Monetary Economics

October 28, 2016
Ricardo J. Caballero of MIT and Eric R. Sims of University of Notre Dame, Organizers

Adrien Auclert, Stanford University and NBER, and Matthew Rognlie, Princeton University

Inequality and Aggregate Demand

Auclert and Rognlie explore the effects of transitory and persistent increases in income inequality on the level of economic activity in the context of a Bewley-Huggett-Aiyagari model in its Keynesian regime of constant real interest rates. A temporary rise in inequality lowers output modestly because the covariance between changes in income and marginal propensities to consume is negative but small in the model and the data. A permanent rise in inequality leads to a permanent Keynesian recession whose magnitude depends on the elasticity of aggregate savings to idiosyncratic uncertainty — a potentially much larger effect. Economic slumps create endogenous redistribution and give rise to an inequality multiplier. By reducing the marginal product of capital, they also lead to declines in investment that further amplify the recession. Government spending and public debt issuances are expansionary and crowd capital in. The researchers' methodology separates sufficient statistics from general equilibrium multipliers and is applicable to the study of all macroeconomic models of aggregate demand.

Xavier Gabaix, Harvard University and NBER

A Behavioral New Keynesian Model

In this paper, Gabaix presents a framework for analyzing how bounded rationality affects monetary and fiscal policy. The model is a tractable and parsimonious enrichment of the widely-used New Keynesian model — with one main new parameter, which quantifies how poorly agents understand future policy and its impact. That myopia parameter in turn affects the power of monetary and fiscal policy in a microfounded general equilibrium. A number of consequences emerge. First, fiscal stimulus or "helicopter drops of money" are powerful and, indeed, pull the economy out of the zero lower bound. More generally, the model allows for the joint analysis of optimal monetary and fiscal policy. Second, the model helps solve the "forward guidance puzzle," the fact that in the rational model, shocks to very distant rates have a very powerful impact on today's consumption and inflation: because the agent is de facto myopic, this effect is muted. Third, the zero lower bound is much less costly than in the traditional model. Fourth, even with passive monetary policy, equilibrium is determinate, whereas the traditional rational model generates multiple equilibria, which reduce its predictive power. Fifth, optimal policy changes qualitatively: the optimal commitment policy with rational agents demands "nominal GDP targeting;" this is not the case with behavioral firms, as the benefits of commitment are less strong with myopic firms. Sixth, the model is "neo-Fisherian" in the long run, but Keynesian in the short run — something that has proven difficult for other models to achieve: a permanent rise in the interest rate decreases inflation in the short run but increases it in the long run. The non-standard behavioral features of the model seem warranted by the empirical evidence.

Òscar Jordà, Federal Reserve Bank of San Francisco; Moritz Schularick, University of Bonn; and Alan M. Taylor, University of California at Davis and NBER

Large and State-Dependent Effects of Quasi-Random Monetary Experiments

When open economies fix their exchange rate, they constrain monetary policy. The trilemma implies that arbitrage, not the central bank, determines how interest rates fluctuate. The annals of international finance thus provide quasi-natural experiments with which to measure how macroeconomic outcomes respond to policy rates. Using historical data since 1870, Jordà, Schularick, and Taylor estimate the local average treatment effect (LATE) of monetary policy interventions with a trilemma instrument and discuss the connection with the population ATE. Using local projection instrumental variable methods the researchers find that the effects of monetary policy are much larger than previously estimated, and that these effects are state-dependent. Using a novel control function approach they allow for possible spillovers via other channels and their results prove to be robust. Monetary policy has weak effects when output is depressed and when the economy has "lowflation." The researchers' findings have profound implications for monetary economics.

Vladimir Asriyan, Universitat Pompeu Fabra; Luca Fornaro, CREI, Universitat Pompeu Fabra and Barcelona GSE; Alberto Martin, CREI; and Jaume Ventura, CREI and Universitat Pompeu Fabra and NBER

Monetary Policy for a Bubbly World (NBER Working Paper No. 22639)

Asriyan, Fornaro, Martin, and Ventura propose a model of money, credit and bubbles, and use it to study the role of monetary policy in managing asset bubbles. In this model, bubbles pop up and burst, generating fluctuations in credit, investment and output. Two key insights emerge from the analysis. First, the growth rate of bubbles, which is driven by agents' expectations, can be set in real or in nominal terms. This gives rise to a novel channel of monetary policy, as changes in the inflation rate affect the real growth rate of bubbles and their effect on economic activity. Crucially, this channel does not rely on contract incompleteness or price rigidities. Second, there is a natural limit on monetary policy's ability to control bubbles: the zero-lower bound. When a bubble crashes, the economy may enter into a liquidity trap, a regime in which agents shift their portfolios away from bubbles — and the credit that they sustain — to money, reducing intermediation, investment and growth. The researchers explore the implications of the model for the conduct of "conventional" and "unconventional" monetary policy, and use the model to provide a broad interpretation of salient macroeconomic facts of the last two decades.

Florian Heider and Glenn Schepens, European Central Bank, and Farzad Saidi, Stockholm School of Economics

Life Below Zero: Bank Lending Under Negative Policy Rates

This paper studies the transmission of negative monetary-policy rates via the lending behavior of banks. Unlike for positive rates, the transmission of negative rates depends on banks' funding structure. High-deposit banks take on more risk and lend less than low-deposit banks. The risk taking is concentrated in poorly-capitalized banks. Part of the risk taking comes in the form of new syndicated loans to risky firms without such loans previously. Safe borrowers switch from high-deposit to low-deposit banks. The new risky borrowers appear financially constrained, and use the new funding to invest. For identification, the researchers employ a difference-in-differences approach. Banks with different reliance on deposit funding experience a different pass-through of negative policy rates. To isolate borrowers from interest-rate changes, the researchers use lenders located in a different currency zone. A placebo at the time when policy rates fall – but are still positive – shows no effect. The results point to distributional consequences of negative policy rates with potential risks to financial stability.

Joshua Hausman, University of Michigan and NBER; Paul Rhode, University of Michigan and NBER; and Johannes Wieland, University of California and NBER

Recovery from the Great Depression: The Farm Channel in Spring 1933

In the four months following the trough of the Great Depression in March 1933, industrial production rose 57 percent. Hausman, Rhode, and Wieland argue that an important channel aiding recovery came through the direct effect of devaluation on farm prices, incomes, and consumption. The researchers call this the farm channel. Using U.S. and British crop price data, they document that devaluation raised prices of traded crops and their close substitutes (other grains). And using state and county auto sales and income data, the researchers document that recovery proceeded much more rapidly in farm areas. Their baseline estimates imply that a one standard deviation increase in the share of a state's population living on farms is associated with a 20–34 percentage point increase in auto sales growth from winter to fall 1933. This effect is concentrated in states producing traded crops (cotton, tobacco, wheat) or close substitutes, suggesting an important role for devaluation. In annual county data the researchers show that the farm channel is strongest in counties with more indebted farmers. To map these cross-sectional estimates into an aggregate effect, they build an incomplete-markets model that explicitly incorporates both the benefits of the farm channel to farmers (higher farm income) as well as the costs to nonfarmers (higher prices paid for farm goods). The model suggests that by redistributing income to indebted farmers with a high marginal propensity to consume, the farm channel may explain 25-50% of the spring 1933 recovery.

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