Category Archives: Article

Does the Government Spending Multiplier Depend on the Business Cycle?

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Abstract

We investigate the state dependency of the government spending multiplier across the business cycle using a nonlinear two-regime VAR model. We find little evidence that multipliers vary between expansionary and recessionary periods. This is because the state of the business cycle itself changes after government spending shocks and converges toward a similar state. This result holds true regardless of how we model the business cycle. Our analysis shows that assumptions about the economic state built into linear impulse response functions are the key driver of the state dependency reported elsewhere in the literature.

The Credit‐Card‐Services Augmented Divisia Monetary Aggregates*

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Abstract

While credit cards provide transaction services, they have never been included in measures of money supply. We derive the theory to measure the joint services of credit cards and money and propose two measures of their joint services: one based on microeconomic structural aggregation theory, providing an aggregated variable within the macroeconomy; the other a credit-card-extended aggregate, optimized as an indicator to capture the contributions of monetary and credit card as nowcasting indicator of nominal GDP. The inclusion of the new aggregates yields substantially more accurate nowcasts of nominal GDP, illustrating the usefulness of the information contained in credit cards.

Expectations Formation, Sticky Prices, and the ZLB

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Abstract

At the zero lower bound (ZLB), expectations about the future path of monetary or fiscal policy are crucial. We model expectations formation under level-k thinking, a form of bounded rationality formalized by García-Schmidt and Woodford (2019) and Farhi and Werning (2019), consistent with experimental evidence. This process does not lead to a number of puzzling features from rational expectations models, such as the reversal puzzle, or implausible large fiscal multipliers. Optimal monetary policy at the ZLB under level-k thinking prescribes keeping the nominal rate lower for longer, but short-run macro-economic stabilization is less powerful compared to rational expectations.

Countercyclical Capital Buffers: A Cautionary Tale

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Abstract

Countercyclical capital buffers (CCyBs) are an old idea recently resurrected. They compel systemically important banks to accumulate capital during expansions to sustain operations during downturns. We compare banks before the Great Depression, when CCyBs existed, and Great Recession, when they did not. Pre-Depression systemically important banks built capital buffers between 3% and 5% of total assets during booms, nearly twice the maximum modern CCyB, while also reducing risky lending and building cash reserves. These buffers enabled banks at the core of the financial system to continue operations during severe crises while the rest of the financial system collapsed. This analogy indicates that modern countercyclical buffers may achieve their goals of protecting core banks during crises but raises questions about whether they will contribute to overall financial stability.

The Size Distribution of the Banking Sector and Financial Fragility

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Abstract

We study the role of the size distribution of the banking sector for bailout policy and financial fragility in a model of financial intermediation with limited commitment and noisy sunspots. In particular, due to the different costs of mitigating depositors' losses, differences in financial fragility arise endogenously in the sense that the large banking market admits a higher degree of instability. Moreover, the desire to reduce differences in the amount of bailout funding across segments of the banking system leads the fiscal authority to collect less taxes ex-ante but ends up rendering the scope for run equilibria larger.

The Quality‐Weighted Matching Function: Did the German Labor Market Reforms Trade‐Off Efficiency against Job Quality?

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Abstract

We evaluate the quantity–quality trade-off on the labor market by estimating an augmented matching function weighting the matches by quality measures. We use the approach to evaluate the German labor market reforms conducted between 2003 and 2005. Indeed, we find a significant quantity–quality trade-off. However, even after controlling for job quality, a good half of the positive effect of the reforms on matching efficiency remains.

Owner‐Occupied Housing, Inflation, and Monetary Policy

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Abstract

Owner-occupied housing (OOH) is currently excluded from the harmonized index of consumer prices (HICP) in Europe. Using microlevel data for Sydney and aggregated data for the United States, France, and Germany, we compare the impact of alternative treatments of OOH on measured inflation. We recommend including OOH in the HICP using a simplified version of the user-cost method. This would improve the harmonization of the HICP, help close the credibility gap between measured inflation and public perceptions of it, and allow the ECB to lean against a housing boom without departing from its inflation target.

Financial Expectations and Household Consumption: Does Middle‐Inflation Matter?

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Abstract

We explore the finding that households often expect their financial position to remain unchanged compared to other alternatives. A generalized middle inflated ordered probit (GMIOP) model is used to account for the tendency of individuals to choose “neutral” responses when faced with opinion-based questions. Our analysis supports the use of a GMIOP model to account for this response pattern. Expectation indices based on competing discrete choice models are also explored. While financial optimism is significantly associated with increased consumption at both the intensive and extensive margin, indices which fail to take into account middle-inflation overestimate the impact of financial expectations.

Collateral Framework: Liquidity Premia and Multiple Equilibria

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Abstract

Central banks normally accept debt of their own governments as collateral in liquidity operations without reservations. This gives rise to a valuable liquidity premium that reduces the cost of government finance. The ECB is an interesting exception in this respect. It relies on external assessments of the creditworthiness of its member states, such as credit ratings, to determine eligibility and the haircut it imposes on such debt. We show how such features in a central bank's collateral framework can give rise to cliff effects and multiple equilibria in bond yields and increase the vulnerability of governments to external shocks. This policy can potentially induce sovereign debt crises and defaults that would not otherwise occur. The success of the ECB's temporary suspension of these features of its collateral framework during the pandemic illustrates the practical relevance of this mechanism.

A Theory of Intrinsic Inflation Persistence

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Abstract

We propose a novel theory of intrinsic inflation persistence by introducing trend inflation and Kimball (1995)-type aggregators of individual differentiated goods and labor in a model with staggered price- and wage-setting. Under nonzero trend inflation, the non-CES (constant elasticity of substitution) aggregator of goods and staggered price-setting give rise to a variable real marginal cost of goods aggregation, which becomes a driver of inflation. This marginal cost consists of an aggregate of the goods' relative prices, which depends on past inflation, thereby generating intrinsic inertia in inflation. Likewise, the non-CES aggregator of labor and staggered wage-setting lead to intrinsic inertia in wage inflation, which enhances the persistence of price inflation. With the theory we show that inflation exhibits a persistent, hump-shaped response to monetary policy shocks. We also demonstrate that lower trend inflation reduces inflation persistence and that a credible disinflation leads to a gradual decline in inflation and a fall in output.