Monetary Economics

March 3, 2017
Yuriy Gorodnichenko of the University of California at Berkeley and Kinda Cheryl Hachem of the University of Chicago, Organizers

Ernesto Pasten, Central Bank of Chile; Raphael Schoenle, Brandeis University; and Michael Weber, the University of Chicago and NBER

Nominal Rigidities and the Granular Origins of Aggregate Fluctuations

Pasten, Schoenle, and Weber study the aggregate implications of sectoral shocks in a multi-sector New Keynesian model with intermediate inputs featuring sectoral heterogeneity in price stickiness, sector size, and input-output linkages. Heterogeneity in price stickiness by itself can generate aggregate fluctuations from idiosyncratic shocks but it also distorts the "granular" effect of large sectors on aggregate volatility as well as the "network" effect of central sectors in the production network. This distortion affects both the magnitude of GDP volatility due to sectoral shocks and the identity of sectors driving aggregate fluctuations. Price rigidity can even distort the sign of fluctuations. Importantly, sector sales are no longer a sufficient statistic for a sector's contribution to aggregate volatility, as in Hulten (1978). The researchers calibrate a 348-sector version of the model to the BEA input-output tables and BLS micro pricing data and find: (i) sectoral heterogeneity of price rigidity alone generates sizable GDP volatility from sectoral shocks; (ii) sectoral heterogeneity of price rigidity amplifies both the "granular" and the "network" effects; and (iii) sectoral heterogeneity of price rigidity alters the identity and relative contributions of the most important sectors for aggregate fluctuations. Price rigidity generates "frictional" origins of aggregate fluctuations conceptually different from the granular and network effects.

Camila Casas, Banco de la Republica; Federico Diez, Federal Reserve Bank of Boston; Gita Gopinath, Harvard University and NBER; and Pierre-Olivier Gourinchas, the University of California at Berkeley and NBER

Dominant Currency Paradigm (NBER Working Paper No. 22943)

Most trade is invoiced in very few currencies. Despite this, the Mundell-Fleming benchmark and its variants focus on pricing in the producer's currency or in local currency. Casas, Diez, Gopinath, and Gourinchas model instead a 'dominant currency paradigm' for small open economies characterized by three features: pricing in a dominant currency, pricing complementarities, and imported input use in production. Under this paradigm: (a) terms of trade are stable; (b) dominant currency exchange rate pass-through into export and import prices is high regardless of destination or origin of goods; (c) exchange rate pass-through of non-dominant currencies is small; (d) expenditure switching occurs mostly via imports and export expansions following depreciations are weak. Consequently, a strengthening of the dominant currency relative to non-dominant ones can negatively impact global trade. Using merged firm level and customs data from Colombia the researchers document strong support for the dominant currency paradigm and reject the alternatives of producer currency and local currency pricing.

Juan Rubio Ramírez, Emory University, and Juan Antolin-Diaz, Fulcrum Asset Management

Narrative Sign Restrictions for SVARs

Antolin-Diaz and Rubio Ramírez identify structural vector autoregressions using narrative sign restrictions. Narrative sign restrictions constrain the structural shocks and the historical decomposition around key historical events, ensuring that they agree with the established narrative account of these episodes. Using models of the oil market and monetary policy, the researchers show that narrative sign restrictions are highly informative. They highlight that adding a single narrative sign restriction dramatically sharpens and even changes the inference of SVARs originally identified via traditional sign restrictions. The researchers' approach combines the appeal of narrative methods with the popularized usage of traditional sign restrictions.

Jeffrey W. Huther, Jane Ihrig, and Elizabeth Klee, Federal Reserve Board

The Federal Reserve's Portfolio and its Effect on Interest Rates

Huther, Ihrig, and Klee explore the Federal Reserve's portfolio composition over a 30-year period and its effect on Treasury yields. They examine the achievement of theoretical portfolio objectives used by the Federal Reserve, broadly defined as market neutrality, market liquidity, and interest rate risk ("duration") absorption. The researchers construct measures for these objectives, investigate how these objectives were achieved over time and then posit how the attainment of these objectives could evolve as the size of the portfolio normalizes in the future. They then discuss how, on an aggregate and CUSIP-level basis, these measures are correlated with prices on Treasury securities. Their results suggest that the further the Federal Reserve's portfolio is from the Treasury's portfolio on any of these measures, the larger the effect on the term premium and on the pricing of individual securities.

Andres Drenik, Columbia University, and Diego Perez, New York University

Price Setting Under Uncertainty About Inflation

Drenik and Perez use the manipulation of inflation statistics that occurred in Argentina starting in 2007 to test the relevance of informational frictions in price setting. The researchers estimate that the manipulation of statistics had associated a higher degree of price dispersion. This effect is analyzed in the context of a quantitative general equilibrium model in which firms use information about the inflation rate to set prices. Consistent with empirical evidence, they find that monetary policy becomes more effective with less precise information about inflation. Not reporting accurate measures of the CPI entails significant welfare losses, especially in economies with volatile monetary policy.

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