Topics in Empirical Macroeconomics

National Bureau Of Economic Research Inc, Cambridge MA

Investigators

Abstract

This research aims at developing empirically based dynamic general equi-librium models for analyzing monetary policy based on evidence both from the U.S. and from countries that have experienced currency crises. The research agenda can be divided into two general topics: (i) understanding the link between monetary policy and private sector outcomes in the US. and (ii) understanding the links between government policy and currency crises in emerging markets. Projects under the first topic involve constructing and estimating models that can account quantitatively for the key facts about the US monetary transmission mechanism. The models investigated have four key- characteristics. First. they embody complementary sources of monetary non-neutrality steming from frictions in good, labor and asset markets. Second. they embody modifications to the real side of standard business cycle models. These modifications play a key role in the analysis because they help render the models consistent with the fact that marginal production costs are only mildly procyclical. Third, the models are designed so that individual agents, taking as given economy-wide variables, have only small incentives to overcome the nominal frictions in their environment. Nevertheless nominal frictions have a first order effect on the economy. Fourth. the models are empirically tractable and can be formally investigated using econometric methods. Preliminary evidence from a simple version of the model, embodying modest nominal rigidities, is capable of generating persistent real effects from monetary shocks consistent with those identified in the data. In addition. the model can account for the inertial behavior of inflation and real wages. Much of this research is joint research with Lawrence Christiano (Northwestern University) and Charles Evans (Federal Reserve Bank of Chicago). The second topic consists of three projects aimed at under-standing the causes and consequences of currency crises. The unifying theme between the projects is the link between government policies, the fragility of financial systems and currency crises. The first project explores why governments with similar sized prospective deficits, stemming from failing financial systems, experience exchange rate crises of different magnitudes and different post-crises inflation rates. The key observation here is that governments differ in the extent to which their lia-bilities are indexed to inflation. The inflation that follows a currency devaluation acts like a partial fiscal reform, effectively providing a government with a source of revenue other than seignorage. Ex ante heterogeneity regarding non-indexed liabilities leads to ex post heterogeneity with respect to monetary policy and inflation. In addition, the research also explores why reported inflation is so much lower than the rate of exchange rate devaluation in the wake of many currency crises. The second project examines the relationship between government guarantees, the sectoral composition of bank lending and banks' hedging activities. It analyzes the impact of government guarantees on the exposure of banking systems to real shocks and the corresponding fragility of fixed exchange rate regimes. The third project investigates why governments extend guarantees to banks' foreign creditors in developing countries. Much of the research in this section of the proposal is joint with Sergio Rebelo (Northwestern University) and Craig Burnside (World Bank).