Completed papers
Completed papers
We study the impact of monetary policy on regional inequality using granular data on economic activity at the city- and county-level in Europe. We document pronounced heterogeneity in the regional patterns of monetary policy transmission. The output response to monetary policy shocks is stronger and more persistent in poorer regions, with the difference becoming particularly pronounced in the tails of the distribution. Regions in the lower parts of the distribution exhibit hysteresis, consisting of long-lived adjustments in employment and labor productivity in response to the shocks. As a consequence, policy tightening aggravates regional inequality and policy easing mitigates it. Finally we provide a structural interpretation of our results using a New Keynesian Currency Union Model with hysteresis effects.
This paper presents a toolkit for generating optimal policy projections. It makes five contributions. First, the toolkit requires a minimal set of inputs: only a baseline projection for target and instrument variables and impulse responses of those variables to policy shocks. Second, it solves optimal policy projections under commitment, limited-time commitment, and discretion. Third, it handles multiple policy instruments. Fourth, it handles multiple constraints on policy instruments such as a lower bound on the policy rate and an upper bound on asset purchases. Fifth, it allows alternative approaches to address the forward guidance puzzle. The toolkit that accompanies this paper is Dynare compatible, which facilitates its use. Examples replicate existing results in the optimal monetary policy literature and illustrate the usefulness of the toolkit for highlighting policy trade-offs. We use the toolkit to analyse US monetary policy at the height of the Great Financial Crisis. Given the Fed’s early-2009 baseline macroeconomic projections, we find the Fed’s planned use of the policy rate was close to optimal whereas a more aggressive QE program would have been beneficial.
GitHub site for the COPPs toolkit: click here
When a DSGE model features stochastic volatility, is a third-order perturbation approximation sufficient? The answer is often no. A key parameter - the standard deviation of stochastic volatility innovations - does not appear in the coefficients of the decision rules of endogenous variables until a fourth- or sixth-order perturbation approximation (depending on the functional form of the stochastic volatility process). This paper shows analytically this general result and demonstrates, using three models, that important model moments can be imprecisely measured when the order of approximation is too low. i) In the Bansal-Yaron long-run risk model, the equity risk premium rises from 4.5% to 10% by going to sixth-order. ii) In a workhorse real business cycle model, the welfare cost of business cycles also rise when a fourth-order approximation properly accounts for the presence of stochastic volatility. iii) In a canonical New-Keynesian model, the risk-aversion parameter can be lowered while matching the term premium when a fourth-order approximation is used.
See the NEP-DGE Blog for a discussion.
On February 24, 2022, as Russia invaded, the National Bank of Ukraine abandoned exchange-rate flexibility and fixed the hryvnia to the US dollar. Was this wartime peg an optimal policy response, and under what conditions could it be justified? We consider two candidate rationales---subsistence consumption and defense spending. To address this, we develop a tractable small open-economy two-agent New Keynesian (SOE-TANK) model of Ukraine with nominal price rigidities and low-income households close to subsistence consumption. We find that the optimal exchange-rate policy is state-contingent: for a small-scale invasion, exchange-rate flexibility remains desirable, whereas for a large shock---such as the 2022 invasion---a significant depreciation becomes suboptimal, and a fixed exchange rate regime dominates a floating exchange rate regime with a standard Taylor-rule policy. Extending the model to incorporate essential fiscal defense-spending needs, reflecting the surge in foreign-currency-denominated military imports, however, does not yield the same result.
Business cycle implications of banking system heterogeneity and complexity (with Grzegorz Wesołowski) (2020), NBP Working Paper No. 330
Mitigating the forward guidance puzzle: inattention, credibility, finite planning horizons and learning (with Falk Mazelis) (2020), ECB Working Paper No. 2426
Using forecast-augmented VAR evidence to dampen the forward guidance puzzle (with Kai Christoffel, Falk Mazelis, and Carlos Montes-Galdón) (2020), ECB Working Paper No. 2495
Bank Heterogeneity, Financial Stress, & the Market for Deposits (with Gustavo Mellior) (2025)
On February 24, 2022, as Russia invaded, the National Bank of Ukraine switched from a flexible to a fixed exchange rate regime. Was this policy response optimal? To answer this, we develop an open-economy model with both nominal rigidities and frictions in borrowing on international financial markets. We find that the carefully calibrated model can rationalize the NBU’s decision: the optimal response to small shocks is to allow exchange rate flexibility, whereas in response to large shocks—such as an invasion—currency depreciation is suboptimal. For robustness, we consider tradable endowment, risk-premium, and non-tradable supply shocks, and add subsistence consumption.
Featured in the VoxUkraine blog here
We compare global (fixed-point iteration) and local (first-order, higher-order, risky-steady-state, and quasi-linear) solutions of open-economy incomplete-markets models. Cyclical moments of a workhorse endowment model are broadly in line with the data and similar across solutions calibrated to the same data targets, but impulse responses and spectral densities differ. Alternative local solutions yield nearly identical results. Calibrating them requires nontrivial interest-rate elasticities that make net foreign assets (NFA) “sticky,” causing them to differ sharply from global solutions in experiments altering precautionary savings (e.g., increasing income volatility, adding capital controls). Analytic and numerical results show that our findings are due to the near-unit-root nature of NFA under incomplete markets and imprecise solutions of their autocorrelation. These findings extend to a Sudden Stops model with an occasionally binding collateral constraint. In addition, quasi-linear methods yield smaller financial premia and macroeconomic responses when the constraint binds.
Negative policy rates can convince markets that deposit rates will remain lower-for-longer, even when current deposit rates are constrained by zero. This is the signalling channel of negative interest rates. We analyse the optimality and eectiveness of negative rates in the context of this novel transmission channel. In a stylized model, we prove two necessary conditions for optimality: time-consistency and a preference for policy smoothing. In an estimated model, we show the signalling channel dominates banks' costly interest margin channel. However, the eectiveness of negative rates depends sensitively on the degree of policy inertia, level of reserves, and ZLB duration.
Coverage of the paper in the European Parliament's September 2018 Monetary Dialogue here; Non-technical summary of the paper on the Royal Economic Society's homepage here. Featured in the LSE Business Review blog here and in the Liverpool Economic Insights publication.
This research has been presented at the Bank of Canada, Bank of England, National Bank of Poland, Dutch National Bank, European Central Bank, University of Lancaster, University of Zurich, University of Liverpool, Dynare conference, CFE conference and EABCN conference.
This paper shows the success of valuation risk—time-preference shocks in Epstein-Zin utility—in resolving asset pricing puzzles rests sensitively on the way it is introduced. The specification used in the literature is at odds with several desirable properties of recursive preferences because the weights in the time-aggregator do not sum to one. When we revise the specification in a simple asset pricing model the puzzles resurface. However, when estimating a sequence of increasingly rich models, we find valuation risk under the revised specification consistently improves the ability of the models to match asset price and cash-flow dynamics.
This research has been presented at the NBER EFSF meeting 2019, MMCN research conference 2019, and SED 2021.
This special issue brings new insights to the optimal design of monetary policy. These insights come from a wide spectrum of research, stretching from rigorous theoretical proofs in stylized models, to simulation results from large-scale quantitative models, to new empirical findings. In particular, this special issue refines the optimal design of monetary policy along the following dimensions: In considering a new concept of optimality; in responding to uncertainty, liquidity, and news-driven credit shocks; in setting (un)conventional policy in the presence of the effective lower bound and a low natural rate; in the selection of optimal simple (asymmetric) rules; when policy is imperfectly credible; and by shedding new light on international spillovers. This introductory article begins by reviewing new conceptual and methodological challenges facing the study of optimal monetary policy and thereby providing context for the articles that follow. We then provide an overview of each of the articles in this special issue and conclude by offering suggestions for future research in this field.
This paper studies the effect of liquidity problems in markets for short-term debt within a DSGE model with leveraged borrowers. Creditors (financial intermediaries) receive imperfect signals regarding the profitability of borrowers (entrepreneurs) and, based on these signals and their beliefs about other intermediaries' actions, choose between rolling over and foreclosing on the debt. Due to the uncoordinated actions of intermediaries, the incidence of rollover is suboptimal, generating endogenous capital scrapping and an illiquidity premium on external finance. As entrepreneurs become more leveraged, the magnitude of the coordination inefficiency increases as do the premiums paid on external finance. The interaction between entrepreneurial leverage and the illiquidity premium generates significant amplification of technology shocks, and predicts that periods of illiquidity in credit markets can generate sharp contractions in output. Two unconventional policy responses are analyzed. Direct lending to entrepreneurs is found to dampen output fluctuations. Equity injections into entrepreneurs' balance sheets, however, are significantly more powerful in dampening the contemporaneous effect of illiquidity shocks, but cause output deviations from potential to persist.
Basu and Bundick (2017) show a second moment intertemporal preference shock creates meaningful declines in output in a sticky price model with Epstein and Zin (1991) preferences. The result, however, rests on the way they model the shock. If a preference shock is included in Epstein-Zin preferences, the distributional weights on current and future utility must sum to 1, otherwise it creates an asymptote in the response to the shock with unit intertemporal elasticity of substitution. When we change the preferences so the weights sum to 1, the asymptote disappears as well as their main results—uncertainty shocks generate small increases in output and comovement with consumption and investment that is at odds with the data. We examine three changes to the model—recalibration, a risk-premium shock, and a disaster risk-type shock—to try and restore their results, but in all three cases the model is unable to match VAR evidence.
The financial accelerator refers to the mechanism by which distortions (frictions) in financial markets amplify the propagation of shocks through an economy. This article sets out the theoretical foundations of the financial accelerator in financial friction DSGE (Dynamic Stochastic General Equilibrium) models and discusses the ability of these models to provide policy recommendations and a narrative for the 2007–08 financial crisis.
Do capital markets impose fiscal discipline? To answer this question, we estimate the fiscal response to a change in the interest rate paid by 14 European governments over four decades in a panel VAR, using sign restrictions to identify structural shocks. A jump in the cost of borrowing leads to an improvement in the primary balance although insufficient to prevent a rise in the debt-to-GDP ratio. Adjustment mainly takes place via rising revenues rather than falling primary expenditures. For EMU countries, the primary balance response was stronger after 1992, when the Maastricht Treaty was signed, suggesting an important interaction between market discipline and fiscal rules.
This paper provides a closed-form solution for the price-dividend ratio in a standard asset pricing model with stochastic volatility. The growth rate of the endowment is a first-order Gaussian autoregression, while the stochastic volatility innovations can be drawn from any distribution for which the moment-generating function exists. The solution is useful in allowing comparisons among numerical methods used to approximate the nontrivial closed form. The closed-form solution reveals that, when using perturbation methods around the deterministic steady state, the approximate solution needs to be sixth-order accurate in order for the parameter capturing the conditional standard deviation of the stochastic volatility process to be present.
This paper examines how monetary policy affects the riskiness of the financial sector's aggregate balance sheet, a mechanism referred to as the risk channel of monetary policy. I study the risk channel in a DSGE model with nominal frictions and a banking sector that can issue both outside equity and debt, making banks' exposure to risk an endogenous choice, and dependent on the (monetary) policy environment. Banks' equilibrium portfolio choice is determined by solving the model around a risk-adjusted steady state. I find that banks reduce their reliance on debt finance and decrease leverage when monetary policy shocks are prevalent. A monetary policy reaction function that responds to movements in bank leverage or to movements in credit spreads can incentivizes banks to increase their use of debt finance and increase leverage, ceteris paribus, increasing the riskiness of the financial sector for the real economy.
The International Journal of Central Banking also published Javier Bianchi's discussion of "The Risk Channel of Monetary Policy".
This note describes a simple procedure for solving the risky steady state in medium-scale macroeconomic models. This is the "point where agents choose to stay at a given date if they expect future risk and if the realization of shocks is 0 at this date" [Coeurdacier, N., H. Rey, and P. Winant, 2011. "The risky steady state," The American Economic Review, 101(3), 398-401]. This new procedure is a direct method which makes use of a second-order approximation of the macroeconomic model around its deterministic steady state, thus avoiding the need to employ an iterative algorithm to solve a fixed point problem.
Discussion of "Optimal QE and QT", by Paolo Gelain, Junior Maih, Eric Sims, & Jing Cynthia Wu, at Qatar Centre for Global Banking & Finance Annual Conference, July 2024
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Discussion of "The dynamics of stock market participation", by Sigurd Galaasen & Akash Raja, at 1st Annual Cambridge Alumni in Macro (CAM) Conference, May 2024
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Discussion of "A quantitative model for the Integrated Policy Framework", by Tobias Adrian, Christopher Erceg, Jesper Lindé, Pawel Zabczyk, & Jianping Zhou, at CEBRA Annual Meeting, July 2021
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Discussion of "Quest for robust optimal macroprudential policy'', by Pablo Aguilar, Stephan Fahr, Eddie Gerba, & Samuel Hurtado, at MMCN research conference, June 2019
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Discussion of "Structural stress tests", by Dean Corbae, Pablo D'Erasmo, Sigurd Galaasen, Alfonso Irarrazabal, & Thomas Siemsen, at CEBRA Annual Meeting, August 2018
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Discussion of "Financial vulnerability & monetary policy", by Tobias Adrian & Fernando Duarte at ECB conference on Credit, Banking and Monetary Policy, October 2017
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Discussion of "The risk-taking channel of monetary policy: Exploring all avenues", by Diana Bonfim & Carla Soares at the IBEFA/ASSA meeting, January 2015
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Discussion of "House prices, heterogeneous banks, & unconventional monetary policy options", by Andrew Lee Smith at the Federal Reserve System Meeting on Macroeconomics, October 2014
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