OPTIMAL MONETARY POLICY AND IMPERFECT FINANCIAL MARKETS: A CASE FOR NEGATIVE NOMINAL INTEREST RATES?

This article studies optimal monetary policy in a model with credit frictions and money demand. We show that augmenting a standard New Keynesian model with money demand and financial frictions generates a mechanism that, in equilibrium, gives rise to optimal negative nominal interest rates. In addition, we find that the tighter credit markets are, the lower the optimal nominal policy interest rate and the more likely it is to be negative. Quantitatively, when credit constraints are binding, a standard calibration of the model generates an optimal nominal policy interest rate that is roughly ?4% annually. (JEL E31, E41, E43, E44, E52, E58)     

EXCHANGE RATE REGIMES AND FISCAL DISCIPLINE: THE ROLE OF CAPITAL CONTROLS

How do exchange rate regimes influence fiscal discipline? This important question has typically been addressed exploiting the classic dichotomy of fixed versus flexible exchange rate regimes assuming perfect capital mobility. However, the role of capital controls cannot be neglected, particularly in developing countries. This paper analyzes the effects of capital controls on fiscal performance by focusing on dual exchange rate regimes. In a model in which the fiscal policy is endogenously determined by a nonbenevolent fiscal authority, dual regimes induce politicians to have higher fiscal deficits than under fixed and flexible regimes operating under perfect capital mobility. The model also shows this effect increases as fiscal authorities become more impatient. Dynamic panel regressions confirm that dual regimes lead to higher fiscal deficits than fixed and flexible regimes operating under unified rates. Using a dummy for pre‐electoral year as an indicator of fiscal authorities' shortsightedness, we also confirm that dual exchange rate has a more adverse effect on fiscal deficits as the authorities become more impatient. (JEL E50, E60, F31, F41)     

MONETARY POLICY AND ANTI‐CYCLICAL BANK CAPITAL REGULATION

The financial crisis of 2008–2009 revived attention given to booms and busts in bank credit, and their effects on real activity. This interest sparked two different strands of research in macro. The first one focuses on monetary policy in the context of financial frictions. The second studies capital regulation in banking. To the best of our knowledge, so far these two topics have mostly been studied in isolation from each other. Thus, we still lack an understanding of how monetary policy and bank capital regulation interact in the presence of financial fragility. This paper aims to contribute to furthering this understanding. Specifically, we ask how the monetary policy rule should look like in the presence of cyclical capital requirements. We extend the dynamic stochastic general equilibrium model with bank capital in Aliaga‐Díaz and Olivero by introducing price rigidities in the spirit of the New‐Keynesian literature. We find that: First, anti‐cyclical requirements have important stabilization properties relative to the case of constant requirements. This is true for all types of fluctuations that we study, which include those caused by productivity, preference, fiscal, monetary, and financial shocks. Second, output and consumption volatilities present in the no regulation economy can be recovered with anti‐cyclical requirements as long as the policy rate responds only slightly to credit spreads. Third, monetary policy rules that respond to credit conditions also perform better in terms of welfare. (JEL E32, E44)     

A MONETARY BUSINESS CYCLE MODEL FOR INDIA

A New Keynesian monetary business cycle model is constructed to study why monetary transmission in India is weak. Our models feature banking and financial sector frictions as well as an informal sector. The predominant channel of monetary transmission is a credit channel. Our main finding is that base money shocks have a larger and more persistent effect on output than an interest rate shock, as in the data. The presence of an informal sector hinders monetary transmission. Contrary to the consensus view, financial repression in the form of a statutory liquidity ratio and administered interest rates, does not weaken monetary transmission. (JEL E31, E32, E44, E52, E63)     

UNDERSTANDING THE COSTS OF CONSUMER DURABLE ADJUSTMENTS

This article examines whether adjustment frictions help account for the patterns of household consumption expenditures observed in the Consumer Expenditure Survey, namely, that the variance of log durable expenditure is four times larger than that of log nondurable expenditure for annual data and this gap substantially widens for quarterly data. Estimating a structural model of household consumption with nondurable and durable goods with the simulated method of moments, I find that the fixed costs associated with durable adjustments are important in matching the cross‐sectional moments. Using the estimated model, I also examine the response of nondurable and durable expenditures to income shocks. (JEL D12, D91, E21)     

SIGNAL EXTRACTION AND RATIONAL INATTENTION

In this paper we examine the implications of two theories of informational frictions, signal extraction (SE) and rational inattention (RI), for optimal decisions and economic dynamics within the linear‐quadratic‐Gaussian (LQG) setting. We first show that if the variance of the noise and channel capacity (or marginal information cost) is fixed exogenously in the SE and RI problems, respectively, the two environments lead to different policy and equilibrium asset pricing implications. Second, we find that if the signal‐to‐noise ratio and capacity in the SE and RI problems are fixed, respectively, the two theories generate the same policy implications in the univariate case, but different policy implications in the multivariate case. We also show that our results do not depend on the presence of correlation between fundamental and noise shocks. We then discuss the applications to macroeconomic models of permanent income and price‐setting. (JEL C61, D81, E21)     

THE EFFECTS OF ASSET PURCHASES AND NORMALIZATION OF U.S. MONETARY POLICY

This paper examines changes in the effects of unconventional monetary policies in the United States. To this end, we estimate a Markov-switching VAR model with absorbing regimes to capture possible structural changes. Our results detect regime changes around the beginning of 2011 and the middle of 2013. Before 2011, the U.S. large-scale asset purchases (LSAPs) had relatively large impacts on the real economy and prices, but after the middle of 2013, their effects were weaker and less-persistent. In addition, after the middle of 2013, which includes the monetary policy normalization period, the asset purchase (or balance sheet) shocks had slightly weaker effects than during the early stage of the LSAPs but stronger effects than during the late stage of the LSAPs, while interest rate shocks had insignificant effects on the real economy and prices. Finally, our results suggest that the positive responses of durables and capital goods expenditures to interest rate shocks weakened the negative impacts of interest rate hikes after the middle of 2013 including the period of monetary policy normalization. (JEL C32, E21, E52)     

ASSET PRICE BUBBLES AND TECHNOLOGICAL INNOVATION

We introduce borrowing constraints into a two‐sector Schumpeterian growth model and examine the impact of asset price bubbles on innovation. In this environment, rational bubbles arise when the intermediate good producing R&D sector is faced with adverse productivity shocks. Importantly, these bubbles help alleviate credit constraints and facilitate innovation in the stagnant economy. On the policy front, we make a case for debt financed credit to the R&D sector. Further, we establish that a constant credit growth rule (akin to the Friedman rule) outperforms the often prescribed counter‐cyclical “lean against the wind” credit policy. (JEL E32, E44, O40)     

CURRENT ACCOUNT ADJUSTMENT IN DEVELOPING COUNTRIES: THE ROLE OF EXCHANGE RATE REGIMES

This article employs hazard models to investigate the role of exchange rate regimes in the timing of current account adjustment in developing countries. We identify high current account deficit spells and find that fixed exchange rate regimes increase the duration of high deficit spells and thus delay current account adjustment. The result is robust to a variety of model specifications and alternative classifications of exchange rate regimes. When distinguishing between hard pegs and soft pegs, we notice that the delay in the current account adjustment is primarily driven by hard pegs rather than soft pegs. (JEL F3, F4)     

ACROSS TIME AND REGIMES: 212 YEARS OF THE US‐UK REAL EXCHANGE RATE

The behavior of the US‐UK real exchange rate over the period 1794–2005 is examined. This series includes five intervals of floating nominal exchange rates and four fixed exchange rate regime periods. A consistent pattern of higher real exchange rate volatility under floating nominal rates is shown. Over time, real exchange rate movements have increasingly been driven by movements in the nominal exchange rate rather than relative prices. The persistence of the real exchange rate has been considerably higher in the postwar period. (JEL F31, N20)     

THE CYCLICALITY OF PRICE‐COST MARGINS IN BANKING: AN EMPIRICAL ANALYSIS OF ITS DETERMINANTS

We study the determinants of the cyclical behavior of banks' price‐cost margins in the United States banking sector, using time series quarterly data for the period 1979–2005. We contribute to the literature by building an empirical model of the countercyclical behavior of these margins first documented by Aliaga‐Díaz and Olivero (2010a) . Doing so we are able to explore potential explanations for this behavior, and to show that margins are consistently countercyclical, even after controlling for the effects of credit risk and monetary policy. As a mechanism for the propagation of aggregate shocks, the countercyclical nature of margins in banking can provide additional support to stabilization policy. (JEL E32, E44, G21)     

LEANING AGAINST WINDY BANK LENDING

Using an estimated dynamic stochastic general equilibrium model with banking, this paper first provides evidence that monetary policy reacted to bank loan growth in the United States during the Great Moderation. It then shows that the optimized simple interest‐rate rule features no response to the growth of bank credit. However, the welfare loss associated to the empirical responsiveness is small. The sources of business cycle fluctuations are crucial in determining whether a “leaning‐against‐the‐wind” policy is optimal or not. In fact, the predominant role of supply shocks in the model gives rise to a trade‐off between inflation and financial stabilization. (JEL E32, E44, E52)     

CAPITAL CONTROLS,MONETARY POLICY,AND BALANCE SHEETS IN A SMALL OPEN ECONOMY

We develop a small open economy, New Keynesian model that incorporates a financial accelerator in combination with liability dollarization. Applying a Ramsey‐type analysis, we compare the welfare implications of an optimal monetary policy under flexible exchange rates and an optimal capital control policy under fixed exchange rates. In an economy without the financial accelerator, an optimal monetary policy under flexible exchange rates is superior to an optimal capital control policy under fixed exchange rates. In contrast, in an economy with the financial accelerator, an optimal capital control under fixed exchange rates yields higher welfare than an optimal monetary policy under flexible exchange rates.(JEL E44, E52, F32, F38, F41)     

IDENTIFYING THE ROLE OF RISK SHOCKS IN THE BUSINESS CYCLE USING STOCK PRICE DATA

I analyze the sources of U.S. business cycle fluctuations in an estimated Dynamic Stochastic General Equilibrium model with a rich set of nominal and real rigidities and various exogenous disturbances. The model includes a shock to the expected risk‐premium, which introduces a time‐varying wedge between the policy rate set by the central bank and the cost‐of‐capital of firms. In the aggregate data, most U.S. corporations finance their investment using internal funds, and stock prices reveal the opportunity cost of this type of financing. I therefore use corporate market value and dividend data in the Bayesian estimation of the model to identify risk shocks. Variance decomposition exercises show that these shocks account for a substantial part of the variation in the stock market, as well as the variation in output and investment, especially at short forecast horizons. The variation of these variables at longer forecast horizons are mainly captured by shocks to investment‐specific technological change. Historical decomposition points to the important role played by risk shocks in the run up of stock prices and output in the late 90s, and in the reversal of these variables in the early 2000s and during the recent recession. (JEL E32, E44)     

POLITICAL BUSINESS CYCLES IN THE NEW KEYNESIAN MODEL

This paper tests various political business cycle theories in a New Keynesian model with a monetary and fiscal policy mix. All the policy coefficients, the target levels of inflation and the budget deficit, the firms' frequency of price setting, and the standard deviations of the structural shocks are allowed to depend on “political” regimes: a preelection versus postelection regime, a regime that depends on whether the president (or the Fed chairman) is a Democrat or a Republican, and a regime under which the president and the Fed chairman share party affiliation in preelection quarters or not. The results provide evidence that several coefficients are influenced by political variables. The best‐fitting specification, in fact, is one that allows coefficients to vary according to a regime that depends on whether the economy is in the few quarters before a presidential election or not. Monetary policy becomes considerably more inertial before elections and fiscal policy deviations from a simple rule are more common. There is some evidence that policies become more expansionary before elections, but this evidence disappears for monetary policy in the post‐1985 sample. (JEL C11, D72, E32, E52, E58, E63)     

THE WELFARE EFFECT OF ACCESS TO CREDIT

I present a model in which credit and outside money can be used as means of payment in order to analyze how access to credit affects welfare when credit markets feature limited participation. Allowing more agents to use credit has an ambiguous effect on welfare because it may make consumption‐risk sharing more inefficient. I calibrate the model using U.S. data on credit‐card use and show that the increase in access to credit from 1990 to the near present has had a slightly negative impact on welfare. (JEL E51, E41)     

DESPERATE TIMES CALL FOR DESPERATE MEASURES: GOVERNMENT SPENDING MULTIPLIERS IN HARD TIMES

We investigate state-dependent effects of fiscal multipliers and allow for endogenous sample splitting to determine whether the U.S. economy is in a slack state. When the endogenized slack state is estimated as the period of the unemployment rate higher than about 12%, the estimated cumulative multipliers are significantly larger during slack periods than nonslack periods and are above unity. We also examine the possibility of time-varying regimes of slackness and find that our empirical results are robust under a more flexible framework. Our estimation results point out the importance of the heterogenous effects of fiscal policy and shed light on the prospect of fiscal policy in response to economic shocks from the current COVID-19 pandemic. (JEL C32, E62, H20, H62)     

FORWARD GUIDANCE AND THE STATE OF THE ECONOMY

This paper analyzes forward guidance in a nonlinear model with a zero lower bound (ZLB) on the nominal interest rate. Forward guidance is modeled with news shocks to the monetary policy rule, which capture innovations in expectations from central bank communication about future policy rates. Whereas most studies use quasi‐linear models that disregard the expectational effects of hitting the ZLB, we show how the effectiveness of forward guidance nonlinearly depends on the state of the economy, the speed of the recovery, the degree of uncertainty, the policy shock size, and the forward guidance horizon when households account for the ZLB. (JEL E43, E58, E61)     

THE CREDIT‐CHANNEL TRANSMISSION MECHANISM AND THE NONLINEAR GROWTH AND WELFARE EFFECTS OF INFLATION AND TAXES

With the credit‐channel effect driven by the central bank's open market operations, this paper's model easily gives rise to the nonlinear inflation‐growth nexus, which is evidenced by a number of cross‐country empirical studies. The threshold level of the inflation rate is found to be lower when tax rates are higher. The presence of the credit‐channel effect also provides the rationale for setting positive (and smaller than 1) tax rates on consumption, labor income, and capital income. The optimal tax rates rise as the inflation target declines. Under a fiscal policy rule where labor and capital income taxes move proportionally to each other, the optimal capital income tax rate could be higher than the optimal labor income tax rate. Under a sufficiently large central bank balance sheet, the credit‐channel effect will be so weak that inflation and all kinds of taxes are growth and welfare repressing. This provides a rationale for central banks that have implemented quantitative easing policies to shrink their balance sheets. (JEL E58, E62, O42)     

MONETARY POLICY SHOCKS,EXPECTATIONS, AND INFORMATION RIGIDITIES

This paper contributes to the literature by assessing expectation effects from monetary policy for G7 economies. We rely on expectation data from Consensus Economics and a panel vector autoregression framework, which accounts for international spillovers and time‐variation. We analyze whether monetary policy has changed the degree of information rigidity after the emergence of the subprime crisis and estimate effects of interest rate changes on expectations, disagreements, and forecast errors. We find strong evidence for information rigidities and identify higher forecast errors by professionals after monetary policy shocks. Our results suggest that the international transmission of monetary policy shocks introduces noisy information and partly increases disagreement among forecasters. (JEL E31, E52)