Before the 2008 crisis, the cross-sectional skewness of banks’ leverage went up and macro risk concentrated in the balance sheets of large banks. Using a model of profit-maximizing banks with heterogeneous Value-at-Risk constraints, we extract the distribution of banks’ risk-taking parameters from balance sheet data. The time series of these estimates allow us to understand systemic risk and its concentration in the banking sector over time. Counterfactual exercises show that (1) monetary policymakers confront the trade-off between stimulating the economy and financial stability, and (2) macroprudential policies can be effective tools to increase financial stability.
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 study optimal monetary policy and central bank communication when firms make nominal pricing decisions under uncertainty and when the monetary authority likewise has incomplete information about the current economic state. We find that the optimal monetary policy implements flexible-price allocations despite this multitude of measurability constraints; we explore a series of different implementations. Away from such policies, we find that public communication by the central bank is welfare-improving as long as either firm information or central bank information is sufficiently precise.