Research Papers

“The Zero Lower Bound and the Dual Mandate
(Revised May 2012, with William T. Gavin.) This article uses a DSGE framework to evaluate the role of monetary policy in determining the likelihood of encountering the zero lower bound. We find that the probability of experiencing episodes of being at zero lower bound depends almost exclusively on the monetary policy rule. A policy rule, such as the one proposed by Taylor (1993) which is based on the dual mandate is highly likely to lead to episodes of zero short-term interest rates if the central bank is not committed to its inflation target. Our results on nominal interest rate and inflation dynamics do not depend on the particular mechanism that makes monetary policy have real effects. The key and necessary assumption is that expectations are forward looking. The bottom line in models in which monetary policy can influence the real economy is that a central bank must be committed to a long-run average-inflation objective if it wishes to achieve a dual mandate while avoiding the zero lower bound.

“How Robust are Popular Models of Nominal Frictions?”
(Revised June 2016, with Evan F. Koenig) This paper analyzes various combinations of nominal price and wage frictions to determine which specifications best fit post-war U.S. data. We construct dynamic stochastic general equilibrium (DSGE) models that incorporate those frictions and use Bayesian methods to estimate each model's parameters. Since inflation was unanchored during the 1970s, we divide the data into three distinct periods: the early sample (from the mid-1950s through the 1960s), the middle sample (during the 1970s), and the late sample (from 1983 through 2007). Our estimates indicate that price and wage contracting arrangements have changed over time. Prices are re-optimized more often and exhibit a higher degree of indexation to past inflation in the middle sample than in the other two samples. In contrast, wages are re-optimized more frequently and display less evidence of indexation as time progresses. Our empirical results also suggest that both smaller and less-frequent technology shocks and improved monetary policy contributed to the reduced volatility in output observed during the "Great Moderation" period.

“Forward Guidance and the State of the Economy
(Revised April 2017, this paper is forthcoming in Economic Inquiry, with Alexander W. Richter,and Nathaniel A. Throckmorton.) This paper analyzes forward guidance in a nonlinear model with a zero lower bound (ZLB) on the nominal interest rate. Forward guidance is modeled with news shocks to the monetary policy rule, which capture innovations in expectations from central bank communication about future policy rates. Whereas most studies use quasi-linear models that disregard the expectational effects of hitting the ZLB, we show how the effectiveness of forward guidance nonlinearly depends on the state of the economy, the speed of the recovery, the degree of uncertainty, the policy shock size, and the forward guidance horizon when households account for the ZLB.

“Monetary Policy, the Tax Code, and the Real Effects of Energy Shocks
(Revised June 2014, this paper is published in Review of Economic Dynamics, 2015, 18(3), 694-707, with William T. Gavin and Finn E. Kydland.) This paper develops a monetary model with taxes to account for the time-varying effects of energy shocks on output and hours worked in post-World War II U.S. data. In our model, the real effects of an energy shock are amplified when the monetary authority responds to that shock by changing its inflation objective. Specifically, higher inflation raises households’ nominal capital gains taxes since those taxes are not indexed to inflation. The increase in taxes behaves as a negative wealth effect and generates an immediate decline in output, investment, and hours worked. The large drop in investment then causes a gradual but very persistent decline in the capital stock. That protracted decline in the capital stock is associated with an extended period of low labor productivity and high inflation. The real effects from the increase in nominal capital gains taxes are magnified by the tax on nominal interest income, which is also not indexed to inflation. A prolonged period of higher inflation and lower labor productivity following a negative energy shock is consistent with the stagflation of the 1970s. The negative effects, however, subsided greatly after 1980 due to the Volcker disinflation policy which prevented the Fed from accommodating negative energy shocks with higher inflation.

The Zero Lower Bound, Dual Mandate and Unconventional Dynamics
(Revised March 2015, this paper is published in the Journal of Economic Dynamics & Control, 2015, 55, 14-38, with William T. Gavin, Alexander W. Richter, and Nathaniel A. Throckmorton.) This paper examines monetary policy when it is constrained by the zero lower bound (ZLB) on the nominal interest rate. Our analysis uses a nonlinear New Keynesian model with technology and discount factor shocks. Specifically, we investigate why technology shocks may have unconventional effects at the ZLB, what factors affect the likelihood of hitting the ZLB, and the implications of alternative monetary policy rules. We initially focus on a New Keynesian model without capital (Model 1) and then study that model with capital (Model 2). The advantage of including capital is that it introduces another mechanism for intertemporal substitution that strengthens the expectational effects of the ZLB. Four main findings emerge: (1) In Model 1, the choice of output target in the Taylor rule may reverse the effects of technology shocks when the ZLB binds; (2) When the central bank targets steady-state output in Model 2, a positive technology shock at the ZLB leads to more pronounced unconventional dynamics than in Model 1; (3) The presence of capital changes the qualitative effects of demand shocks and alters the impact of a monetary policy rule that emphasizes output stability; and (4) In Model 1, the constrained linear solution is a decent approximation of the nonlinear solution, but meaningful differences exist between the solutions in Model 2.

“U.S. Monetary Policy: A View from Macro Theory
(Revised June 2012, this paper is published in Open Economics Review, 2013, 24(1), 33-49, with William T. Gavin.) We use a dynamic stochastic general equilibrium model to address two questions about U.S. monetary policy: 1) Can monetary policy elevate output when it is below potential? and 2) Is the zero lower bound a trap? The model’s answer to the first question is yes it can, but the effect is only temporary and probably not welfare enhancing. The answer to the second question is more complicated because it depends on policy. It also depends on whether it is the inflation rate or the real interest rate that will adjust over the longer run if the policy rate is held near zero for an extended period. We use the Fisher equation to analyze possible outcomes for situations where the central bank has promised to keep the interest rate near zero for an extended period.

“Taylor-Type Rules and Total Factor Productivity
(Published in the Federal Reserve Bank of St. Louis Review, January/February 2012, 91(1), 41 -64, with William T. Gavin and Michael R. Pakko.) This paper examines the impact of a persistent shock to the growth rate of total factor productivity in a New Keynesian model in which the central bank does not observe the shock. The authors then investigate the performance of alternative policy rules in such an incomplete information environment. While some rules perform better than others, the authors demonstrate that inflation is more stable after a persistent productivity shock when monetary policy targets the output growth rate (not the output gap) or the price-level path (not the inflation rate). Both the output growth and price-level path rules generate less volatility in output and inflation following a persistent productivity shock compared with the Taylor rule.

“Monetary Policy and Natural Disasters in a DSGE Model”
(Revised March 2010, this paper is published in the Southern Economic Journal, 2011, 77(4), 973-990, with Michael R. Pakko.) In the immediate aftermath of Hurricane Katrina, speculation arose that the Federal Reserve might respond by easing monetary policy. This paper uses a dynamic stochastic general equilibrium (DSGE) model to investigate the appropriate monetary policy response to a natural disaster. We show that the standard Taylor (1993) rule response in models with and without nominal rigidities is to increase the nominal interest rate. That finding is unchanged when we consider the optimal policy response to a disaster.  A nominal interest rate increase following a disaster mitigates both temporary inflation effects and output distortions that are attributable to nominal rigidities.

“The Signal Extraction Problem Revisited: A Note on Its Impact on a Model of Monetary Policy”
(Revised March 2009, this paper is published in Macroeconomic Dynamics, 2010, 14(4), 405-426.) This paper develops a dynamic stochastic general equilibrium (DSGE) model with sticky prices and sticky wages, where agents have imperfect information on the stance and direction of monetary policy. Agents respond by using Kalman filtering to unravel persistent and temporary monetary policy changes in order to form optimal forecasts of future policy actions. Our results show that a New Keynesian model with imperfect information can account for several key effects of an expansionary monetary policy shock: the hump-shaped increase in output, the delayed and gradual rise in inflation, and the fall in the nominal interest rate.

“Output, Inflation, and Interest Rates in an Estimated Optimizing Model of Monetary Policy”
(Revised November 2006, this is an extended version of my paper published in the Review of Economic Dynamics, 2009, 12(2), 327-343.) This paper examines the impact of sticky price and limited participation frictions, both separately and combined, in a dynamic stochastic general equilibrium model. Using U.S. data on output, inflation, interest rates, money growth, consumption, and investment, likelihood ratio tests and Bayesian pseudo-odds measures reveal that the data prefers a model with both structural features. Our results also show that the combined model mimics many important features of the business cycle. In particular, the model generates plausible impulse responses, and monetary policy shocks are responsible for only a modest amount of output, inflation, and nominal interest rate movements.

“Inflation Risk and Optimal Monetary Policy”
(Revised December 2007, this paper is published in Macroeconomic Dynamics, 2009, 13(s1), 58-75, with William T. Gavin and Michael R. Pakko.) This paper shows that the optimal monetary policies recommended by New Keynesian models still imply a large amount of inflation risk. We calculate the term structure of inflation uncertainty in New Keynesian models when the monetary authority adopts the optimal policy. When the monetary policy rules are modified to include some weight on a price path, the economy achieves equilibria with substantially lower long-run inflation risk. With either sticky prices or sticky wages, a price path target reduces the variance of inflation by an order of magnitude more than it increases the variability of the output gap.

“Sticky Price and Sticky Information Price Setting Models: What is the Difference?”
(Revised June 2006, this version of my paper is published in Economic Inquiry, 2007, 45(4), 770-786.) Using a partial equilibrium framework, Mankiw and Reis [2002] show that a sticky information model can generate a lagged and gradual inflation response after a monetary policy shock, whereas a sticky price model cannot. Our paper demonstrates that that finding is sensitive to their model's parameterization. To determine a plausible parameterization, we specify a general equilibrium model with sticky information. In that model, we find that inflation peaks only one period after a monetary disturbance. A sensitivity analysis of our results reveals that the inflation peak is delayed by including real rigidities when the monetary policy instrument is money growth, whereas inflation peaks immediately when the policy instrument is the nominal interest rate.

“What is a Realistic Value for Price Adjustment Costs in New Keynesian Models?”
(Revised December 2005, this is an extended version of our paper published in Applied Economics Letters, 14(11), 789-793, with Yongsheng Wang.) Rotemberg's [1982] price adjustment costs framework is a popular sticky price specification; yet, the data provides little information on the magnitude of those costs. This paper finds a plausible range of parameterizations for those price adjustment costs. Our results show that the specific size of the price adjustment costs depends on the average markup of price over real marginal cost and the average time firms wait to reoptimize their price. In particular, the price adjustment costs are higher when the average markup is lower and the mean time between price reoptimizations is longer.

“The Monetary Instrument Matters”
(Published in the Federal Reserve Bank of St. Louis Review, September/October 2005, 87(5), 633-658, with William T. Gavin and Michael R. Pakko.)  This paper revisits the issue of money growth versus the interest rate as the instrument of monetary policy.  Using a dynamic stochastic general equilibrium framework, the authors examine the effects of alternative monetary policy rules on inflation persistence, the information content of monetary data, and real variables.  They show that inflation persistence and the variability of inflation relative to the money growth depend on whether the central bank follows a money growth rule or an interest rate rule.  With a money growth rule, inflation is not persistent and the price level is much more volatile than the money supply.  Those counterfactual implications are eliminated by the use of interest rate rules whether prices are sticky or not.  A central bank’s utilization of interest rate rules, however, obscures the information content of monetary aggregates and also leads to subtle problems for econometricians trying to estimate money demand functions or to identify shocks to the trend and cycle components of the money stock.

“In Search of the Liquidity Effect in a Modern Monetary Model”
(Revised April 2001, this is an earlier version of my paper published in the Journal of Monetary Economics, 2004, 51(7), 1467-1494.) This paper examines the impact of a monetary policy shock in a dynamic stochastic general equilibrium model with sticky prices and financial market frictions. First, we examine the shortcomings of monetary models emphasizing these frictions individually. The model then is specified to limit the response of prices and savings to a current period monetary disturbance. Our results show that this model can account for the following key responses to an expansionary monetary policy shock: a fall in the nominal interest rate; a rise in output, consumption, and investment; and a gradual increase in the price level. Finally, a detailed sensitivity analysis shows the model's results depend on the parameters assigned to critical structural features. Technical Appendix

“Results of a Study of Stability of Cointegrating Relations Comprised of Broad Monetary Aggregates”
(Federal Reserve Bank of Cleveland Working Paper #99-17, published in the Journal of Monetary Economics, 2000, 46(2), 345-383, with John B. Carlson, Dennis L. Hoffman, and Robert H. Rasche.) We find strong evidence of a stable "money demand" relationship for MZM and M2M through the 1990s. Though the M2 relation breaks down somewhere around 1990, evidence has been accumulating that the disturbance is well characterized as a permanent upward shift in M2 velocity, which began around 1990 and was largely over by 1994. Taken together, our results support the hypothesis that households permanently reallocated a portion of their wealth from time deposits to mutual funds. Although this reallocation may have been induced by depository restructuring, we argue that the substitution could be explained by appropriately measured opportunity cost.

“MZM: A Monetary Aggregate for the 1990s?”
(Published in the Federal Reserve Bank of Cleveland Economic Review, 1996 Quarter 2, 15-23, with John B. Carlson.) Deregulation and financial innovation have wreaked havoc on the relationship of traditionally defined money measures with economic activity and interest rates. In this article, the authors present some tentative evidence that an alternative measure of money, MZM, has endured these events reasonably well. MZM is broader than M1 but essentially narrower than M2, comprising all instruments payable at par on demand. Since 1974, MZM has exhibited a fairly stable relationship with nominal GDP and with its own opportunity cost, suggesting that the aggregate has a potential role for policy.

“Where is All the Currency Hiding?”
(Published in the Federal Reserve Bank of Cleveland Economic Commentary, April 15, 1996, with John B. Carlson.) An examination of the U.S. dollar’s growing popularity abroad and a discussion of the implications of rising currency demand for U.S. economic policy.

“M2 Growth in 1995: A Return to Normalcy?”
(Published in the Federal Reserve Bank of Cleveland Economic Commentary, December 1995, with John B. Carlson.) In recent years, M2 growth has been unusually weak. This aberrant behavior led to its demise as the primary indicator of monetary policy. Although the aggregate has been behaving more normally over the past year or so, it seems unlikely that it will soon regain its earlier stature as a key policy guide.

Maintained by
Last Modified: April 13, 2017