output and inflation dynamics: a higher level of inflation makes prices more flexible, leading output and inflation to be more volatile, and bonds to become more risky. The model matches well the relation between the level of inflation and a number of salient macro-finance moments. Moreover, we show that empirically, inflation and output respond more strongly to productivity ...
Working Paper
Welfare-enhancing inflation and liquidity premia
We investigate what principles govern the evolution and maturity structure of the national debt when nominal government securities constitute an important form of exchange media. Even in the absence of government funding risk, we find a rationale for issuing nominal debt in different maturities, purposely mispricing long-term debt, and growing the nominal debt to support a strictly positive inflation target. The policy of discounting long-term debt and supporting a strictly positive inflation target provides superior risk-sharing arrangements for clienteles characterized by different degrees ...
Working Paper
Revisiting the Interest Rate Effects of Federal Debt
This paper revisits the relationship between federal debt and interest rates. A common approach in the literature is to regress an expected interest rate on a projection of federal debt. We show that issues related to nonstationarity have become more pronounced over the last 20 years, raising significant concern about the reliability of estimates from this model. We argue that estimating the model in first differences rather than in levels addresses these concerns. Our preferred specification indicates that a 1 percentage point increase in the debt-to-GDP ratio raises the 5-year-ahead, 5-year ...