The Monetary/Fiscal Policy Mix: Note and Slides
Overview of my research on the Monetary/Fiscal Policy Mix prepared for the G20 Framework Working Group March 2021 meeting.
A Structural Approach to High-Frequency Event Studies: The Fed and Markets as Case History with Sydney Ludvigson and Sai Ma (May 2025)
We integrate a high-frequency event study of Federal Reserve (Fed) communications into a mixed-frequency macro-finance model and structural estimation. The methodology allows for jumps at Fed announcements in investor beliefs about the economic state and/or future regime change in monetary policy conduct, effectively identifying state-dependent reaction functions to real-world events. We find market volatility attributable to Fed announcements is frequently traced to jumps in investor beliefs about future policy conduct that directly affect subjective risk premia. Such jumps can generate a positive comovement between short rates and the stock market, erroneously suggesting a role for "Fed information shocks."
Inflation and Real Activity over the Business Cycle with Gianni Nicolo' and Dongho Song (February 2025)
Revise and Resubmit at the Review of Economic Studies
We study the relation between inflation and real activity over the business cycle. We employ a Trend-Cycle VAR to control for low-frequency movements in inflation, unemployment, and growth that are pervasive in the post-WWII period. We show that cyclical fluctuations of inflation are related to cyclical movements in real activity and unemployment, in line with what is implied by the New Keynesian framework. We then discuss the reasons for which our results relying on a Trend-Cycle VAR differ from the findings of previous studies based on VAR analysis. We explain empirically and theoretically how to reconcile these differences. Online Appendix
Smooth Diagnostic Expectations with Cosmin Ilut and Hikaru Saijo (September 2024)
Revise and Resubmit at the Review of Economic Studies
We show that the formalization of representativeness (Kahneman and Tversky (1972)) developed by Gennaioli and Shleifer (2010) features an intrinsic connection between uncertainty and overreaction. In the time series domain, we develop this connection in a smooth version of Diagnostic Expectations (DE). Intuitively, under smoothness, when uncertainty is low there is less room for representativeness to distort beliefs. Smooth DE implies a joint and parsimonious micro-foundation for key properties of survey data: overreaction to news, stronger overreaction for longer forecast horizons, overconfidence in subjective uncertainty, and a new stylized fact documented in this paper, namely that overreaction is stronger when uncertainty is high. An analytical Real Business Cycle model featuring Smooth DE accounts for overreaction and overconfidence in surveys, as well as three salient properties of the business cycle: asymmetry, countercyclical micro volatility, and countercyclical macro volatility.
What Hundreds of Economic News Events Say About Belief Overreaction in the Stock Market
with Sydney Ludvigson and Sai Ma (February 2024)
We measure the nature and severity of a variety of belief distortions in market reactions to hundreds of economic news events using a new methodology that synthesizes estimation of a structural asset pricing model with algorithmic machine learning to quantify bias. Distortions apply to a system of macroeconomic dynamics, rather than to a univariate process. We estimate that investors overreact to perceptions about multiple fundamental shocks, creating asymmetric compositional effects when several counteracting shocks happen simultaneously. These effects imply that overreaction to each perceived shock individually often generates overall market under reaction to real-world events.Â
Who is Afraid of Eurobonds? with Leonardo Melosi and Anna Rogantini-Picco (July 2023)
The current Euro Area policy framework exposes its members to the opposite risks of deflation and high inflation because it does not separate the need for short-run macroeconomic stabilization from the issue of long-run fiscal sustainability. We study a new policy framework that addresses this deficiency. A centralized Treasury issues Eurobonds to finance stabilization policies, while national governments remain responsible for the country-level long-term spending programs. The centralized Treasury can run larger primary deficits during recessions, followed by primary surpluses during expansions. However, following an exceptionally large contractionary shock, the centralized Treasury can coordinate with the monetary authority to reflate the economy and avoid the zero lower bound. The policy acts as an automatic stabilizer and removes the risk of deflation. At the same time, the proposed policy framework removes the risk of high inflation and fiscal stagflation because it does not require suspending the fiscal rules designed to preserve long-run fiscal sustainability.
Monetary and Fiscal Policies in Times of Large Debt: Unity is Strength with Renato Faccini and Leonardo Melosi (July 2022)
The COVID pandemic found policymakers facing constraints on their ability to react to an exceptionally large negative shock. The current low interest rate environment limits the tools the central bank can use to stabilize the economy, while the large public debt curtails the efficacy of fiscal interventions by inducing expectations of costly fiscal adjustments. Against this background, we study the implications of a coordinated fiscal and monetary strategy aiming at creating a controlled rise of inflation to wear away a targeted fraction of debt. Under this coordinated strategy, the fiscal authority introduces an emergency budget with no provisions on how it will be balanced, while the monetary authority tolerates a temporary increase in inflation to accommodate the emergency budget. In our model the coordinated strategy enhances the efficacy of the fiscal stimulus planned in response to the COVID pandemic and allows the Federal Reserve to correct a prolonged period of below-target inflation. The strategy results in only moderate levels of inflation by separating long-run fiscal sustainability from a short-run policy intervention. Vox article