Welcome Research Experience Code CV
Does Communicating a Numerical Inflation Target Anchor Inflation Expectations? Evidence & Bond Market Implications
(with A. Lee Smith)
Inflation expectations in the United States became better anchored after the Federal Reserve began communicating a numerical inflation target. Using an event-study approach, we find that forward measures of inflation compensation became unresponsive to news about current inflation after the adoption of an explicit inflation target. In contrast, we find that forward measures of nominal compensation in Japan continue to drift with news about current inflation, even after the Bank of Japan adopted a numerical inflation target. These empirical findings have implications for the term structure of interest rates in the United States.
Summary: Macro Bulletin
|Forward Guidance, Monetary Policy Uncertainty, & the Term Premium |
(with Trenton Herriford and A. Lee Smith)
We examine the macroeconomic and term-premia implications of monetary policy uncertainty shocks. Using Eurodollar options, we employ the VIX methodology to measure implied volatility about future short-term interest rates at various horizons. We identify monetary policy uncertainty shocks using the unexpected changes in this term structure of implied volatility around monetary policy announcements. We find that an unexpected decline in the slope of implied volatility lowers term premia in longer-term bond yields and leads to higher economic activity and inflation. Our results suggest that forward guidance about future monetary policy can materially affect bond market term premia, even without large-scale asset purchases.
Additional Material: Technical Appendix & Slides
The Dynamic Effects of Forward Guidance Shocks (with A. Lee Smith)
We examine the macroeconomic effects of forward guidance shocks at the zero lower bound. In the data, forward guidance shocks that lower the expected path of policy stimulate economic activity and prices (blue line). A textbook framework of monetary policy (red line) can largely replicate the dynamic responses from the empirical evidence. Our results suggest no disconnect between the empirical effects of forward guidance shocks and the predictions from a standard model of monetary policy.
Conditionally accepted at The Review of Economics & Statistics
Additional Material: Technical Appendix & Slides
Endogenous Volatility at the Zero Lower Bound:
Implications for Stabilization Policy (with Susanto Basu)
At the zero lower bound, the central bank's inability to offset shocks endogenously generates volatility. In this setting, an increase in uncertainty about future shocks causes significant contractions in the economy and may lead to non-existence of an equilibrium. The form of the monetary policy rule is crucial for avoiding catastrophic outcomes. State-contingent optimal monetary and fiscal policies can attenuate this endogenous volatility by stabilizing the distribution of future outcomes. Fluctuations in uncertainty and the zero lower bound help our model match the unconditional and stochastic volatility in the recent macroeconomic data.
Also available as NBER Working Paper 21838
Real Fluctuations at the Zero Lower Bound
Aggregate demand becomes upward sloping when the economy is stuck at the zero lower bound. Thus, the economy may respond very differently to real shocks. A positive technology shock which shifts aggregate supply downward can cause a large contraction in output. However, these differential responses to shocks emerge when the central bank follows a standard Taylor rule (TR) subject to the zero lower bound. This rule implies that the central bank stops responding to the state of the economy at the zero lower bound. This assumption is inconsistent with the recent behavior by monetary policymakers. The responses to shocks may not be so different if the central bank follows a history-dependent (HD) rule, which continues to respond the economy using expectations about future policy.
Uncertainty Shocks in a Model of Effective Demand (with Susanto Basu)
An uncertainty shock in the data causes a contraction in output and its components. A standard model of nominal price rigidity is fully consistent with this empirical evidence. We calibrate changes in uncertainty using implied stock market volatility and find that increased uncertainty about the future may have played a significant role in worsening the Great Recession.
Econometrica, 2017, 85(3): 937-958.
Press and Blog Coverage: Reuters.com, Econbrowser
Also, see our Reply to the critique by de Groot, Richter, & Throckmorton, which was also published in Econometrica.
Additional Material: NBER Working Paper Version, Technical Appendix & Slides
How Do FOMC Projections Affect Policy Uncertainty?
(with Trenton Herriford)
Uncertainty about future interest rates fell after the FOMC began releasing its participants’ projections for the appropriate federal funds rate. In addition, changes in the participant disagreement help explain movements in uncertainty around FOMC meetings.
Federal Reserve Bank of Kansas City Economic Review, 2017, 102(2): 5-22.
Estimating the Monetary Policy Rule Perceived by Forecasters
The FOMC’s implicit monetary policy rule, as perceived by professional forecasters, is similar before and during the recent zero lower bound period.
Federal Reserve Bank of Kansas City Economic Review, 2015, 100(4): 33-49.
Summary: Macro Bulletin
Discussion of Monetary Policy Slope & the Stock Market
By Andreas Neuhierl and Michael Weber
Midwest Finance Association Annual Meeting, March 2018
Discussion of Learning in the Oil Futures Market: Evidence & Macroeconomic Implications
By Sylvain Leduc, Kevin Moran, and Robert Vigfusson
Federal Reserve System Energy Conference, September 2017
Discussion of Oil Volatility Risk
By Lin Gao, Steffen Hitzemann, Ivan Shaliastovich, & Lai Xu
American Finance Association Meeting, January 2017
Discussion of Global Dynamics at the Zero Lower Bound
By William T. Gavin, Benjamin D. Keen, Alexander Richter, & Nathaniel Throckmorton
Federal Reserve System Macroeconomics Meeting, April 2014
Short, Policy-Related Works
Does the Recent Decline in Household Longer-Term Inflation Expectations Signal a Loss of Confidence in the FOMC? (with Trenton Herriford, Emily Pollard, and A. Lee Smith)
Over the past five years, the number of households with high inflation expectations has fallen, while the number of households with low inflation expectations has increased. This shift in composition helps to explain the recent decline in household longer-term inflation expectations. It does not suggest a loss of confidence in the FOMC’s ability to achieve its price stability mandate, however, as households with low inflation expectations give policymakers higher marks than do households with high inflation expectations.
Are Longer-Term Inflation Expectations Stable? (with Craig Hakkio)
Throughout 2014, survey-based expectations of inflation were relatively stable and consistent with the FOMC’s longer-term inflation objective of 2 percent. However, individual participants’ longer-term forecasts can vary considerably and are not always aligned with this target.