Working Papers
Output Hysteresis and Optimal Monetary Policy (with Vaishali Garga)
July 2018
Abstract: We analyze the implications for monetary policy when deficient aggregate demand can cause a permanent loss in potential output, a phenomenon termed as output hysteresis. In the model, incomplete stabilization of a temporary shortfall in demand reduces the return to innovation, thus reducing TFP growth and generating a permanent loss in output. The origin of output hysteresis is contingent on the monetary policy rule. When the nominal interest rate is constrained at the zero lower bound, a central bank unable to commit to future policy actions suffers from hysteresis bias: it does not offset past losses in potential output. A new policy rule that targets zero output hysteresis approximates the optimal policy by keeping output at the first-best level. Estimated structural impulse response functions for key variables align with predictions of the model. A quantitative model provides evidence of significant output hysteresis resulting from endogenous growth over the Great Recession.
Policy Citation: Tobias Adrian, Director of the Monetary and Capital Markets Department at the IMF (September 7, 2018)
Understanding Persistent Stagnation (with Pablo Cuba-Borda)
August 2018
Abstract: We theoretically explore long-run stagnation at the zero lower bound in a representative agent framework. We analytically compare expectations-driven stagnation to a secular stagnation episode and find contrasting policy implications for changes in government spending, supply shocks and neo-Fisherian policies. Using Bayesian methods, we estimate a DSGE model that can accommodate two competing hypotheses of long- run stagnation. Using data for Japan, we document that equilibrium selection under indeterminacy matters in accounting for model fit.
Output Hysteresis and Optimal Monetary Policy (with Vaishali Garga)
July 2018
Abstract: We analyze the implications for monetary policy when deficient aggregate demand can cause a permanent loss in potential output, a phenomenon termed as output hysteresis. In the model, incomplete stabilization of a temporary shortfall in demand reduces the return to innovation, thus reducing TFP growth and generating a permanent loss in output. The origin of output hysteresis is contingent on the monetary policy rule. When the nominal interest rate is constrained at the zero lower bound, a central bank unable to commit to future policy actions suffers from hysteresis bias: it does not offset past losses in potential output. A new policy rule that targets zero output hysteresis approximates the optimal policy by keeping output at the first-best level. Estimated structural impulse response functions for key variables align with predictions of the model. A quantitative model provides evidence of significant output hysteresis resulting from endogenous growth over the Great Recession.
Policy Citation: Tobias Adrian, Director of the Monetary and Capital Markets Department at the IMF (September 7, 2018)
Understanding Persistent Stagnation (with Pablo Cuba-Borda)
August 2018
Abstract: We theoretically explore long-run stagnation at the zero lower bound in a representative agent framework. We analytically compare expectations-driven stagnation to a secular stagnation episode and find contrasting policy implications for changes in government spending, supply shocks and neo-Fisherian policies. Using Bayesian methods, we estimate a DSGE model that can accommodate two competing hypotheses of long- run stagnation. Using data for Japan, we document that equilibrium selection under indeterminacy matters in accounting for model fit.
Publications
Log-linear Approximation versus an Exact Solution at the ZLB in the New Keynesian Model (with Gauti Eggertsson)
Forthcoming at Journal of Economic Dynamics and Control
August 2018
Abstract: How accurate is a log-linear approximation of the New Keynesian model when the nominal interest rate is bounded by zero? This paper compares the solution of the exact non-linear model to the log-linear approximation. It finds that the difference is modest. This applies even for extreme events in numerical experiments that replicate the U.S. Great Depression. The exact non-linear model makes the same predictions as the log-linear approximation for key policy questions such as the size and sign of government spending and tax multipliers. It also replicates well known paradoxes like the paradox of toil and the paradox of price flexibility. The paper also reconciles different findings reported in the literature using Calvo versus Rotemberg pricing.
NBER Working Paper no. 22784
A Contagious Malady? Open Economy Dimensions of Secular Stagnation (with Gauti B. Eggertsson, Neil R. Mehrotra, and Lawrence H. Summers)
IMF Economic Review, Vol. 64(4), pp. 581-634
December 2016
Abstract: Conditions of secular stagnation - low interest rates, below target inflation, and sluggish output growth - characterize much of the global economy. We consider an overlapping generations, open economy model of secular stagnation, and examine the effect of capital flows on the transmission of stagnation. In a world with a low natural rate of interest, greater capital integration transmits recessions across countries as opposed to lower interest rates. In a global secular stagnation, expansionary fiscal policy carries positive spillovers implying gains from coordination, and fiscal policy is self-financing. Expansionary monetary policy, by contrast, is beggar-thy-neighbor with output gains in one country coming at the expense of the other. Similarly, we find that competitiveness policies including structural labor market reforms or neo-mercantilist trade policies are also beggar-thy-neighbor in a global secular stagnation.
Here's a VoxEU summary of the paper written by Gauti Eggertsson and Lawrence Summers. NBER Working Paper no. 22299.
Policy Citations:
Jason Furman, Chairman of the Council of Economic Advisers (October 5, 2016, August 2, 2016)
Simon Potter, Executive Vice-President of the Federal Reserve Bank of New York (September 30, 2016)
Vítor Constâncio, Vice-President of the European Central Bank (April 13, 2016)
Press Coverage:
Washington Post (July 7, 2016)
Paul Krugman's Blog (June 20, 2016)
Economist's View (June 7, 2016)
Log-linear Approximation versus an Exact Solution at the ZLB in the New Keynesian Model (with Gauti Eggertsson)
Forthcoming at Journal of Economic Dynamics and Control
August 2018
Abstract: How accurate is a log-linear approximation of the New Keynesian model when the nominal interest rate is bounded by zero? This paper compares the solution of the exact non-linear model to the log-linear approximation. It finds that the difference is modest. This applies even for extreme events in numerical experiments that replicate the U.S. Great Depression. The exact non-linear model makes the same predictions as the log-linear approximation for key policy questions such as the size and sign of government spending and tax multipliers. It also replicates well known paradoxes like the paradox of toil and the paradox of price flexibility. The paper also reconciles different findings reported in the literature using Calvo versus Rotemberg pricing.
NBER Working Paper no. 22784
A Contagious Malady? Open Economy Dimensions of Secular Stagnation (with Gauti B. Eggertsson, Neil R. Mehrotra, and Lawrence H. Summers)
IMF Economic Review, Vol. 64(4), pp. 581-634
December 2016
Abstract: Conditions of secular stagnation - low interest rates, below target inflation, and sluggish output growth - characterize much of the global economy. We consider an overlapping generations, open economy model of secular stagnation, and examine the effect of capital flows on the transmission of stagnation. In a world with a low natural rate of interest, greater capital integration transmits recessions across countries as opposed to lower interest rates. In a global secular stagnation, expansionary fiscal policy carries positive spillovers implying gains from coordination, and fiscal policy is self-financing. Expansionary monetary policy, by contrast, is beggar-thy-neighbor with output gains in one country coming at the expense of the other. Similarly, we find that competitiveness policies including structural labor market reforms or neo-mercantilist trade policies are also beggar-thy-neighbor in a global secular stagnation.
Here's a VoxEU summary of the paper written by Gauti Eggertsson and Lawrence Summers. NBER Working Paper no. 22299.
Policy Citations:
Jason Furman, Chairman of the Council of Economic Advisers (October 5, 2016, August 2, 2016)
Simon Potter, Executive Vice-President of the Federal Reserve Bank of New York (September 30, 2016)
Vítor Constâncio, Vice-President of the European Central Bank (April 13, 2016)
Press Coverage:
Washington Post (July 7, 2016)
Paul Krugman's Blog (June 20, 2016)
Economist's View (June 7, 2016)