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Costly information, planning complementarities and the Phillips Curve
Standard sticky information pricing models successfully capture the sluggish movement of aggregate prices in response to monetary policy shocks but fail at matching the magnitude and frequency of price changes at the micro level. This paper shows that in a setting where firms choose when to acquire costly information about different types of shocks, strategic complementarities in pricing generate planning complementarities. This results in firms optimally updating their information about monetary policy shocks less frequently than about idiosyncratic shocks. When calibrated to match frequent ...
Report
The side effects of safe asset creation
We present an incomplete markets model to understand the costs and benefits of increasing government debt in a low interest rate environment. Higher risk increases the demand for safe assets, lowering the natural rate of interest below zero, constraining monetary policy at the zero lower bound, and raising unemployment. Higher government debt satiates the demand for safe assets, raising the natural rate and restoring full employment. While this permanently lowers investment, a policymaker committed to low inflation has no alternative. Higher inflation targets, instead, permit both full ...
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Slow recoveries and unemployment traps: monetary policy in a time of hysteresis
We analyze monetary policy in a model where temporary shocks can permanently scar the economy's productive capacity. Unemployed workers? skill losses generate multiple steady-state unemployment rates. When monetary policy is constrained by the zero bound, large shocks reduce hiring to a point where the economy recovers slowly at best?at worst, it falls into a permanent unemployment trap. Since monetary policy is powerless to escape such traps ex post, it must avoid them ex ante. The model quantitatively accounts for the slow U.S. recovery following the Great Recession, and suggests that lack ...
Report
Estimating HANK for Central Banks
We provide a toolkit for efficient online estimation of heterogeneous agent (HA) New Keynesian (NK) models based on Sequential Monte Carlo methods. We use this toolkit to compare the out-of-sample forecasting accuracy of a prominent HANK model, Bayer et al. (2022), to that of the representative agent (RA) NK model of Smets and Wouters (2007, SW). We find that HANK’s accuracy for real activity variables is notably inferior to that of SW. The results for consumption in particular are disappointing since the main difference between RANK and HANK is the replacement of the RA Euler equation with ...
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Liquidity traps, capital flows
Motivated by debates surrounding international capital flows during the Great Recession, we conduct a positive and normative analysis of capital flows when a region of the global economy experiences a liquidity trap. Capital flows reduce inefficient output fluctuations in this region by inducing exchange rate movements that reallocate expenditure toward the goods it produces. Restricting capital mobility hampers such an adjustment. From a global perspective, constrained efficiency entails subsidizing capital flows to address an aggregate demand externality associated with exchange rate ...
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Understanding HANK: insights from a PRANK
We show analytically that whether incomplete markets resolve New Keynesian ?paradoxes? depends primarily on the cyclicality of income risk, rather than marginal propensity to consume (MPC) heterogeneity. Incomplete markets reduce the effectiveness of forward guidance and multipliers in a liquidity trap only with procyclical risk. Countercyclical risk amplifies these ?puzzles.? Procyclical risk permits determinacy under a peg; countercyclical risk generates indeterminacy even under the Taylor principle. MPC heterogeneity leaves determinacy and paradoxes qualitatively unaffected, but can change ...
Discussion Paper
Understanding Heterogeneous Agent New Keynesian Models: Insights from a PRANK
In recent years there has been a lot of interest in the effect of income inequality (heterogeneity) on the economy, from both academics and policymakers. Researchers have developed Heterogeneous Agent New Keynesian (HANK) models that incorporate heterogeneity and uninsurable idiosyncratic risk into the New Keynesian models that have become a cornerstone of monetary policy analysis. This research has argued that heterogeneity and idiosyncratic risk change many features of New Keynesian models – the transmission of conventional monetary policy, the forward guidance puzzle, fiscal multipliers, ...
Report
Rational inattention in hiring decisions
We provide an information-based theory of matching efficiency fluctuations. Rationally inattentive firms have limited capacity to process information and cannot perfectly identify suitable applicants. During recessions, higher losses from hiring unsuitable workers cause firms to be more selective in hiring. When firms cannot obtain sufficient information about applicants, they err on the side of caution and accept fewer applicants to minimize losses from hiring unsuitable workers. Pro-cyclical acceptance rates drive a wedge between meeting and hiring rates, explaining fluctuations in matching ...
Discussion Paper
Natural Experiment Sheds Light on the Market Effects of Herding
Pension funds are expected to behave in a patient, countercyclical manner, making the most of low valuations over the business cycle to achieve high returns. Such behavior provides liquidity and stability to the financial system. However, this belief has come under question. A large theoretical literature has emerged which looks at how short-term considerations affecting these institutional investors might arise from relative performance concerns or from the influence of other incentives introduced by market and regulatory monitoring. Such considerations might incentivize fund managers to ...
Discussion Paper
Revisiting the Case for International Policy Coordination
Prompted by the U.S. financial crisis and subsequent global recession, policymakers in advanced economies slashed interest rates dramatically, hitting the zero lower bound (ZLB), and then implemented unconventional policies such as large-scale asset purchases. In emerging economies, however, the policy response was more subdued since they were less affected by the financial crisis. As a result, capital flows from advanced to emerging economies increased markedly in response to widening interest rate differentials. Some emerging economies reacted by adopting measures to slow down capital ...