Monetary Economics

March 5, 2010
Mark Gertler and Emi Nakamura, Organizers

Martin Ellison, University of Oxford; and Thomas Sargent, New York University and NBER
A Defence of the FOMC

Ellison and Sargent defend the forecasting performance of the FOMC from the recent criticism of Christina and David Romer (2008). The argument here is that the FOMC forecasts a worst-case scenario that it then uses to design robust decisions that will work well enough despite possible mis-specification of its model. The authors' interpretation of the FOMC as reporting forecasts designed to rationalize a robust decision rule can explain all of the findings of Romer and Romer, including the pattern of differences between FOMC forecasts and forecasts published by the staff of the Federal Reserve System in the Greenbook.

Mary Amiti, Federal Reserve Bank of New York; and David Weinstein, Columbia University and NBER
Exports and Financial Shocks

A striking feature of many financial crises is the collapse of exports relative to output. In the 2008 financial crisis, real world exports plunged 17 percent while GDP fell 5 percent. Amiti and Weinstein examine whether the drying up of trade finance can help to explain the large drops in exports relative to output. This paper is the first to establish a causal link between the health of banks providing trade finance and growth in a firm's exports relative to its domestic sales. The authors overcome measurement and endogeneity issues by using a unique dataset, covering the Japanese financial crises of the 1990s, which enables them to match exporters with the main bank that provides them with trade finance. The point estimates are economically and statistically significant, suggesting that trade finance accounts for about one-third of the decline in Japanese exports in the financial crises of the 1990s.

V.V. Chari, University of Minnesota and NBER; and Patrick Kehoe, Federal Reserve Bank of Minneapolis and NBER
Bailouts, Time Inconsistency and Optimal Regulation

Chari and Kehoe make three points. First, ex ante efficient contracts often require ex post inefficiency. Second, the time inconsistency problem for the government is more severe than for private agents because fire sale effects give governments stronger incentives to renegotiate contracts than private agents. Third, given that the government cannot commit itself to not bailing out firms ex post, ex ante regulation of firms is desirable.

Pietro Veronesi and Luigi Zingales, University of Chicago and NBER
Paulson's Gift

Veronesi and Zingales calculate the costs and benefits of the largest ever U.S. government intervention in the financial sector announced on the 2008 Columbus Day weekend. They estimate that this intervention increased the value of banks' financial claims by $130 billion at a taxpayers' cost of $21-$44 billion, with a net benefit of between $86 billion and $109 billionn. By looking at the limited cross section, thye infer that this net benefit arises from a reduction in the probability of bankruptcy, which they estimate would destroy 22 percent of the enterprise value. The big winners of the plan were the bondholders of the three former investment banks and Citigroup, while the losers were JP Morgan shareholders and the U.S. taxpayers.

Markus Brunnermeier, Princeton University and NBER; and Yuliy Sannikov, Princeton University
A Macroeconomic Model with a Financial Sector

Brunnermeier and Sannikov study a macroeconomic model in which financial experts borrow from less productive agents in order to invest in financial assets. The researchers pursue three set of results: 1) Going beyond a steady state analysis, they show that adverse shocks cause amplifying price declines, not only through the erosion of net worth of the financial sector but also through increased price volatility, leading to precautionary hoarding and fire sales. 2) Financial sector's leverage and maturity mismatch is excessive, since it does not internalize externalities it imposes on the labor sector and other financial experts because of a fire-sale externality. 3) Securitization, which allows the financial sector to offload some risk, exacerbates the excessive risk-taking.

Marco Del Negro, Gauti Eggertsson, Andrea Ferrero,Federal Reserve Bank of New York; and Nobuhiro Kiyotaki, Princeton University and NBER
The Great Escape: A Quantitative Evaluation of the Fed's Non-Standard Policies
Response to the Crisis

Del Negro, Eggertsson, Ferrero, and Kiyotaki extend the model in Kiyotaki and Moore (2008) to include nominal wage and price frictions and explicitly incorporate the zero bound on the short-term nominal interest rate. They subject this model to a shock which arguably captures the 2008 U.S. financial crisis. Within this framework they ask: Once interest rate cuts are no longer feasible because of the zero bound, what are the effects of non-standard open market operations in which the government exchanges liquid government liabilities for illiquid private assets? They find that the effect of this non-standard monetary policy can be large at zero nominal interest rates. They show model simulations in which these policy interventions prevented a repeat of the Great Depression in 2008-9.

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