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Working Paper
The Dire Effects of the Lack of Monetary and Fiscal Coordination
What happens if the government?s willingness to stabilize a large stock of debt is waning, while the central bank is adamant about preventing a rise in inflation? The large fiscal imbalance brings about inflationary pressures, triggering a monetary tightening, further debt accumulation, and additional inflationary pressure. Thus, the economy will go through a spiral of higher inflation, output contraction, and further debt accumulation. A coordinated commitment to inflate away the portion of debt resulting from a large recession leads to better macroeconomic outcomes by separating the issue ...
Working Paper
Constrained Discretion and Central Bank Transparency
We develop and estimate a general equilibrium model in which monetary policy can deviate from active inflation stabilization and agents face uncertainty about the nature of these deviations. When observing a deviation, agents conduct Bayesian learning to infer its likely duration. Under constrained discretion, only short deviations occur: Agents are confident about a prompt return to the active regime, macroeconomic uncertainty is low, welfare is high. However, if a deviation persists, agents? beliefs start drifting, uncertainty accelerates, and welfare declines. If the duration of the ...
Working Paper
Constrained Discretion and Central Bank Transparency
We develop and estimate a general equilibrium model to quantitatively assess the effects and welfare implications of central bank transparency. Monetary policy can deviate from active inflation stabilization and agents conduct Bayesian learning about the nature of these deviations. Under constrained discretion, only short deviations occur, agents? uncertainty about the macroeconomy remains contained, and welfare is high. However, if a deviation persists, uncertainty accelerates and welfare declines. Announcing the future policy course raises uncertainty in the short run by revealing that ...
Working Paper
Escaping the Great Recession
We show that policy uncertainty about how the rising public debt will be stabilized accounts for the lack of deflation in the US economy at the zero lower bound. We first estimate a Markov-switching VAR to highlight that a zero-lower-bound regime captures most of the comovements during the Great Recession: a deep recession, no deflation, and large fiscal imbalances. We then show that a micro-founded model that features policy uncertainty accounts for these stylized facts. Finally, we highlight that policy uncertainty arises at the zero lower bound because of a trade-off between mitigating the ...
Working Paper
Escaping the Great Recession
While high uncertainty is an inherent implication of the economy entering the zero lower bound, deflation is not, because agents are likely to be uncertain about the way policymakers will deal with the large stock of debt arising from a severe recession. We draw this conclusion based on a new-Keynesian model in which the monetary/fiscal policy mix can change over time and zero-lower-bound episodes are recurrent. Given that policymakers? behavior is constrained at the zero lower bound, beliefs about the exit strategy play a key role. Announcing a period of austerity is detrimental in the short ...