Walker Ray

Research

Published and Accepted Papers

Unbundling Quantitative Easing: Taking a Cue from Treasury Auctions (with Michael Droste and Yuriy Gorodnichenko), (Journal of Political Economy, September 2024, 132(9) pp. 3115-3172)

We study empirically and theoretically the role of preferred habitat in understanding the economic effects of the Federal Reserve's quantitative easing (QE) programs. Using high-frequency identification and exploiting the structure of the primary market for U.S. Treasuries, we isolate demand shocks that are transmitted solely through preferred habitat channels, but otherwise mimic QE shocks. We document large "localized" yield curve effects when financial markets are disrupted. Our calibrated model, which embeds a preferred habitat model in a New Keynesian framework, can largely account for the observed financial effects of QE. We find that QE is modestly stimulative for output and inflation, but alternative policy designs can generate stronger effects.

A Preferred-Habitat Model of Term Premia, Exchange Rates, and Monetary Policy Spillovers (with Pierre-Olivier Gourinchas and Dimitri Vayanos), (conditionally accepted, American Economic Review)

We develop a two-country model in which currency and bond markets are populated by different investor clienteles, and segmentation is partly overcome by global arbitrageurs with limited capital. Our model accounts for the empirically documented violations of Uncovered Interest Parity (UIP) and the Expectations Hypothesis, and for how UIP violations depend on bond maturity, investment horizon, and yield curve slope differentials. Large-scale purchases of long-maturity bonds lower domestic and foreign bond yields, and depreciate the currency. Conventional monetary policy is transmitted to domestic and international bond yields as well, but its international transmission is weaker than for unconventional policy.

Working Papers

Attention-Driven Sentiment and the Business Cycle (with Rupal Kamdar)

Using survey data, we show that consumers' economic beliefs are driven by one component, which observationally behaves like "sentiment." Surprisingly, "optimistic" consumers expecting an expansion also consistently predict disinflation, contrasting with professional forecasts. We explain these facts in a New Keynesian model where rationally inattentive consumers face fundamental uncertainty regarding aggregate demand and supply shocks. Optimal information-gathering economizes on information costs but compresses the dimensionality of consumer beliefs. Moreover, because supply-driven recessions are more costly for typical households relying on labor income, more attention is optimally devoted to supply shocks. Consumers' countercyclical perception of inflation is thus (i) attention-driven; and (ii) a reflection of a focus on supply factors. Consistent with our theoretical mechanisms, we find strong evidence in favor of (i) using measures of attention which exploit methodological features of consumer surveys. Consumers' explicit "reasoning" provides direct evidence in favor of (ii). Finally, consumer beliefs react strongly to identified supply shocks but show only muted reactions to identified demand shocks.

Monetary Policy and the Limits to Arbitrage: Insights from a New Keynesian Preferred Habitat Model

With conventional monetary policy unable to stabilize the economy in the wake of the global financial crisis, central banks turned to unconventional tools. This paper embeds a model of the term structure of interest rates featuring market segmentation and limits to arbitrage within a New Keynesian model to study these policies. Because the transmission of monetary policy depends on private agents with limited risk-bearing capacity, financial market disruptions reduce the efficacy of both conventional policy as well as forward guidance. Conversely, financial crises are precisely when large scale asset purchases are most effective. Policymakers can take advantage of the inability of financial markets to fully absorb these purchases, which can push down long-term interest rates and help stabilize output and inflation.

Polarized Expectations, Polarized Consumption (with Rupal Kamdar, new draft coming soon)

This paper argues that political affiliation plays a central role in shaping household expectations and consumption behavior. Using survey and consumption data of U.S. households, we document five facts. First, household beliefs are well-described by a single factor "sentiment" model, with nearly identical factor structures regardless of political affiliation. Second, sentiment is highly persistent, with one exception: following changes in the White House, "optimists" become "pessimists" (and vice versa). Third, wide cross-sectional dispersion in sentiment is increasingly driven by political affiliation and subjectively justified by partisan narratives. Fourth, consumption responds differentially along party lines following changes in the White House. Fifth, equity prices of companies with distinct partisan consumer bases also react differentially.

Work-in-Progress

Optimal Unconventional Policy in a New Keynesian Preferred Habitat Model (with Rupal Kamdar) [slides]

We study the transmission mechanisms of monetary policy in a general equilibrium model featuring heterogeneous households, nominal rigidities, and limits to arbitrage. The interaction of bond market segmentation and household heterogeneity introduces novel rebalancing transmission mechanisms of monetary policy, rationalizing a number of empirical puzzles regarding the reactions of term premia to short-term interest rates. We show that the induced fluctuations in term premia may be suboptimal due to imperfect risk sharing across households. Reducing the volatility of short-rate fluctuations can improve welfare, but necessarily comes at the cost of increased macroeconomic volatility. With balance sheet tools, we derive a separation principle for optimal policy: conventional policy stabilizes aggregate fluctuations, while unconventional policy stabilizes term premia. Balance sheets are necessary but imperfect tools for macroeconomic stabilization when short rates are constrained. Our model provides a justification and implementation details for a central bank "triple mandate" which seeks to stabilize output, inflation, and long-term rates.

The Effects of News Shocks and Supply-Side Beliefs (with Rupal Kamdar) [slides]

This paper investigates the causes and consequences of "supply-side beliefs" - the tendency for households to overweight the importance of aggregate supply shocks relative to demand-side factors. We develop a New Keynesian model where agents receive news about future supply and demand shocks. Because supply shocks are more costly, potential model misspecification causes agents to endogenously downweight the likelihood that news is informative about demand shocks. The model rationalizes a number of empirical puzzles, such as the observed positive correlation between survey-based inflation and unemployment expectations, and the instability of estimated Phillips curve slope coefficients. Next, we empirically test a key prediction of the model: news shocks cause realized inflation and unemployment to move in the same direction. Using daily survey-based inflation expectations around CPI releases, we construct a novel measure of news-driven inflation expectation shocks. Consistent with the model, following an increase in our inflation expectation measure, both realized inflation and unemployment rise. These results are robust across a wide range of specifications and sample periods; quantitatively, we find that a one percentage point shock to inflation expectations boosts inflation by roughly 0.1% and unemployment by 0.2% over the next 2 years.

We Think That They Think: Political Affiliation and Higher-Order Beliefs (with Rupal Kamdar) [slides] 

Surveys consistently show large heterogeneity of macroeconomic beliefs across consumers. However, very little empirical work has been done to measure higher-order beliefs. Moreover, existing studies find that agents' own and higher-order beliefs are nearly identical. In this paper, we conduct a novel survey soliciting inflation and unemployment forecasts of US consumers. Crucially, we ask respondents to report higher-order beliefs specifically of different politically affiliated consumers (Republican, Democrat, or Independent). In this context, we find that higher-order beliefs differ substantially from own beliefs. Quantitatively, consumers correctly understand the "partisan gap" in inflation and unemployment forecasts. Providing consumers information from partisan news sources tends to move higher-order beliefs of consumers of the opposite partisan affiliation. Our results suggest that "group identity" is an important driver of own and higher-order beliefs, and provide a puzzle for noisy information models.

A Two-Country New-Keynesian Model with Limited Arbitrage in Currency and Bond Markets (with Pierre-Olivier Gourinchas and Dimitri Vayanos)

Discussions

2025

"Exchange Rate Disconnect and the Trade Balance" - Bodenstein, Cuba-Borda, Gornemann, Presno

"Granular Treasury Demand with Arbitrageurs" - Jansen, Li, Schmid

"Demand-Driven Risk Premia in FX and Bond Markets" - Krohn, Uthemann, Vala, Yang

"How Large Is Too Large? A Risk-Benefit Framework for Quantitative Easing" - d’Avernas, Hubert de Fraisse, Ning, Vandeweyer

2024

"Inelastic Markets: The Demand and Supply of Risky Sovereign Bonds" - Moretti, Pandolfi, Schmukler, Villegas Bauer, Williams

"Optimal Monetary Policy during a Cost-of-Living Crisis" - Olivi, Sterk, Xhani

"Exchange Rates, Natural Rates, and the Price of Risk" - Kekre, Lenel

"Currency Centrality in Equity Markets, Exchange Rates and Global Financial Cycles" - Rey, Stavrakeva, Tang

"Monetary Policy, the Yield Curve, and the Repo Market" - Jappelli, Pelizzon, Subrahmanyam

"Long-Term Bond Supply, Term Premium, and the Duration of Corporate Investment" - Hubert de Fraisse

2023

"Price Elasticity of Demand and Risk-bearing Capacity in Sovereign Bond Auctions" - Albuquerque, Cardoso-Costa, Faias

"Monetary Policy, Segmentation, and the Term Structure" - Kekre, Lenel, Mainardi

2022

"How Unconventional is Green Monetary Policy?" - Papoutsi, Piazzesi, Schneider

2021

"Corporate Debt Maturity Matters for Monetary Policy" - Jungherr, Meier, Reinelt, Schott

"The Term Structure of Interest Rates in a Heterogeneous Monetary Union" - Costain, Nuño, Thomas

"The Heding Channel of Exchange Rate Determination" - Liao, Zhang

2019

"A Model of Intermediation, Money, Interest, and Prices" - Bigio, Sannikov

"Monetary Policy Uncertainty and Monetary Policy Surprises" - De Pooter, Favara, Modugno, Wu

"What Can Repatriation Tax Holidays Teach Us About Monetary Policy Transmission?" - Argudo