Job Market Paper:
Abstract:Standard sticky-price models predict that temporary, negative supply shocks are expansionary at the zero lower bound (ZLB) because they raise inflation expectations and lower expected real interest rates, which stimulates consumption. This paper tests that prediction with oil supply shocks, an earthquake, and inflation risk premia, demonstrating that negative supply shocks are contractionary at the ZLB despite also lowering expected real interest rates. These findings are rationalized in a model with financial frictions, where negative supply shocks reduce asset prices and net worth, translating into larger borrowing spreads so that consumption contracts. In this data-consistent model fiscal stimulus at the ZLB is substantially less effective than in standard sticky-price models.
The Optimal Inflation Rate in New Keynesian Models: Should Central Banks Raise Their Inflation Targets in Light of the ZLB?(with Olivier Coibion and Yuriy Gorodnichenko)
Review of Economic Studies, forthcoming
Abstract: We study the effects of positive steady-state inflation in New Keynesian models subject to the zero bound on interest rates. We derive the utility-based welfare loss function taking into account the effects of positive steady-state inflation and solve for the optimal level of inflation in the model. For plausible calibrations with costly but infrequent episodes at the zero-lower bound, the optimal inflation rate is low, less than two percent, even after considering a variety of extensions, including optimal stabilization policy, price indexation, endogenous and state-dependent price stickiness, capital formation, model-uncertainty, and downward nominal wage rigidities. On the normative side, price level targeting delivers large welfare gains and a very low optimal inflation rate consistent with price stability. These results suggest that raising the inflation target is too blunt an instrument to efficiently reduce the severe costs of zero-bound episodes.
Coming Soon (available upon request):
Slow Recoveries in the Aftermath of Financial Crises: Financial Acceleration vs. Dampening.(with Mu-Jeung Yang)
Abstract: We document a systematic change in the behavior of financial sector leverage and credit growth, which declined more strongly and persistently in post-1990 recessions and recoveries compared to pre-1990 recessions and recoveries, and provide evidence that this has reduced the efficacy of monetary policy in engineering a rapid recovery. In our model of financial intermediation, where banks have leverage targets and asymmetric portfolio adjustment costs, deleveraging banks will have a lower pass-through from reductions in policy rates to credit supply. We call this novel mechanism financial dampening. We find strong support for financial dampening in micro-data on U.S. regulated financial intermediaries. In response to a 1% monetary policy shock, a bank at the 10th percentile of the deleveraging distribution increases its loan growth by 1.7% more than a bank at the 90th percentile according to our baseline specification. Using these estimates we illustrate that by reducing the effectiveness of monetary policy financial dampening was likely an important contributor to slow post-1990 recoveries.