Research

We integrate Keynesian economics with general equilibrium theory in a new way. We develop a simple graphical apparatus, the IS-LM-NAC framework, that can be used by policy makers to understand how policy affects the economy. A new element, the No-Arbitrage-Condition (NAC) curve, connects the interest rate to current and expected future values of the stock market and it explains how ‘animal spirits’ influence economic activity. Our framework provides a rich new approach to policy analysis that explains the short-run and long-run effects of policy.

Central banks set the nominal interest rate to target inflation and stabilize output. In monetary models, monetary policy affects output directly via the wealth effect. I show that in these models, the response of the central bank to fluctuations in output may induce real indeterminacy even if the Taylor principle is satisfied. I find that the determinacy conditions depend on the interest elasticity of output and generally, the Taylor principle is neither necessary nor sufficient for determinacy. This is in stark contrast with the New Keynesian model where a sufficiently strong policy response to inflation or output usually ensures determinacy.

Financial crises tend to spread across countries, causing equity price crashes that cannot be fully explained by fundamentals. This paper introduces a two-country dynamic general equilibrium model of global financial crises that distinguishes between interdependence and financial contagion. Interdependence arises through trade and capital flows, while contagion occurs through a new channel: confidence spillovers. In the model, contagion is possible due to multiple dynamic and steady-state equilibria, even with fully rational consumers. Self-fulfilling beliefs about equity prices can shift the economy between equilibria, amplifying negative effects and causing contagion. The model has three policy implications. Firstly, monetary policy can offset recessions without causing inflation. Coordinated international policy can potentially improve welfare further.  Secondly, capital controls can prevent contagion. Lastly, increased trust in government can mitigate negative confidence shocks. These recommendations emphasize the role of beliefs, where pessimism can spread internationally via the confidence channel, leading to contagion.

We study determinacy conditions in a neoclassical monetary model. In addition to inflation, we introduce a second argument of the interest rate rule: output, a case empirically relevant but mostly overlooked in the existing literature. Firstly, we estimate a model with money in utility and the production function. Our key finding is that to achieve determinacy, the central bank should maintain a fine balance between the stabilization of inflation and output and avoid focusing on one target only. Secondly, we compare monetary policy in the era before the appointment of Paul Volcker and after. We find that, in the post-Volcker era, monetary policy shifted its focus from output to inflation. The equilibrium is found indeterminate in both sub-samples due to an imbalanced approach to stabilization. Thirdly, we find that in the estimated model, monetary shocks, inflation shocks, and productivity shocks have long-lasting effects on inflation and output. We attribute this to endogenous persistence caused by indeterminacy. Lastly, we apply the results of our model to the post-pandemic monetary policy and discuss the implications.

After the outbreak of the COVID-19 pandemic, in the United States output recovered quickly, labor productivity went up above the pre-pandemic trend, and the labor market was tight, all despite high unemployment. I explain these stylized facts in a canonical search and matching model of unemployment with two additional assumptions: endogenous labor demand and the presence of coordination effects. The first assumption allows firms to adjust to recessions instead of shutting down. The second assumption introduces strategic complementarity in firm entry: the larger the number of firms, the larger the demand for varieties of intermediate goods, and the smaller firm size will become sufficient to justify costly entry. Two regimes arise endogenously: a regime with weak coordination effects and a regime with strong coordination effects. The regime with weak coordination effects describes the pre-pandemic era and the regime with strong coordination effects describes the post-pandemic period. Under strong coordination effects, when a job separation shock realizes, new firms find it easier to hire workers. As firms enter, they post vacancies, and the labor market becomes tight. Under strong coordination effects, the model also predicts the net creation of establishments, an increase in labor productivity and in producer prices, and a reduction in the average firm size in response to a job separation shock, as found in the post-pandemic data.