Research Papers:
Term Structure, Forecast Revision and the Information Channel of Monetary Policy, November 2017
Monetary policy shocks affect interest rates at long horizons (10 years or more). Furthermore, the private sector’s real GDP forecasts are revised upward in response to a monetary tightening. These facts challenge the prevailing theories in academic and policy circles, which are based on the paradigm that monetary policy has limited long-run effects and a monetary policy tightening should depress agents’ beliefs. In this paper, I propose a micro-founded model to rationalize those facts, based on the information channel of monetary policy. I consider a framework where the central bank has private information about future economic conditions. Agents update their beliefs according to the Bayes' rule. Policy actions play a signaling role, and may thus have an impact on both short and long- term interest rates. Moreover I provide novel facts that the aforementioned responses are stronger when monetary shocks are expansionary. An extension of the model with ambiguity averse agent and ambiguous signals rationalizes such an asymmetry. Finally, I discuss the implications of information friction for the design of optimal simple rule.
Monetary policy shocks affect interest rates at long horizons (10 years or more). Furthermore, the private sector’s real GDP forecasts are revised upward in response to a monetary tightening. These facts challenge the prevailing theories in academic and policy circles, which are based on the paradigm that monetary policy has limited long-run effects and a monetary policy tightening should depress agents’ beliefs. In this paper, I propose a micro-founded model to rationalize those facts, based on the information channel of monetary policy. I consider a framework where the central bank has private information about future economic conditions. Agents update their beliefs according to the Bayes' rule. Policy actions play a signaling role, and may thus have an impact on both short and long- term interest rates. Moreover I provide novel facts that the aforementioned responses are stronger when monetary shocks are expansionary. An extension of the model with ambiguity averse agent and ambiguous signals rationalizes such an asymmetry. Finally, I discuss the implications of information friction for the design of optimal simple rule.
The Random Walk Beats Professional Forecast: Facts, Puzzles and Explanations, May 2018
For short horizon exchange rate predictability the simple random walk model outperforms professional forecasts. A new puzzle arises: why do professional forecasters not adapt the simple random walk model to provide a more accurate estimate? This paper provides an explanation. In this framework, the forecaster faces model uncertainty and reports the forecast that minimizes the forecast error under the worst-case scenario. Therefore professional forecasts are intentionally suboptimal. Estimation results show that the model matches the empirical puzzle. In addition, the model predicts that the forecaster substantially underreacts to current news, which is consistent with empirical facts provided in this paper. Moreover, the null of "rationality" is rejected using simulated data confirming existing findings even though forecasters in the model perform optimally.
For short horizon exchange rate predictability the simple random walk model outperforms professional forecasts. A new puzzle arises: why do professional forecasters not adapt the simple random walk model to provide a more accurate estimate? This paper provides an explanation. In this framework, the forecaster faces model uncertainty and reports the forecast that minimizes the forecast error under the worst-case scenario. Therefore professional forecasts are intentionally suboptimal. Estimation results show that the model matches the empirical puzzle. In addition, the model predicts that the forecaster substantially underreacts to current news, which is consistent with empirical facts provided in this paper. Moreover, the null of "rationality" is rejected using simulated data confirming existing findings even though forecasters in the model perform optimally.
Which Inflation Index to Stabilize? The Role of Market Power, May 2018
Existing empirical evidence suggest cross-sector heterogeneities in both nominal rigidity and market power. This paper studies the optimal choice of inflation index for a central bank to stabilize in a framework that embeds those features. The optimal weight attached to inflation in a sector is increasing in this sector’s: i) price stickiness (stickiness channel) and ii) degree of market competition (competition channel). Moreover, if firms in a more competitive sector adjust their price more frequently as predicted by costly price adjustment models, the competition channel offsets the stickiness channel. The finding challenges the conventional wisdom that the central bank should attach a higher weight to a sector with a higher degree of nominal rigidity, and supports the current practice of central banks around the world (CPI targeting).
Existing empirical evidence suggest cross-sector heterogeneities in both nominal rigidity and market power. This paper studies the optimal choice of inflation index for a central bank to stabilize in a framework that embeds those features. The optimal weight attached to inflation in a sector is increasing in this sector’s: i) price stickiness (stickiness channel) and ii) degree of market competition (competition channel). Moreover, if firms in a more competitive sector adjust their price more frequently as predicted by costly price adjustment models, the competition channel offsets the stickiness channel. The finding challenges the conventional wisdom that the central bank should attach a higher weight to a sector with a higher degree of nominal rigidity, and supports the current practice of central banks around the world (CPI targeting).
Research Papers in Progress:
An Empirical Assessment of Central Banks’ Preferences (coming soon) with Shengliang Ou
The Time-Varying Effect of Unconventional Monetary Policy (under revision) with Francesca Loria, Carlos Montes-Galdón, and Shengliang Ou