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Working Paper
Helicopter Drops and Liquidity Traps
We show that if the central bank operates without commitment and faces constraints on its balance sheet, helicopter drops can be a useful stabilization tool during a liquidity trap. With commitment, even with balance sheet constraints, helicopter drops are, at best, irrelevant.
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 ...
Working Paper
Fiscal Multipliers at the Zero Lower Bound: The Role of Policy Inertia
The presence of the lagged shadow policy rate in the interest rate feedback rule reduces the government spending multiplier nontrivially when the policy rate is constrained at the zero lower bound (ZLB). In the economy with policy inertia, increased inflation and output due to higher government spending during a recession speed up the return of the policy rate to the steady state after the recession ends. This in turn dampens the expansionary effects of the government spending during the recession via expectations. In our baseline calibration, the output multiplier at the ZLB is 2.5 when the ...
Working Paper
Raising the Inflation Target: How Much Extra Room Does It Really Give?
Some, but less than intended. The reason is a shift in the behavior of the private sector: Prices adjust more frequently, lowering the potency of monetary policy. We quantitatively investigate this channel across different models, based on a calibration using micro data. By raising the target from 2 percent to 4 percent, the monetary authority gets only between 0.51 and 1.60 percentage points of effective extra policy room for monetary policy (not 2 percentage points as intended). Getting 2 percentage points of effective extra room requires raising the target to more than 4 percent. Taking ...
Report
Central bank transparency and nonlinear learning dynamics
Central bank communication plays an important role in shaping market participants' expectations. This paper studies a simple nonlinear model of monetary policy in which agents have incomplete information about the economic environment. It shows that agents' learning and the dynamics of the economy are heavily affected by central bank transparency about its policy rule. A central bank that does not communicate its rule can induce "learning equilibria" in which the economy alternates between periods of deflation coupled with low output and periods of high economic activity with excessive ...
Working Paper
Bubbles and Stagnation
This paper studies the consequences of asset bubbles for economies that are vulnerable to persistent stagnation. Stagnation is the result of a shortage of assets that creates an oversupply of savings and puts downward pressure on the level of interest rates. Once the zero lower bound on the nominal interest rate binds, the real rate cannot fully adjust downward, forcing output to fall instead. In such context, bubbles are useful as they expand the supply of assets, absorb excess savings and raise the natural interest rate - the real rate that is compatible with full employment - crowding in ...
Working Paper
A Tractable Model of Monetary Exchange with Ex-Post Heterogeneity
We construct a continuous-time, New-Monetarist economy with general preferences that displays an endogenous, non-degenerate distribution of money holdings. Properties of equilibria are obtained analytically and equilibria are solved in closed form in a variety of cases. We study policy as incentive-compatible transfers financed with money creation. Lump-sum transfers are welfare-enhancing when labor productivity is low, but regressive transfers achieve higher welfare when labor productivity is high. We introduce illiquid government bonds and draw implications for the existence of ...
Working Paper
Gradualism and Liquidity Traps
Modifying the objective function of a discretionary central bank to include an interest-rate smoothing objective increases the welfare of an economy in which large contractionary shocks occasionally force the central bank to lower the policy rate to its effective lower bound. The central bank with an interest-rate smoothing objective credibly keeps the policy rate low for longer than the central bank with the standard objective function. Through expectations, the temporary overheating of the economy associated with such a low-for-long interest rate policy mitigates the declines in inflation ...
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
Helicopter Drops and Liquidity Traps
We show that if the central bank operates without commitment and faces constraints on its balance sheet, helicopter drops can be a useful stabilization tool during a liquidity trap. With commitment, even with balance sheet constraints, helicopter drops are, at best, irrelevant.