CAREER: Normative Macro-Finance

Yale University, New Haven CT

Investigators

Abstract

This CAREER project expands and consolidates a particular area of economics, normative macro-finance. This field studies the efficiency, distributional impact, and optimal design of policy in economies in which risk, heterogeneity, dynamic considerations, imperfect commitment, and financial frictions are of first-order relevance. To that end, this project i) develops a general framework to make welfare assessments in environments with risk and uncertainty, ii) explores the welfare implications of assigning different mandates to central bankers, iii) studies the design of corrective regulation with imperfect instruments and multiple regulators, iv) examines the welfare properties of trading in financial markets when agents have different information, and v) explores the welfare consequences of allowing for joint borrowing agreements among different governments. The educational component of this project develops new self-contained materials on how to conduct normative analysis on questions pertaining to financial economics and macroeconomics. This will lower the barriers to entry to normative macro-finance, in particular for policymakers and economists in policymaking institutions. Better understanding of the welfare consequences of economic policies will influence the optimal design and implementation of government policy. This CAREER project has five components. The first component develops a general framework for making welfare assessments in dynamic stochastic economies with rich individual heterogeneity by introducing the notion of Dynamic-Stochastic weight (DS-weights). This framework allows for a novel, exact, and widely applicable decomposition of welfare assessments. This decomposition opens the door to defining new mandates for policy institutions that were not possible before. The second component explores the welfare implications of assigning different mandates to central bankers in an environment in which optimal monetary policy may be time inconsistent, perhaps because of distributional considerations. The third component studies the design of optimal corrective regulation whenever policies are conducted with imperfect instruments and when there are multiple regulators with potentially different regulatory mandates. The fourth component studies the welfare properties of trading in financial markets when individual investors have dispersed information and markets are incomplete. The fifth component studies the welfare consequences of allowing for joint borrowing agreements among different governments. Each component is directly related to economic policymaking and will provide new insights into normative questions in finance and macroeconomics. This award reflects NSF's statutory mission and has been deemed worthy of support through evaluation using the Foundation's intellectual merit and broader impacts review criteria.