This paper presents new stylized facts about exchange rates and their relationship with macroeconomic fundamentals. We show that macroeconomic surprises explain, on average, about 70 percent of variation in nominal exchange rate changes at quarterly frequency. Using a novel present value decomposition of exchange rate changes that is disciplined with survey forecast data, we further show that macroeconomic surprises are also a very important driver of the currency risk premia component and explain about 50 percent of its variation. These surprises have even greater explanatory power during periods of economic downturns and financial uncertainty.
I develop an analytical framework for monetary policy in a multi-sector economy with a general input-output network. I derive the Phillips curve and welfare as a function of the underlying production primitives. Building on these results, I characterize (i) the correct definition of aggregate inflation and (ii) how the optimal policy trades off inflation in different sectors, based on the production structure. I construct two novel inflation indicators. The first yields a well-specified Phillips curve. Consistent with the theory, this index provides a better fit in Phillips curve regressions than conventional specifications with consumer prices. The second is an optimal policy target, which captures the tradeoff between stabilizing aggregate output and relative output across sectors. Calibrating the model to the U.S. economy I find that targeting consumer inflation generates a welfare loss of 0.8% of per-period GDP relative to the optimal policy, while targeting the output gap is close to optimal.
This note presents an overview of my research on the monetary/fiscal policy mix. I discuss why central bank’s ability to control inflation requires fiscal backing. The post-Volcker consensus about the importance of central bank independence was a response to the fiscal nature of the Great Inflation of the 1970s. This consensus is now called into question in light of the limits of monetary policy and the little appetite for fiscal orthodoxy following two severe re- cessions. In this context, a coordinated strategy between the monetary and fiscal authorities works as an automatic stabilizer, reducing the likelihood of a disastrous conflict between the two authorities. Under this coordinated strategy, the fiscal authority introduces an emergency budget, while the monetary authority announces a temporary increase in the inflation target to accommodate the emergency budget. The strategy results in only moderate levels of inflation by separating long-run fiscal sustainability from a short-run policy intervention. In the context of the Euro area, Eurobonds could be used to achieve better coordination between monetary and fiscal policy.
We estimate the slope of the Phillips curve in the cross section of U.S. states using newly constructed state-level price indexes for non-tradeable goods back to 1978. Our estimates indicate that the Phillips curve is very flat and was very flat even during the early 1980s. We estimate only a modest decline in the slope of the Phillips curve since the 1980s. We use a multi-region model to infer the slope of the aggregate Phillips curve from our regional estimates. Applying our estimates to recent unemployment dynamics yields essentially no missing disinflation or missing reinflation over the past few business cycles. Our results imply that the sharp drop in core inflation in the early 1980s was mostly due to shifting expectations about long-run monetary policy as opposed to a steep Phillips curve, and the greater stability of inflation since the 1990s is mostly due to long-run inflationary expectations becoming more firmly anchored.
How does the health of creditors affect the pass-through of monetary policy to households? In a financial crisis, asset losses among creditors can either dampen or amplify the effects of monetary policy on lending, depending on how these losses and policies interact with financial frictions. Frictions such as leverage constraints may hinder creditor responses, however easing may instead alleviate frictions that would otherwise constrain lending. Using data on the universe of US credit unions, I document that asset losses increase the sensitivity of consumer credit to monetary policy. Identification exploits plausibly exogenous variation in asset losses and high frequency identification of monetary policy shocks. I find that a one standard deviation asset loss increases the response of credit union lending to a 10 basis point fall in the two-year Treasury rate from a 0.86 to 1.15 percentage point increase. The estimates imply that constraints on monetary policy become more costly in a financial crisis characterized by creditor asset losses and that an additional benefit of monetary easing is that it weakens the causal, contractionary effect of asset losses.
The negative relationship between inflation and unemployment (also known as the Phillips curve) has been repeatedly challenged in the last decades: missing inflation in 2013-2019, missing deflation in 2007-2010, missing inflation in the late 1990s, stagflation in the 1970s, contrasting with always strong regional Phillips curves. Using data from multiple sources, this paper helps to solve many empirical puzzles by distinguishing between fixed and flexible exchange rate regimes: in fixed exchange rate regimes, inflation is negatively correlated with unemployment but this relationship does not hold in flexible regimes. By contrast, there is a negative correlation between real exchange rate appreciation and unemployment, which remains consistent in both fixed and flexible regimes. These crucial observations have important implications for identifying the source of business cycle fluctuations, for normative analysis, and imply a significant departure from rational-expectation-based solutions to Phillips curve puzzles.