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  5. New Frontiers in Open Economy Macroeconomics
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New Frontiers in Open Economy Macroeconomics

Paper Session

Sunday, Jan. 8, 2023 1:00 PM - 3:00 PM (CST)

New Orleans Marriott, Preservation Hall Studio 9
Hosted By: Korea-America Economic Association & American Economic Association
  • Chair: Kei-Mu Yi, University of Houston

Exchange Rates and Monetary Policy with Heterogeneous Agents: Sizing up the Real Income Channel

Adrien Auclert
,
Stanford University
Matthew Rognlie
,
Northwestern University
Martin Souchier
,
Stanford University
Ludwig Straub
,
Harvard University

Abstract

Introducing heterogeneous households to a New Keynesian small open economy model amplifies the real income channel of exchange rates: the rise in import prices from a depreciation lowers households’ real incomes, and leads them to cut back on spending. When the sum of import and export elasticities is one, this channel is offset by a larger Keynesian multiplier, heterogeneity is irrelevant, and expenditure switching drives the output response. With plausibly lower short-term elasticities, however, the real income channel dominates, and depreciation can be contractionary for output. This weakens monetary transmission and creates a dilemma for policymakers facing capital outflows. Delayed import price pass-through weakens the real income channel, while heterogeneous consumption baskets can strengthen it.

Real Interest Rates, Inflation, and Default

Sewon Hur
,
Federal Reserve Bank of Dallas
Illenin Kondo
,
Federal Reserve Bank of Minneapolis
Fabrizio Perri
,
Federal Reserve Bank of Minneapolis

Abstract

This paper argues that the comovement between inflation and economic activity is an important determinant of real interest rates. Nominal bonds pay out more in bad times when inflation is procyclical. This makes nominal government debt a good hedge against aggregate risk for domestic risk-averse lenders. We show that procyclical inflation leads to lower real rates in the absence of default risk. However, inflation procyclicality implies that the government needs to make larger (real) payments when the economy deteriorates, which could push up default risk and increase real rates. We present empirical findings from advanced economies that are consistent with these patterns of real rates predicted by our simple model. Finally, we turn to a calibrated model that is consistent with our empirical evidence to quantify the welfare consequences of inflation cyclicality and to investigate how real rates respond when inflation uncertainty increases and how this depends on the interaction between inflation cyclicality and default risk.

Discussant(s)
Dmitry Mukhin
,
London School of Economics
Michael Waugh
,
Federal Reserve Bank of MInneapolis
Zachary Stangebye
,
University of Notre Dame
JEL Classifications
  • F0 - General
  • E0 - General