Monetary Policy and Liquidity Constraints: Evidence from the Euro Area with Mattias Almgren (IIES Stockholm), John Kramer (IIES Stockholm) and Ricardo Lima (IIES Stockholm).
Presented at: Stockholm University, IIES Stockholm, Warwick University, Queen Mary University of London, Stanford, Yale, MIT, Harvard, and Università Bocconi.
Conditionally Accepted at AEJ: Macroeconomics
Media Coverage: Nada es Gratis (in spanish).
Abstract: We quantify the relationship between the response of output to monetary policy shocks and the share of liquidity constrained households. We do so in the context of the euro area using a Local Projections Instrumental Variables estimation. We construct an instrument for changes in interest rates from changes in overnight indexed swap rates in a narrow time window around ECB announcements. Monetary policy shocks have heterogeneous effects on output across countries. Using micro data, we show that the elasticity of output to monetary policy is larger in countries that have a larger fraction of households that are liquidity constrained.
Inflation Persistence, Dispersed Information and the Phillips Curve
[Appendix] [Online Appendix]
Presented at IIES Stockholm.
Abstract: Inflation data from the post-war period exhibits a high degree of persistence and volatility up until chairman Volcker's activism in the early 1980s, and have fallen significantly since then. Monetary models can explain the volatility fall, but face significant challenges in explaining the contemporaneous fall of persistence in the recent decades. We cover a wide range of New Keynesian (NK) models, and show that they cannot explain the fall in persistence. We show that, by relaxing the complete information assumption, the NK model generates the documented fall in persistence. Using micro-data on inflation expectations, we show that agents became more informed about inflation after the change in the Federal Reserve monetary stance in the mid 1980s, which endogenously lowers persistence in inflation dynamics. We also contribute to the literature on the flattening of the Phillips curve. The previous literature documented a fall in the sensitivity in the inflation dynamics towards the demand side of the economy. In the standard model, the Phillips curve relates inflation to current output gap and expected future inflation. In such framework, inflation is only related to the output gap through the Phillips curve slope. As a result, the only possible explanation for the lack of dependence of inflation on output in the recent decades is a fall in the Phillips curve slope. We show that in the dispersed information model, inflation is instead related to current and future output through two different channels: the slope of the Phillips curve and firms' expectation formation process. We show that, once we correct for the misspecification in the original NK Phillips curve, there is no empirical evidence on a change in the Phillips curve slope. Our model explains the fall in inflation sensitivity towards the demand side of the economy without resorting to changes in the slope. Finally, in a rational inattention framework we show that the fall in monetary policy shock volatility after Volcker activism in the 1980s triggered an excess optimal attention from agents towards inflation, which explains the fall in information frictions over time.
HANK beyond FIRE
Presented at IIES Stockholm, Oxford NuCamp Virtual Workshop, Nordic Junior Macro Virtual Series, UCL Enter Seminar, and Norges Bank Macro Modelling Workshop.
Abstract: The transmission channel of monetary policy in the benchmark New Keynesian (NK) framework relies heavily on the counterfactual Full-Information Rational-Expectations (FIRE) assumption, both at the partial equilibrium (PE) and general equilibrium (GE) dimensions. We relax the Full-Information assumption and build a Heterogeneous-Agents NK model under dispersed information. We find that the response of output is amplified, compared to the Representative-Agent (RANK) version whenever income inequality is procyclical, but the amplification magnitude is dampened by dispersed information. This difference is explained by the lessened role of GE effects in our framework. We conduct the standard full-fledged NK analysis: we find that the determinacy region is widened as a result of as if aggregate myopia and show that our framework beyond FIRE does not suffer from the forward guidance puzzle. Finally, we find that transitory "animal spirits" or belief shocks produce large and persistent effects in output and inflation.
Reconciling Empirics and Theory: The Behavioural Hybrid New Keynesian Model with Atahan Afsar (Stockholm School of Economics), Richard Jaimes (Pontificia Universidad Javeriana) and Edgar Silgado (Central Bank of Ireland).
Presented at IIES Stockholm, Stockholm School of Economics and Pontificia Universidad Javeriana.
WP Javeriana
Abstract: Structural estimates of the standard New Keynesian model are at odds with microeconomic estimates. To reconcile these findings, we develop and estimate a behavioral New Keynesian model augmented with backward-looking households and firms. We find (i) strong evidence for bounded rationality, with a cognitive discount factor estimate of 0.4 at quarterly frequency; and (ii) that the behavioral setting with backward-looking agents helps us in harmonizing the New Keynesian theory with empirical studies. We suggest that both cognitive discounting and anchoring are essential, first, to match empirical estimates for certain parameters of interest, and second, to obtain the hump-shaped and initially muted impulse-response functions that we observe in the data.
Presented at: Stockholm University, IIES Stockholm, Warwick University, Queen Mary University of London, Stanford, Yale, MIT, Harvard, and Università Bocconi.
Conditionally Accepted at AEJ: Macroeconomics
Media Coverage: Nada es Gratis (in spanish).
Abstract: We quantify the relationship between the response of output to monetary policy shocks and the share of liquidity constrained households. We do so in the context of the euro area using a Local Projections Instrumental Variables estimation. We construct an instrument for changes in interest rates from changes in overnight indexed swap rates in a narrow time window around ECB announcements. Monetary policy shocks have heterogeneous effects on output across countries. Using micro data, we show that the elasticity of output to monetary policy is larger in countries that have a larger fraction of households that are liquidity constrained.
Inflation Persistence, Dispersed Information and the Phillips Curve
[Appendix] [Online Appendix]
Presented at IIES Stockholm.
Abstract: Inflation data from the post-war period exhibits a high degree of persistence and volatility up until chairman Volcker's activism in the early 1980s, and have fallen significantly since then. Monetary models can explain the volatility fall, but face significant challenges in explaining the contemporaneous fall of persistence in the recent decades. We cover a wide range of New Keynesian (NK) models, and show that they cannot explain the fall in persistence. We show that, by relaxing the complete information assumption, the NK model generates the documented fall in persistence. Using micro-data on inflation expectations, we show that agents became more informed about inflation after the change in the Federal Reserve monetary stance in the mid 1980s, which endogenously lowers persistence in inflation dynamics. We also contribute to the literature on the flattening of the Phillips curve. The previous literature documented a fall in the sensitivity in the inflation dynamics towards the demand side of the economy. In the standard model, the Phillips curve relates inflation to current output gap and expected future inflation. In such framework, inflation is only related to the output gap through the Phillips curve slope. As a result, the only possible explanation for the lack of dependence of inflation on output in the recent decades is a fall in the Phillips curve slope. We show that in the dispersed information model, inflation is instead related to current and future output through two different channels: the slope of the Phillips curve and firms' expectation formation process. We show that, once we correct for the misspecification in the original NK Phillips curve, there is no empirical evidence on a change in the Phillips curve slope. Our model explains the fall in inflation sensitivity towards the demand side of the economy without resorting to changes in the slope. Finally, in a rational inattention framework we show that the fall in monetary policy shock volatility after Volcker activism in the 1980s triggered an excess optimal attention from agents towards inflation, which explains the fall in information frictions over time.
HANK beyond FIRE
Presented at IIES Stockholm, Oxford NuCamp Virtual Workshop, Nordic Junior Macro Virtual Series, UCL Enter Seminar, and Norges Bank Macro Modelling Workshop.
Abstract: The transmission channel of monetary policy in the benchmark New Keynesian (NK) framework relies heavily on the counterfactual Full-Information Rational-Expectations (FIRE) assumption, both at the partial equilibrium (PE) and general equilibrium (GE) dimensions. We relax the Full-Information assumption and build a Heterogeneous-Agents NK model under dispersed information. We find that the response of output is amplified, compared to the Representative-Agent (RANK) version whenever income inequality is procyclical, but the amplification magnitude is dampened by dispersed information. This difference is explained by the lessened role of GE effects in our framework. We conduct the standard full-fledged NK analysis: we find that the determinacy region is widened as a result of as if aggregate myopia and show that our framework beyond FIRE does not suffer from the forward guidance puzzle. Finally, we find that transitory "animal spirits" or belief shocks produce large and persistent effects in output and inflation.
Reconciling Empirics and Theory: The Behavioural Hybrid New Keynesian Model with Atahan Afsar (Stockholm School of Economics), Richard Jaimes (Pontificia Universidad Javeriana) and Edgar Silgado (Central Bank of Ireland).
Presented at IIES Stockholm, Stockholm School of Economics and Pontificia Universidad Javeriana.
WP Javeriana
Abstract: Structural estimates of the standard New Keynesian model are at odds with microeconomic estimates. To reconcile these findings, we develop and estimate a behavioral New Keynesian model augmented with backward-looking households and firms. We find (i) strong evidence for bounded rationality, with a cognitive discount factor estimate of 0.4 at quarterly frequency; and (ii) that the behavioral setting with backward-looking agents helps us in harmonizing the New Keynesian theory with empirical studies. We suggest that both cognitive discounting and anchoring are essential, first, to match empirical estimates for certain parameters of interest, and second, to obtain the hump-shaped and initially muted impulse-response functions that we observe in the data.
