Monetary Policy, Asset Prices, and the Macroeconomy
Lightning Round SessionSunday, Jan. 5, 2025 1:00 PM - 3:00 PM (PST)
- Chair: Kevin J. Lansing, Federal Reserve Bank of San Francisco
Blanchard-Type Speculative Bubbles in a Real Business Cycle Economy
Abstract
This paper studies speculative bubbles that arise in a Real Business Cycle (RBC) economy, under the assumption that there is no transversality condition (TVC) for production capital. The lack of TVC can be due to an overlapping-generations population structure. Except for the absence of the TVC, the model here is identical to a canonical RBC model with an infinitely-lived representative agent. I show how to construct speculative bubbles that feature recurrent boom-bust cycles characterized by bounded investment and output expansions that are followed by abrupt contractions in real activity. Importantly, speculative bubbles can arise when there are no shocks to technologies or preferences. Speculative bubbles are thus a novel potential source of real activity fluctuations.The notion of speculative bubbles, defined as multiple equilibria due to the absence of a TVC for asset holdings, was introduced by Blanchard (1979), in a simple log-linear asset pricing model. This notion has been very influential in finance, as it provides a powerful narrative about explosive asset price booms that are followed by sudden crashes. However, so far, that concept has had little impact on structural macroeconomics. This paper provides the first analysis of Blanchard-type speculative bubbles, in a general equilibrium production economy without a TVC for physical capital.
Like Blanchard, I assume a two-states bubble process. The economy can either be in a ‘boom’ or in a ‘bust’. Booms/busts reflect self-fulfilling expectations about future investment. In a boom, investment diverges positively from the no-bubble decision rule; this is driven by agents’ belief that, with positive probability, investment will grow next period, thereby depressing future consumption and raising the (expected) future marginal utility-weighted return of capital, which rationalizes high current investment (in boom). At any time, a bust can occur; in a bust, investment drops abruptly, and reverts towards the no-bubble decision rule.
Business Cycles in A Model with Banks and Occasionally Binding Constraints
Abstract
Changes in leverage play an important role in impacting consumption and investment behavior in the economy, but some lenders may choose not to utilize their full credit limits. Using Bayesian methods, we estimate a dynamic stochastic general equilibrium model of heterogeneous agents with leveraged banks and occasionally binding collateral constraints. We study the business cycle dynamics of two specific shocks affecting the leveraged sector: loan-to-value shocks on impatient households and default shocks on entrepreneurs' loans. We compare the impulse responses to two other models excluding either banks or occasionally binding constraints. Only in the model with banks and occasionally binding constraints do macro variables co-move consistently with empirical evidence in response to these two shocks affecting the leveraged sector.Disaster Risk in HANK
Abstract
Motivated by the evidence that recessions widen inequality (Heathcote, Perri, Violante 2020), this paper studies a Heterogeneous Agent New Keynesian (HANK) model with a risk of economic disaster following Gourio (2013). A disaster drives a decline in hand-to-mouth employment and output. Inequality between households persists long after the impact of the disaster subsides. The disaster dampens the indirect effect of expansionary monetary policy in HANK but causes an increase in the expected return on illiquid, risky assets. Under certain conditions, expansionary monetary policy reduces inequality by encouraging households to hold more high return assets or providing an opportunity to refinance.Market's Time-Varying Sensitivity to Macro News and Monetary Policy
Abstract
This paper studies the market's time-varying sensitivity to macroeconomic news announcements, focusing on the responsiveness of interest rates. I find that the market's sensitivity varies substantially over time, with high sensitivity during high inflation, rising unemployment, or when the Fed frequently mentions macroeconomic data. This pattern is consistent with the theory of "rational inattention". The documented time-varying sensitivity has significant macroeconomic implications. When the market has been highly sensitive to macro news, it is also more responsive to FOMC announcements -- monetary policy shocks are significantly more effective in moving the yield curve when the prevailing sensitivity is high. Additionally, the market‘s sensitivity appears to predict its disagreement with the Fed. Overall, this study highlights the role of market attention and learning intensity in macroeconomic dynamics.Market Liquidity and Inventory Cycles
Abstract
Inventory behavior is an important part of the business cycles. Using U.S. data, the structural VAR shows that inventory investment is pro-cyclical, the inventory-sales ratio is counter-cyclical and the aggregate markup is pro-cyclical. However, the existing explanations for inventory holdings can’t adequately capture these empirical regularities. To fill the gap, this paper rationalizes inventory holdings via search friction and explains its cyclical behavior by market liquidity – the trade-off between markup and selling speed. In the proposed model, sellers stock goods and post prices, while buyers choose which sellers to visit. Due to the lack of coordination, the sales are stochastic and there is leftover inventory. The frictional trade reveals a new incentive to hold inventory. Sellers compete in not only pricing but also buyers’ probability of consumption as part of their shopping experience. As a result, carrying additional inventory allows sellers to post more profitable terms of trade. This new incentive has negative externality, such that sellers largely overstock in equilibrium. In contrast to the Walrasian framework in which agents take prices as given, sellers in the proposed model can actively adjust prices in addition to quantities. The additional pricing channel helps the model making predictions that are in line with the empirical regularities of inventory cycles.Optimal Policy Without Rational Expectations: A Sufficient Statistic Solution
Abstract
How should policymakers respond to mistakes made by agents without rational expectations? I demonstrate in a general setting that the optimal policy is determined by a sufficient statistic: agents' belief distortions. This result is both simple and only semi-structural: in order to calculate policy from the belief distortion, the policymaker does not need to know the whole macroeconomic model. They only need to know how beliefs and policies distort decisions. Crucially, they do not even need to know how expectations are formed; they only need to measure them. Next, I study several examples. In a behavioral RBC model, the optimal policy is to tax capital when agents are overly optimistic about future returns. In a behavioral New Keynesian model, the optimal policy is to raise interest rates when agents misperceive the economy to be running hot.The Interaction between Monetary and Macroprudential Policies under Inflationary Shocks
Abstract
This paper studies the interaction between monetary policy and macroprudential policy under an inflationary environment. We use a DSGE model with collateral constraints to show that inflationary shocks post a unique challenge to the conduct of macro stabilization policies, as inflationary shocks push inflation and output to opposite directions and binding collateral constraints could influence the transmission of inflationary shocks through the tightness of macroprudential policy. In other words, the inflationary shocks create a richer environment in which macroprudential policy and monetary policy interact. In lights of multiple trade-offs faced by policy-makers, the optimal policy needs to find the balance between stabilizing the macro economy and financial stability.The Macroeconomics of Liquidity in Financial Intermediation
Abstract
In financial crises, the premium on liquid assets such as US Treasuries increases alongside credit spreads. This paper explains the link between the liquidity premium and spreads. We present a theory of endogenous bank fragility arising from a coordination friction among bank creditors. The theory’s implications reduce to a single constraint on banks, which is embedded in a quantitative macroeconomic model to investigate the transmission of shocks to spreads and economic activity. Shocks that reduce bank net worth exacerbate the coordination friction. In response, banks lend less and demand more liquid assets. This drives up both credit spreads and the liquidity premium. By mitigating the coordination friction, expansions of public liquidity reduce spreads and boost the economy. Empirically, we identify high-frequency exogenous variation in liquidity by exploiting the time lag between auction and issuance of US Treasuries. We find a causal effect on spreads in line with the calibrated model.The Original Sin: Fragmentation in the Money Market and Its Transmission to the Credit Market
Abstract
This paper uses transaction-by transaction data from 2017 to 2023 to analyse fragmentation in the euro area. First, we examine the average degree of fragmentation in the euro are overnight unsecured money market. Second, we develop the first daily country-specific indicator of fragmentation for the euro area unsecured overnight market. Third, we use the newly constructed indicator to estimate how relevant is fragmentation for the transmission of monetary policy to the credit market in the eurozone. The decision to construct a fragmentation indicator using the unsecured money market is rooted not only in the market's pivotal role in monetary policy but also in its inherent characteristics, rendering it an ideal setting for quantifying fragmentation. Our results show significant evidence of fragmentation. Throughout the estimation period, Italian and Belgian banks demonstrate a positive premium of approximately 8 and 4 basis points (bps), respectively, compared to their German counterparts. Conversely, Dutch banks exhibit a negative premium of roughly 4 bps. Moreover, the time-varying country-specific fragmentation indicators show that fragmentation has steadily increased since the beginning of the ECB interest rate hiking cycle (Summer 2022) for countries consistently exhibiting positive premium averages, such as Italy, Spain, and Belgium. Finally, the paper finds that money market fragmentation gets passed-through along the monetary policy transmission chain, and in particular to the credit market, with 1 bp fragmentation premium getting transmitted more than in full to credit rates to firms.JEL Classifications
- E3 - Prices, Business Fluctuations, and Cycles