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Working Paper
When does the cost channel pose a challenge to inflation targeting central banks?
In a sticky-price model where firms finance their production inputs, there is both a lower and an upper bound on the central bank's inflation response necessary to rule out the possibility of self-fulfilling inflation expectations. This paper shows that real wage rigidities decrease this upper bound, but coefficients in the range of those on the Taylor rule place the economy well within the determinacy region. However, when there is time-variation in the share of firms who finance their inputs (i.e. Markov-Switching) then inflation targeting interest rate rules are often found to result in ...
Working Paper
Monetary Policy, Trend Inflation and the Great Moderation: An Alternative Interpretation - Comment
Working with a small-scale calibrated New-Keynesian model, Coibion and Gorodnichenko (2011) find that the reduction in trend inflation during Volcker's mandate was a key factor behind the Great Moderation. We revisit this finding with an estimated New-Keynesian model with trend inflation and no indexation based on Christiano, Eichenbaum and Evans (2005). First, our simulations confirm Coibion and Gorodnichenko's (2011) main finding. Second, we show that a trend inflation-immune Taylor rule based on economic theory can avoid indeterminacy even at high levels of trend inflation such as those ...
Working Paper
On Default and Uniqueness of Monetary Equilibria
We examine the role that credit risk in the central bank's monetary operations plays in the determination of the equilibrium price level and allocations. Our model features trade in fiat money, real assets and a monetary authority which injects money into the economy through short-term and long-term loans to agents. Short-term loans are riskless, but long-term loans are collateralized by a portfolio of real assets and are subject to credit risk. The private monetary wealth of individuals is zero, i.e., there is no outside money. When there is no default in equilibrium, there is indeterminacy. ...
Report
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 ...
Working Paper
POSITIVE TREND INFLATION AND DETERMINACY IN A MEDIUM-SIZED NEW KEYNESIAN MODEL
This paper studies the challenge that increasing the inflation target poses to equilibrium determinacy in a medium-sized New Keynesian model without indexation fitted to the Great Moderation era. For moderate targets of the inflation rate, such as 2 or 4 percent, the probability of determinacy is near one conditional on the monetary policy rule of the estimated model. However, this probability drops significantly conditional on model-free estimates of the monetary policy rule based on real-time data. The difference is driven by the larger response of the federal funds rate to the output gap ...
Working Paper
Monetary Policy and Liquid Government Debt
We examine the conduct of monetary policy in a world where the supply of outside money is controlled by the fiscal authority-a scenario increasingly relevant for many developed economies today. Central bank control over the long-run inflation rate depends on whether fiscal policy is Ricardian or Non-Ricardian. The optimal monetary policy follows a generalized Friedman rule that eliminates the liquidity premium on scarce treasury debt. We derive conditions for determinacy under both fiscal regimes and show that they do not necessarily correspond to the Taylor principle. In addition, ...