Working Papers

Bias in Local Projections (with Edward P. Herbst, 2020)

Local projections (LPs) are a popular tool in applied macroeconomic research. We survey the related literature and find that LPs are often used with very small samples in the time dimension. With small sample sizes, given the high degree of persistence in most macroeconomic data, impulse responses estimated by LPs can be severely biased. This is true even if the right-hand-side variable in the LP is iid, or if the data set includes a large cross-section (i.e., panel data). We derive simple expressions for this bias in a variety of settings. As a byproduct, we propose a way to bias-correct LPs. We also show that, in small samples, autocorrelation-robust standard errors can dramatically understate the uncertainty surrounding LP estimators, even when appropriate. Our results suggest, in LP settings like the ones we study, researchers should avoid them. Using U.S. macroeconomic data and identified monetary policy shocks, we demonstrate that the bias in point estimates can be economically meaningful and the bias in standard errors can affect inference.

Does the New Keynesian Model have a Uniqueness Problem? (with Lawrence J. Christiano and Martin S. Eichenbaum, NBER Working Paper, No. 24612, 2018, revision requested).

This paper addresses whether non-uniqueness of equilibrium is a substantive problem for the analysis of fiscal policy in New-Keynesian (NK) models at the zero lower bound (ZLB). There would be a substantive problem if there were no compelling way to select among different equilibria that give different answers to critical policy questions. We argue that learnability provides such a criterion. We study a fully non-linear NK model with Calvo pricing frictions. Our main finding is that the model we analyze has a unique E-stable rational expectations equilibrium at the ZLB. That equilibrium is also stable-under-learning and inherits all of the key properties of linearized NK models for fiscal policy.

Inflation Experience and Inflation Expectations: Dispersion and Disagreement Within Demographic Groups (2014)

Using consumption data from the Consumer Expenditure Survey, I document persistent differences across demographic groups in the dispersion of household-specific rates of inflation. Using survey data on inflation expectations, I show that demographic groups with greater dispersion in experienced inflation also disagree more about future inflation. I argue that these results can be rationalized from the perspective of an imperfect information model in which idiosyncratic inflation experience serves as a signal about aggregate inflation.

When are the Effects of Fiscal Policy Uncertainty Large? (2014)

Using a new-Keynesian model with endogenous capital accumulation, I show that uncertainty about fiscal policy can cause large declines in consumption, investment, and output when the zero lower bound (ZLB) binds, but has modest effects when the monetary authority is not constrained by the ZLB. I study uncertainty about the level of government spending and uncertainty about tax rates on consumption, wages, capital income, and investment. In my model, uncertainty about government spending and the wage tax rate has particularly large effects. I show that the effects of fiscal policy uncertainty are largest when the nominal interest rate is on the cusp of the ZLB and also that delaying fiscal policy uncertainty diminishes its effects only if the resolution of uncertainty occurs after ZLB no longer binds.

Publications and Accepted Papers

Understanding the New Normal: The Role of Demographics (with Etienne Gagnon and David Lopez-Salido, accepted, IMF Economic Review).

Since the Great Recession, the U.S. economy has experienced low real GDP growth and low real interest rates, including for long maturities. To understand the contribution of demographic factors, we calibrate an overlapping-generation model with a rich demographic structure to observed and projected changes in U.S. population, family composition, life expectancy, and labor market activity. The model accounts for a 1¼–percentage-point decline in both real GDP growth and the equilibrium real interest rate since 1980—essentially all of the permanent declines in those variables according to some estimates. The model also implies that these declines were especially pronounced over the past decade or so because of demographic factors most-directly associated with the post-war baby boom and the passing of the information technology boom. Our results further suggest that real GDP growth and real interest rates will remain low in coming decades, consistent with the U.S. economy having reached a “new normal.”

Supply-Side Effects of Pandemic Mortality: Insights from an Overlapping-Generations Model (with Gagnon, Etienne and David Lopez-Salido, accepted, B.E. Journal of Macroeconomics).

We use an overlapping-generations model to explore the implications of mortality during pandemics for the economy’s productive capacity. Under current epidemiological projections for the progression of COVID-19, our model suggests that mortality will have, in itself, at most small effects on output and factor prices. The reason is that projected mortality is small in proportion to the population and skewed toward individuals who are retired from the labor force. That said, we show that if the spread of COVID-19 is not contained, or if the ongoing pandemic were to follow a mortality pattern similar to the 1918–1920 Great Influenza pandemic, then the effects on the productive capacity would be economically significant and persist for decades.

Oil, Equities, and the Zero Lower Bound (with Deepa Datta, Hanna Kwon, and Robert J. Vigfusson, Forthcoming, American Economic Journal: Macroeconomics)

From late 2008 to 2014, oil and equity returns were more positively correlated than in other periods. In addition, we show that both oil and equity returns became more responsive to macroeconomic news. We provide empirical evidence that these changes resulted from the zero lower bound (ZLB) on nominal interest rates, consistent with the theoretical predictions of a model that includes the ZLB. Although the ZLB alters the economic environment in theory, supportive empirical evidence has been lacking. Our paper provides clear evidence of the ZLB altering the economic environment.

A Time Series Model of Interest Rates With the Effective Lower Bound (with Elmar Mertens, Accepted, Journal of Money, Credit & Banking)

Over the last decade, nominal interest rates have fallen to very low levels in many countries. Thus, central banks have seen their choices for the appropriate path of policy rates constrained by an effective lower bound, a level below which nominal interest rates cannot fall. Nevertheless, traditional forecasting models neglect this lower boundary, which is equivalent to assuming central banks could steer interest rates as low as they like. But acknowledging the lower bound should evidently matter when forecasting the path of interest rates and for understanding economic responses to policy changes.

Monetary Policy and the Predictability of Nominal Exchange Rates (with Martin Eichenbaum and Sergio Rebelo, 2021, The Review of Economic Studies).

This article studies how the monetary policy regime affects the relative importance of nominal exchange rates and inflation rates in shaping the response of real exchange rates to shocks. We document two facts about inflation-targeting countries. First, the current real exchange rate predicts future changes in the nominal exchange rate. Second, the real exchange rate is a poor predictor of future inflation rates. We estimate a medium-size, open-economy DSGE model that accounts quantitatively for these facts as well as other empirical properties of real and nominal exchange rates. The key estimated shocks that drive the dynamics of exchange rates and their covariance with inflation are disturbances to the foreign demand for dollar-denominated bonds.

Comment on Henriksen and Cooley “The Demographic Deficit” (with Etienne Gagnon and David Lopez-Salido, 2018, Journal of Monetary Economics)

Understanding the Volatility of the Canadian Exchange Rate (with Martin Eichenbaum and Sergio Rebelo, 2018, C.D. Howe Institute

Monetary Policy, Incomplete Information, and the Zero Lower Bound (with Chris Gust and David Lopez-Salido, 2017, IMF Economic ReviewWorking paper version.

In the context of a stylized New Keynesian model, we explore the interaction between imperfect knowledge about the state of the economy and the zero lower bound. We show that optimal policy under discretion near the zero lower bound responds to signals about an increase in the equilibrium real interest rate by less than it would when far from the zero lower bound. In addition, we show that Taylor-type rules that either include a time-varying intercept that moves with perceived changes in the equilibrium real rate or that respond aggressively to deviations of inflation and output from their target levels perform similarly to optimal discretionary policy. Our analysis of first-difference rules highlights that rules with interest rate smoothing terms carry forward current and past misperceptions about the state of the economy and can lead to suboptimal performance.

Are Long-Run Inflation Expectations Anchored More Firmly in the Euro Area Than in the United States? (with Meredith J. Beechey and Andrew T. Levin, 2011, American Economic Journal: Macroeconomics). Working paper version.

This paper compares the evolution of long-run inflation expectations in the euro area and the United States, using evidence from financial markets and surveys of professional forecasters. Survey data indicate that long-run inflation expectations are reasonably well anchored in both economies but reveal substantially greater dispersion across forecasters’ long-horizon projections of US inflation. Analysis of daily data on inflation swaps and nominal-indexed bond spreads, which gauge compensation for expected inflation and inflation risk, also suggests that long-run inflation expectations are more firmly anchored in the euro area than in the United States.

Other Publications

Strengthening the FOMC’s Framework in View of the Effective Lower Bound and Some Considerations Related to Time-Inconsistent Strategies (with Fernando Duarte, Leonardo Melosi, and Taisuke Nakata, 2020)

The analysis in this paper was presented to the Federal Open Market Committee as background for its discussion of the Federal Reserve’s review of monetary policy strategy, tools, and communication practices.  The Committee discussed issues related to the review at five consecutive meetings from July 2019 to January 2020.

The Neutral Rate and the Summary of Economic Projections (with Michelle Bongard, 2016, FEDS Note)

The Expected Real Interest Rate in the Long Run: Time Series Evidence with the Effective Lower Bound (with Elmar Mertens, 2016, FEDS Note)