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Working Paper
From Deviations to Shortfalls: The Effects of the FOMC’s New Employment Objective
The Federal Open Market Committee (FOMC) recently revised its interpretation of its maximum employment mandate. In this paper, we analyze the possible effects of this policy change using a theoretical model with frictional labor markets and nominal rigidities. A monetary policy that stabilizes employment “shortfalls” rather than “deviations” of employment from its maximum level leads to higher inflation and more hiring at all times due to firms’ expectations of more accommodative future policy. Thus, offsetting only shortfalls of employment results in higher inflation, employment, ...
Working Paper
Quantitative Easing in Joseph's Egypt with Keynesian Producers
This paper considers monetary and fiscal policy when tangible assets can be accumulated after shocks that increase desired savings, like Joseph's biblical prophecy of seven fat years followed by seven lean years. The model?s flexible-price allocation mimics Joseph?s saving to smooth consumption. With nominal rigidities, monetary policy that eliminates liquidity traps leaves the economy vulnerable to confidence recessions with low consumption and investment. Josephean Quantitative Easing, a fiscal policy that purchases either obligations collateralized by tangible assets or the assets ...
Working Paper
Gradualism and Liquidity Traps
Modifying the objective function of a discretionary central bank to include an interest-rate smoothing objective increases the welfare of an economy in which large contractionary shocks occasionally force the central bank to lower the policy rate to its effective lower bound. The central bank with an interest-rate smoothing objective credibly keeps the policy rate low for longer than the central bank with the standard objective function. Through expectations, the temporary overheating of the economy associated with such a low-for-long interest rate policy mitigates the declines in inflation ...
Working Paper
The Risky Steady State and the Interest Rate Lower Bound
Even when the policy rate is currently not constrained by its effective lower bound (ELB), the possibility that the policy rate will become constrained in the future lowers today's inflation by creating tail risk in future inflation and thus reducing expected inflation. In an empirically rich model calibrated to match key features of the U.S. economy, we find that the tail risk induced by the ELB causes inflation to undershoot the target rate of 2 percent by as much as 45 basis points at the economy's risky steady state. Our model suggests that achieving the inflation target may be more ...
Working Paper
Who is Afraid of Eurobonds?
The growing asymmetry in the size of fiscal imbalances poses a serious challenge to the macroeconomic stability of the Euro Area (EA). We show that following a contractionary shock, the current monetary and fiscal framework weakens economic growth even in low-debt countries because of the zero lower bound (ZLB) constraint. At the same time, the current framework also exposes the EA to the risk of fiscal stagflation if one country were to refuse to implement the necessary fiscal consolidations. We study a new framework that allows EA policymakers to separate the need for short-run ...
Working Paper
On the Theoretical Efficacy of Quantitative Easing at the Zero Lower Bound
We construct a monetary economy in which agents face aggregate demand shocks and hetero- generous idiosyncratic preference shocks. We show that, even when the Friedman rule is the best interest rate policy, not all agents are satiated at the zero lower bound. Thus, quantitative easing can be welfare improving since it temporarily relaxes the liquidity constraint of some agents, without harming others. Moreover, due to a pricing externality, quantitative easing may also have beneficial general equilibrium effects for the unconstrained agents. Lastly, our model suggests that it can be optimal ...
Working Paper
The stimulative effect of forward guidance
This paper examines the stimulative effect of central bank forward guidance?the promise to keep future policy rates lower than its policy rule suggests?when the short-term nominal interest rate is stuck at its zero lower bound (ZLB).We utilize a standard New Keynesian model in which forward guidance enters our model as news shocks to the monetary policy rule. Three key findings emerge: (1) Forward guidance is more stimulative at the ZLB when households believe the economic recovery will be strong. When households expect a weak recovery or initially have low confidence in the economy, forward ...
Working Paper
From Deviations to Shortfalls: The Effects of the FOMC's New Employment Objective
The Federal Open Market Committee (FOMC) recently revised its interpretation of its maximum employment mandate. In this paper, we analyze the possible effects of this policy change using a theoretical model with frictional labor markets and nominal rigidities. A monetary policy which stabilizes “shortfalls” rather than “deviations” of employment from its maximum level leads to higher inflation and more hiring at all times due to expectations of more accommodative future policy. Thus, offsetting only shortfalls of employment results in higher nominal policy rates on average which ...
Working Paper
Should We Be Puzzled by Forward Guidance?
Although a growing literature argues output is too sensitive to future interest rates in standard macroeconomic models, little empirical evidence has been put forth to evaluate this claim. In this paper, we use a range of vector autoregression models to answer the central question of how much output responds to changes in interest rate expectations following a monetary policy shock. Despite distinct identification strategies and sample periods, we find surprising agreement regarding this elasticity across empirical models. We then show that in a standard model of nominal rigidity estimated ...
Working Paper
Expectation and Duration at the Effective Lower Bound
I study unconventional monetary policy in a structural model of risk-averse arbitrage, augmented with an effective lower bound (ELB) on nominal rates. The model exposes nonlinear interactions among short-rate expectations, bond supply, and term premia that are absent from models that ignore the ELB, and these features help it replicate the recent behavior of long-term yields, including event-study evidence on the responses to unconventional policy. When the model is calibrated to long-run moments of the yield curve and subjected to shocks approximating the size of the Federal Reserve?s ...