Research

Keeping Control over Boundedly Rational Expectations

with Magali Marx

How can central banks avoid losing control over inflation expectations? We reconsider the issue for a large class of expectations beyond rational expectations, embedding cognitive discounting and long-term learning. (1) Restricting monetary policy to a Taylor rule, the Taylor principle does not prevent self-fulfilling inflation but inflation spirals. (2) Against inflation spirals, active monetary policy can be characterized beyond Taylor rules, as a sufficient increase of a weighted average of present and future policy rates. Future rates are weighted less, so delaying hikes requires larger hikes. (3) Yet, increasing rates slowly can be optimal provided a large cost on output stabilization.

The Dynamic IS Curve when There Is Both Investment and Savings

How does aggregate demand depend on present and future policy rates? The New-Keynesian dynamic IS curve gives an answer but only when the interest rate channel originates in savings decisions alone. The paper derives it when the interest rate channel also originates in investment decisions. In line with partial-equilibrium intuition, investment can make future rates matter less. But it makes them matter more if the intertemporal elasticity of substitution is not small enough. Adding household heterogeneity, investment can also make future rates matter less for consumption, by making consumption respond primarily as a ripple effect of the response of investment.

A Plucking Model of Business Cycles

with Emi Nakamura And Jón Steinsson

Code to date peaks and troughs

Note on Non-Linearities in the DMP Model

Press: Bloomberg, Agefi, La Planche à Billets

R&R Journal of Monetary Economics

In standard models, economic activity fluctuates symmetrically around a “natural rate” and stabilization policies can dampen these fluctuations but do not affect the average level of activity. An alternative view—labeled the “plucking model” by Milton Friedman—is that economic fluctuations are drops below the economy’s full potential ceiling. We show that the dynamics of the unemployment rate in the US display a striking asymmetry that strongly favors the plucking model: increases in unemployment are followed by decreases of similar amplitude, while the amplitude of a decrease does not predict the amplitude of the following increase. In addition, business cycles last seven years on average and unemployment rises much faster during recessions than it falls during expansions. We augment a standard labor search model with downward nominal wage rigidity and show how it can fit the plucking property. We then show that additional non-standard features are required to match the level and asymmetry of the duration of contractions and expansions.