Monetary Policy and Liquidity Constraints: Evidence from the Euro Area

We quantify the relationship between the response of output to monetary policy shocks and the share of liquidity constrained households. We do so in the context of the euro area, using a Local Projections Instrumental Variables estimation. We construct an instrument for changes in interest rates from changes in overnight indexed swap rates in a narrow time window around ECB announcements. Monetary policy shocks have heterogeneous effects on output across countries. Using micro data, we show that the elasticity of output to monetary policy shocks is larger in countries that have a larger fraction of households that are liquidity constrained.

Reconciling Empirics and Theory: The Behavioral Hybrid New Keynesian Model

Structural estimates of the standard New Keynesian model are at odds with the microeconomic estimates. To reconcile these findings, we develop and estimate a behavioral New Keynesian model augmented with backward-looking households and firms. We find (i) strong evidence for bounded rationality, with a cognitive discount factor estimate of 0.4 at a quarterly frequency; and (ii) that the behavioral setting with backward-looking agents helps us harmonize the New Keynesian theory with empirical studies. We suggest that both cognitive discounting and anchoring are essential, first, to match the empirical estimates for certain parameters of interest and, second, to obtain the hump-shaped and initially muted impulse-response functions that we observe in empirical studies.

HANK beyond FIRE

The transmission channel of monetary policy in the benchmark New Keynesian (NK) framework relies on the counterfactual Full–Information Rational–Expectations (FIRE) assumption, both at the partial and general equilibrium (GE) dimensions. We relax the Full-Information assumption and build a Heterogeneous-Agents NK model under dispersed information. We find that the amplification multiplier is dampened. This result is explained by the lessened and lagged role of GE effects in our framework. We then conduct the standard full-fledged NK analysis: we find that the determinacy region is widened as a result of as if aggregate myopia and show that our framework beyond FIRE does not suffer from the forward guidance puzzle. Finally, we find that transitory “animal spirits” shocks generate persistent effects in output and inflation. 

Inflation Persistence, Noisy Information and the Phillips Curve

A vast literature has documented that US inflation persistence has fallen in recent decades. However, this empirical finding is difficult to explain in monetary models. Using survey data on inflation expectations, I document a positive co-movement between ex-ante average forecast errors and forecast revisions (suggesting forecast sluggishness) from 1968 to 1984, but no co-movement afterwards. I extend the New Keynesian (NK) setting with noisy and dispersed information about the aggregate state, and show that inflation is more persistent in periods of greater forecast sluggishness. My results show that the change in firm forecasting behavior, documented in survey data, explains around 90% of the fall in inflation persistence since the mid 1980s. I also find that the disconnect between inflation and the real side of the economy in recent decades can be explained by the change in information frictions. Contrary to the literature which has emphasized a flattening of the NK Phillips curve in recent data, I do not find any evidence of the change in the structural slope of the Phillips curve once I control for the change in information frictions.