“Inflation
Legacies: Do Early-Life Experiences Affect African Central
Bankers' Policy Preferences?”
(April 2024, with Christine O. Strong.) This paper examines whether
the decision-making dynamics of African central bankers are impacted
by early-life experiences with inflation crises. We address this
question by developing a Barro-Gordon (1983) style model where a
central banker with past exposure to an inflation crisis prefers a
more hawkish monetary policy. To evaluate our theory, we use data
from 26 African countries between 1990 and 2020 to understand the
impact of early-life experiences on the policy preferences of
African central bankers. Our empirical findings show that 1) Money
grows at a significantly lower rate when a central banker
experiences inflation crises in early life; 2) The magnitude of the
decline in money growth is positively related to the number of
early-life inflation crises that a central banker experiences; and
3) Early-life experiences with inflation crises continue to have a
significant impact even when a central banker's professional
experience and educational level are taken into account.
“The
Political Economy of African Currency Unions: Evidence from a
Time-Inconsistent Model”
(Revised February 2023, with Christine O. Strong.) This paper
develops a model to assess the benefits and costs of a currency
union between the monetary autonomous countries of the West African
Monetary Zone (WAMZ) and the monetary union countries of either the
West African Economic and Monetary Union (WAEMU) or the Central
African Economic and Monetary Community (CAEMC). We utilize a
tractable model with three key features to account for the existence
of fiscal dominance and political business cycles that are common in
Africa but are not emphasized in the currency union literature. One,
our model allows central banks to set their own inflation rate
target with the idea that, in Africa, a currency union's inflation
rate target is usually lower than an individual country's desired
target. Two, this paper assumes each African government/central bank
maximizes its own utility rather than the households' utility.
Three, our model captures the lack of monetary policy credibility
when policymakers pursue time-inconsistent policies. Specifically,
we show that an African country without monetary policy credibility
benefits from joining a monetary union when the country has similar
supply shocks to the other currency union countries, but it suffers
when the country must accept the currency union's lower inflation
rate target. [Online Appendix]
“Optimal
Fiscal and Monetary Policy in a Model with Government
Corruption” (Revised July 2023, this paper is an earlier version of our
article published in Finance Research Letters, 2023,
58(B) 104435,
with Christine O. Strong.) This paper builds a theoretical
model where corrupt government officials select the optimal amount
of government spending directed toward building wealth for
themselves and political allies. We refer to this type of government
expenditures as rent extraction spending. Our results show that more
government corruption leads to higher rent extraction spending,
increased inflation, additional taxation, and lower non-rent
extraction spending. The increases in inflation and rent extraction
spending, however, are more muted when the corrupt country is a
member of a currency union.
“Modeling
the Asymmetric Effects of an Oil Price Shock”
(Revised January 2022, this paper is published in the International
Journal of Central Banking, 2023, 19(4), 1-47, with Lance J.
Bachmeier.) This paper documents that an oil price increase
generates a larger decline in output when the oil price hits a
near-term high. We develop a New Keynesian model with energy and a
downward nominal wage rigidity that generates asymmetric responses
of the macroeconomy to energy price shocks. Specifically, a large
energy price increase pushes down the real wage enough that the
downward nominal wage constraint binds for several periods, which
causes firms to reduce their output further. Since that mechanism is
unimportant when energy prices fall, the downward nominal wage
constraint causes output to react asymmetrically to oil price
shocks. [Replication Files]
“How
Robust are Popular Models of Nominal Frictions?”
(Revised August 2017, this paper is published in the Journal
Money, Credit and Banking, 2018, 50(6), 1299-1342, 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: an early sample (mid-1950s through 1960s), a
middle sample (1970s), and a late sample (1983 through 2007). Our
estimates indicate that price and wage setting 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. The differences in wage and price setting are shown to
have important implications for the economy's response to key
economic shocks. [Replication
Files]
“Forward Guidance and the State
of the Economy”
(Revised April 2017, this paper is published in Economic
Inquiry, 2017, 55(4), 1593-1624, 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. [Replication
Files] “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.
“The
Zero Lower Bound and the Dual Mandate”
(Revised May 2012, working paper, 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.
“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 paper is an extended version of my
article 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.