Monetary Economics

November 6, 2015
Gauti Eggertsson of Brown University and James Stock of Harvard University, Organizers

Michael Weber, University of Chicago; Francesco D'Acunto, University of Maryland; and Daniel Hoang, Karlsruhe Institute of Technology

Inflation Expectations and Consumption Expenditure

Households that expect an increase in inflation have an 8% higher reported readiness to spend on durables compared to other households. This positive cross-sectional association is stronger for more educated, working-age, high-income, and urban households. D'Acunto, Hoang, and Weber document these novel facts using German micro data for the period 2000-2013. They use a natural experiment for identification. The German government unexpectedly announced in November 2005 a three-percentage-point increase in value-added tax (VAT) effective in 2007. This shock increased households' inflation expectations during 2006, as well as actual inflation in 2007. Matched households in other European countries, which were not exposed to the VAT shock, serve as counterfactuals in a difference-in-differences identification design. The authors' findings suggest fiscal and monetary policy measures that engineer higher inflation expectations may succeed in stimulating consumption expenditure.

Marco Del Negro and Marc Giannoni, Federal Reserve Bank of New York, and Christina H. Patterson, MIT

The Forward Guidance Puzzle

With short-term interest rates at the zero lower bound, forward guidance has become a key tool for central bankers, and yet we know little about its effectiveness. This paper first empirically documents the impact of forward guidance announcements on a broad cross section of financial markets data and professional forecasts. Del Negro, Giannoni, and Patterson find that FOMC announcements containing forward guidance had heterogenous effects depending on the other content of the statement. The researchers show that once they control for these other elements, forward guidance, on average, had positive effects on output and inflation. Using this benchmark, the researchers then show that standard medium-scale DSGE models tend to grossly overestimate the impact of forward guidance on the macroeconomy, a phenomenon they call the "forward guidance puzzle." The authors explain why this is the case and show that incorporating a perpetual youth structure into the benchmark provides a tentative resolution to the puzzle.

Valerie A. Ramey, University of California, San Diego and NBER,
Macroeconomic Shocks and Their Propagation: Monetary Policy Shocks

This paper is an excerpt from a Handbook of Macroeconomics chapter that is in preparation. Ramey reviews the recent advances in identifying and estimating the effects of macroeconomic shocks and then focuses on monetary policy shocks. After summarizing the various results in the literature, the paper focuses on two leading types of shocks: narrative shocks combined with Greenbook information and high frequency identification shocks. Various robustness checks are conducted that involve different ways of estimating the effects of shocks and different samples. Many of the results suggest pronounced price puzzles and sometimes expansionary effects of contractionary monetary policy shocks. The results suggest that despite the many methodological innovations during the last twenty years, the estimates of monetary policy effects are still quite fragile.

Diego A. Comin, Dartmouth College and NBER; Mark Gertler, New York University and NBER; and Diego Anzoategui and Joseba Martinez, New York University

Endogenous Technology Adoption and R&D as Sources of Business Cycle Persistence

Anzoategui, Comin, Gertler, and Martinez examine the hypothesis that the slowdown in productivity following the Great Recession was in significant part an endogenous response to the contraction in demand that induced the downturn. The researchers first present some descriptive evidence in support of their approach. They then augment a workhorse New Keynesian DSGE model with an endogenous TFP mechanism that allows for both costly development and adoption of new technologies. They then estimate the model and use it to assess the sources of the productivity slowdown. The authors find that the post-Great Recession fall in productivity was a largely endogenous phenomenon. The endogenous productivity mechanism also helps account for the slowdown in productivity prior to the Great Recession. Overall, the results are consistent with the view that demand factors have played a role in the slowdown of capacity growth. More generally, they provide insight into why recoveries from financial crises may be so slow.

Atif R. Mian, Princeton University and NBER; Amir Sufi, University of Chicago and NBER; and Emil Verner, Princeton University

Household Debt and Business Cycles Worldwide (NBER Working Paper No. 21581)

A rise in the household debt to GDP ratio predicts lower output growth and higher unemployment over the medium-run, contrary to standard macroeconomic models. GDP forecasts by the IMF and OECD underestimate the importance of a rise in household debt to GDP, giving the change in household debt to GDP ratio of a country the ability to predict growth forecasting errors. Mian, Sufi, and Verner use lower credit spreads and increases in risky debt issuance as instruments for the rise in household debt to GDP to argue that their results are supportive of recent models where debt growth is driven by changes in credit supply, borrowing constraints, or risk premia. They also show that a rise in household debt to GDP is associated contemporaneously with a rising consumption share of output, a worsening of the current account balance, and a rise in the share of consumption goods within imports. This is followed by strong external adjustment when the economy slows as the current account reverses and net exports increase due to a sharp fall in imports. Finally, an increase in global household debt to GDP also predicts lower global output growth. The pre-2000 predicted relationship between global household debt changes and subsequent global growth matches closely the actual decline in global growth after 2007 given the large increase in household debt during the early to mid-2000s.

Michael Woodford, Columbia University and NBER, and Mariana García-Schmidt, Columbia University

Are Low Interest Rates Deflationary? A Paradox of Perfect-Foresight Analysis (NBER Working Paper No. 21614)

A prolonged period of extremely low nominal interest rates has not resulted in high inflation. This has led to increased interest in the "Neo-Fisherian" proposition according to which low nominal interest rates may themselves cause inflation to be lower. The fact that standard models of the effects of monetary policy have the property that perfect foresight equilibria in which the nominal interest rate remains low forever necessarily involve low inflation (at least eventually) might seem to support such a view. Here, however, García-Schmidt and Woodford argue that such a conclusion depends on a misunderstanding of the circumstances under which it makes sense to predict the effects of a monetary policy commitment by calculating the perfect foresight equilibrium consistent with the policy. The researchers propose an explicit cognitive process by which agents may form their expectations of future endogenous variables. Under some circumstances, such as a commitment to follow a Taylor rule, a perfect foresight equilibrium (PFE) can arise as a limiting case of the authors' more general concept of reflective equilibrium, when the process of reflection is pursued sufficiently far. But they show that an announced intention to fix the nominal interest rate for a long enough period of time creates a situation in which reflective equilibrium need not resemble any PFE. In the researchers' view, this makes PFE predictions not plausible outcomes in the case of policies of the latter sort. According to the alternative approach that they recommend, a commitment to maintain a low nominal interest rate for longer should always be expansionary and inflationary, rather than causing deflation; but the effects of such "forward guidance" are likely, in the case of a long-horizon commitment, to be much less expansionary or inflationary than the usual PFE analysis would imply.

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