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Reputation and Sovereign Default

This paper presents a continuous-time model of sovereign debt. In it, a relatively impatient sovereign government?s hidden type switches back and forth between a commitment type, which cannot default, and an optimizing type, which can default on the country?s debt at any time, and assume outside lenders have particular beliefs regarding how a commitment type should borrow for any given level of debt and bond price. We show that if these beliefs satisfy reasonable assumptions, in any Markov equilibrium, the optimizing type mimics the commitment type when borrowing, revealing its type only by ...
Staff Report , Paper 564

Working Paper
Can Learning Explain Boom-Bust Cycles In Asset Prices? An Application to the US Housing Boom

Explaining asset price booms poses a difficult question for researchers in macroeconomics: how can large and persistent price growth be explained in the absence large and persistent variation in fundamentals? This paper argues that boom-bust behavior in asset prices can be explained by a model in which boundedly rational agents learn the process for prices. The key feature of the model is that learning operates in both the demand for assets and the supply of credit. Interactions between agents on either side of the market create complementarities in their respective beliefs, providing an ...
International Finance Discussion Papers , Paper 1181

Working Paper
Avoiding Nash Inflation : Bayesian and Robust Responses to Model Uncertainty

We examine learning, model misspecification, and robust policy responses to misspecification in a quasi-real-time environment. The laboratory for the analysis is the Sargent (1999) explanation for the origins of inflation in the 1970s and the subsequent disinflation. Three robust policy rules are derived that differ according to the extent that misspecification is taken as a parametric phenomenon. These responses to drifting estimated parameters and apparent misspecification are compared to the certainty-equivalent case studied by Sargent. We find gains from utilizing robust approaches to ...
Finance and Economics Discussion Series , Paper 2002-09

Working Paper
The Natural Rate of Interest Through a Hall of Mirrors

Prevailing explanations of persistently low interest rates appeal to a secular decline in the natural interest rate, or r-star, due to factors outside monetary policy's control. We propose informational feedback via learning as an alternative explanation for persistently low rates, where monetary policy plays a crucial role. We extend the canonical New Keynesian model to an incomplete information setting where the central bank and the private sector learn about r-star and infer each other's information from observed macroeconomic outcomes. An informational feedback loop emerges when each side ...
Finance and Economics Discussion Series , Paper 2022-010

Working Paper
Short-term Planning, Monetary Policy, and Macroeconomic Persistence

This paper uses aggregate data to estimate and evaluate a behavioral New Keynesian (NK) model in which households and firms plan over a finite horizon. The finite-horizon (FH) model outperforms rational expectations versions of the NK model commonly used in empirical applications as well as other behavioral NK models. The better fit of the FH model reflects that it can induce slow-moving trends in key endogenous variables which deliver substantial persistence in output and inflation dynamics. In the FH model, households and firms are forward-looking in thinking about events over their ...
Finance and Economics Discussion Series , Paper 2020-003

Working Paper
Is the Intrinsic Value of Macroeconomic News Announcements Related to their Asset Price Impact?

The literature documents a heterogeneous asset price response to macroeconomic news announcements. We explain this variation with a novel measure of the intrinsic value of an announcement - the announcement's ability to nowcast GDP growth, inflation, and the Federal Funds Target Rate-and decompose it into the announcement's relation to fundamentals, a timeliness premium, and a revision premium. We find that differences in intrinsic value can explain a significant fraction of the variation in the announcements' price impact on Treasury bond yields. The announcements' timeliness and relation to ...
Finance and Economics Discussion Series , Paper 2015-46

Working Paper
Stock Market Volatility and Learning

Consumption-based asset pricing models with time-separable preferences can generate realistic amounts of stock price volatility if one allows for small deviations from rational expectations. We consider rational investors who entertain subjective prior beliefs about price behavior that are not equal but close to rational expectations. Optimal behavior then dictates that investors learn about price behavior from past price observations. We show that this imparts momentum and mean reversion into the equilibrium behavior of the price-dividend ratio, similar to what can be observed in the data. ...
Working Papers , Paper 720

Working Paper
Learning and the Value of Trade Relationships

This paper quantifies the value of importer-exporter relationships. We show that almost 80 percent of U.S. imports take place in pre-existing relationships, with sizable heterogeneity across countries, and show that traded quantities and survival increase as relationships age. We develop a two-country general equilibrium trade model with learning that is consistent with these facts. A model-based measure of relationship value explains survival during the 2008-09 crisis. Knowledge accumulated within long-term relationships is quantitatively important: wiping out all memory from previous ...
International Finance Discussion Papers , Paper 1218

Working Paper
Optimized Taylor Rules for Disinflation When Agents are Learning

Highly volatile transition dynamics can emerge when a central bank disinflates while operating without full transparency. In our model, a central bank commits to a Taylor rule whose form is known but whose coefficient are not. Private agents learn about policy parameters via Bayesian updating. Under McCallum's (1999) timing protocol, temporarily explosive dynamics can arise, making the transition highly volatile. Locally-unstable dynamics emerge when there is substantial disagreement between actual and perceived feedback parameters. The central bank can achieve low average inflation, but its ...
Working Paper , Paper 14-7

Working Paper
Asset Price Learning and Optimal Monetary Policy

We characterize optimal monetary policy when agents are learning about endogenous asset prices. Boundedly rational expectations induce inefficient equilibrium asset price fluctuations which translate into inefficient aggregate demand fluctuations. We find that the optimal policy raises interest rates when expected capital gains, and the level of current asset prices, is high. The optimal policy does not eliminate deviations of asset prices from their fundamental value. When monetary policymakers are information-constrained, optimal policy can be reasonably approximated by simple interest rate ...
International Finance Discussion Papers , Paper 1236


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