Monetary Economics

"Incomplete Price Adjustment and Inflation Persistence," with Insu Kim. (Formerly circulated as "Microfoundations of Inflation Persistence in the New Keynesian Phillips Curve"). Forthcoming, Journal of Money, Credit, and Banking (Donwload) 

Abstract: This paper proposes a sticky inflation model in which inflation persistence is endogenously generated from the optimizing behavior of forward-looking firms. Although firms change prices periodically, their ability to fully adjust them in response to changes in economic conditions is assumed to be constrained due to the presence of managerial and customer costs of price adjustment. In essence, the model assumes that price stickiness arises from a combination of staggered contracts as in Calvo (1983) as well as quadratic adjustment cost as in Rotemberg (1982). We estimate the model using Bayesian techniques. Our findings strongly support both sources of price stickinessin the U.S. data. The model performs well in matching microeconomic evidence on price setting, particularly regarding the size and frequency of price changes. The paper also shows how incomplete price adjustments in a staggered price contracts model limit the contribution of expectations to inflation dynamics: it generates the delayed response of inflation to demand and monetary shocks,and the observed correlation between inflation and economic activity.

"Real-Time Indicator of Weekly Inflation with a Mixed-Frequency Unobserved Component Model with Stochastic Volatility," with Mingyuan Jia, mimeo, University of California Riverside.

Abstract: This paper builds a coincident indicator of inflation at the weekly frequency. We propose a mixed-frequency unobserved component model in which the common permanent and transitory inflation components have time-varying stochastic volatilities. The key aspect of the model is its flexibility to describe the changing inflation over time and to accommodate distinct time series properties across price indices sampled at mixed frequencies. The model is estimated using Bayesian Gibbs Sampler and data on weekly commodity inflation, monthly consumer inflation, expenditures inflation, and quarterly GDP deflator inflation. The empirical results show that the weekly inflation index closely matches monthly consumer and expenditure inflation. Additionally, an alternative measure of high frequency trend inflation is proposed and estimated.

"The Credit-Card Services Augmented Divisia Monetary Aggregates," with W. Barnett, D. Leiva-Leon, and L. Su. Revised/Resubmitted. (Download)

Abstract: While credit cards provide transaction services, they have never been included in measures of the money supply.  The reason is accounting conventions, which do not permit adding liabilities to assets. However, index number theory measures service flows and is based on aggregation theory, not accounting. We derive the theory needed to measure the joint services of credit cards and money, where the transaction services of credit cards are deferred payment services not provided by money. We also propose and evaluate two aggregate measures of their joint services. One is based on microeconomic structural aggregation theory, providing an aggregated variable within the macroeconomy with a wide range of potential applications. The other is a credit-card-augmented aggregate, optimized as an indicator that captures the contributions of monetary and credit card services as a nowcasting indicator of nominal GDP.  Our structural credit-card augmented aggregates are now available monthly from the Center for Financial Stability and soon will be available to Bloomberg Terminal users.  Our indicator optimized credit-card augmented aggregates will be available from the Center for Financial Stability following completion of this research.

"Asset Prices and Optimal Monetary Policy," with S. d'Addona and V. Kakar. Submitted.( Download)

Abstract: This paper proposes a model that incorporates macro-.finance linkages in a production-based economy to study optimal monetary policy in the presence of asset price volatility, while generating realistic asset prices consistent with the historical equity premium and risk-free rate. In particular, we propose a Dynamic Stochastic General Equilibrium (DSGE) model that incorporates .financial frictions, recursive preferences, long-run productivity risk with convex adjustment costs in a production-based economy. We also consider a central bank reaction function and optimal monetary policy rules. Our main result suggests that optimal monetary policy should react to asset price misalignments over and above the inflation and output outlook in order to achieve greater macroeconomic and .nancial stability. This paper contributes to the current debate on how central bankers ought to respond to asset price volatility in the context of an overall strategy for monetary policy.

"Assessment of Hybrid Phillips Curve Specifications,' with J. Hur and I. Kim, Economics Letters, Vol. 156, 53-57, 2017. (Download or EL) 

Abstract: Rudd and Whelan (2006) document evidence that the first-difference of inflation negatively depends on its own lag, and highlight that sticky price models emphasizing the role of firms’ forward-looking pricing behavior cannot be reconciled with the stylized fact. We show that the puzzling negative dependence of the first-difference of inflation on its own lag is consistent with the prediction of the hybrid New Keynesian Phillips Curve (NKPC) with lags of inflation, whereas, as it is argued, it is inconsistent with the prediction of both the purely forward-looking NKPC and its hybrid variant with a lag of inflation. Our theoretical results show that the negative dependence appears only when firms’ forward-looking pricing behavior is relatively more important than backward-looking behavior in determining inflation dynamics.

"Quantifying the Monetary Transmission Mechanism: A Mixed-Frequency Factor-Augmented Vector Autoregressive Regression Approach," with Z. Zhao, Working Paper, University of California Riverside. 

Abstract: This paper studies the monetary transmission mechanism in the U.S. It proposes a mixed-frequency version of the factor-augmented vector autoregressive regression (FAVAR) model, which is used to construct a coincident index to measure the monetary transmission mechanism. The model divides the transmission of changes in monetary policy to the economy into three stages according to the timing and order of the impact. Indicators of each stage are measured and identified using different data frequencies: fast-moving variables (stage 1, asset returns at the weekly frequency), intermediate moving variables (stage 2, credit market data at the monthly frequency), and slow-moving variables (stage 3, macroeconomic variables at the quarterly frequency). The resulting coincident index exhibits leading signal for all recessions in the sample period and provides implications on the dynamics of the monetary transmission mechanism. The proposed coincident index also indicates that monetary transmission mechanism is changing over time.

"Monetary Policy Regimes and the Stock Market," with Chuanlei Sun, in Business Cycles in Economics: Types, Challenges and Impacts on Monetary Policies. Ed. Jason Hsu, Nova Science Chapter 6, 87-1116, 2014. ( Download )

Abstract: This paper studies the relationship between monetary policy and the stock market across business cycle recessions and expansions. A nonlinear two-state Markov switching model is used to obtain regimes in interest rate cycles and in stock market cycles. The model identifies tight and loose monetary policy phases, and bear and bull stock market regimes. Turning points for each cycle are established and their lead-lag relationship is examined and contrasted with NBER recessions. We also examine the linear predictive relationship between interest rates and stock returns. The results indicate that there are strong linkages among interest rate cycles, stock market cycles, and business cycles. We find that, generally, the stock market enters a bear market phase at around the same time as monetary policy enters a tight phase, which is associated with the onset of economic recessions. We also find that future stock returns are substantially impacted by information on monetary policy regimes (i.e. loose or tight). On the other hand, interest rates are most influenced by future inflation and recessions rather than by changes in the stock market. 

"Nonlinear Relationship Between Permanent and Transitory Components of Monetary Aggregates and the Economy," B. Jones, R. Anderson, Econometrics Review, vol. 34:1-2, 228-254, 2014. (Download Working Paper or ER)

Abstract: This paper uses several methods to study the interrelationship among Divisia monetary aggregates, prices, and income, allowing for nonstationary, nonlinearities, asymmetries, and time-varying relationships among the series. We propose a multivariate regime switching unobserved components model to obtain transitory and permanent components for each series, allowing for potential recurrent and structural changes in their dynamics. Each component follows distinct two-state Markov processes representing low or high phases. Since the lead-lag relationship between the phases can vary over time, rather than pre-imposing a structure to their linkages, the proposed flexible framework enables us to study their specific lead-lag relationship over each one of their cycles and over each U.S. recession in the last 40 years. The decomposition of the series into permanent and transitory components reveals striking results. First, we find a strong nonlinear association between the components of money and prices—all low phases of the transitory component of prices were preceded by tight transitory and permanent money phases. We also find that most recessions were preceded by tight money phases (its cyclical and permanent components) and high transitory price phases (with the exception of the 2001 and 2009-2010 recessions). In addition, all recessions were associated with a decrease in transitory and permanent income.  

"Measurement Error in Monetary Aggregates: A Markov Switching Factor Approach,” with William Barnett and Heather Tierney, Macroeconomic Dynamics, Vol 13, 381-412, 2009. (Download Repec or MeasErrMoney) 

Abstract: This paper compares the different dynamics of the simple sum monetary aggregates and the Divisia monetary aggregate indexes over time, over the business cycle, and across high and low inflation and interest rate phases. Although traditional comparisons of the series sometimes suggest that simple sum and Divisia monetary aggregates share similar dynamics, there are important differences during certain periods, such as around turning points. These differences cannot be evaluated by their average behavior. We use a factor model with regime switching. The model separates out the common movements underlying the monetary aggregate indexes, summarized in the dynamic factor, from individual variations in each individual series, captured by the idiosyncratic terms. The idiosyncratic terms and the measurement errors reveal where the monetary indexes differ. We find several new results. In general, the idiosyncratic terms for both the simple sum aggregates and the Divisia indexes display a business cycle pattern, especially since 1980. They generally rise around the end of high interest rate phases — a couple of quarters before the beginning of recessions — and fall during recessions to subsequently converge to their average in the beginning of expansions. We find that the major differences between the simple sum aggregates and Divisia indexes occur around the beginnings and ends of economic recessions, and during some high interestrate phases. We note the inferences' policy relevance, which is particularly dramatic at the broadest (M3) level of aggregation. Indeed, as Belongia (1996) has observed in this regard, "measurement matters."

"How Better Monetary Statistics Could Have Signaled the Financial Crisis," with William Barnett, Journal of Econometrics,Vol. 161, No. 1, 6-23, 2011. (Download Repec or JE) 

Abstract: This paper explores the disconnect of Federal Reserve data from index number theory. A consequence could have been the decreased-systemic-risk misperceptions that contributed to excess risk-taking prior to the housing bust. We find that most recessions in the past 50 years were preceded by more contractionary monetary policy than indicated by simple-sum monetary data. Divisia monetary aggregate growth rates were generally lower than simple-sum aggregate growth rates in the period preceding the Great Moderation, and higher since the mid 1980s. Monetary policy was more contractionary than likely intended before the 2001 recession and more expansionary than likely intended during the subsequent recovery.

“Real Time Changes in Monetary Policy: A Nonparametric Approach,” in Proceedings of the 27th International Forecasting Symposium, New York, June 2007. (Download)

Abstract: This paper investigates potential changes in monetary policy over the last decades using a nonparametric vector autoregression model. In the proposed model, the conditional mean and variance are time-dependent and estimated using a nonparametric local linear method, which allows for different forms of nonlinearity, conditional heteroskedasticity, and non-normality. Our results suggest that there have been gradual and abrupt changes in the variances of shocks, in the monetary transmission mechanism, and in the Fed’s reaction function. The response of output was strongest during Volcker’s disinflationary period and has since been slowly decreasing over time. There have been some abrupt changes in the response of inflation, especially in the early 1980s, but we can not conclude that it is weaker now than in previous periods. Finally, we find significant evidence that policy was passive during some parts of Burn’s period, and active during Volcker’s disinflationary period and Greenspan’s period. However, we find that the uncovered behavior of the parameters is more complex than general conclusions suggest, since they display considerable nonlinearities over time. A particular appeal of the recursive estimation of the proposed VAR-ARCH is the detection of discrete local deviations as well as more gradual ones, without smoothing the timing or magnitude of the changes.