regime switches in exchange rate volatility and uncovered interest parity abstract we use a regime switching model to examine how exchange rate volatility is related to the failure of uncovered interest parity main findings are as follows first exchange rate returns are strongly influenced by regime switches in the relationship between the returns and interest rate differentials second low yielding currencies appreciate less frequently but once it occurs their movements are faster than when they depreciate third depreciation of low yielding currencies and low volatility are mutually dependent on each other finally these three findings are more evident for shorter horizons the second and third results are consistent with a market participants view short term carry trades in a low volatility environment and their rapid unwinding substantially influence exchange rates we consider the effects of funding liquidity to explain these results

reputation with equal discounting in repeated games with strictly conflicting interests we analyze reputation effects in two player repeated games of strictly conflicting interests in such games player 1 has a commitment action such that a best reply to it gives player 1 the highest individually rational payoff and player 2 the minmax payoff players have equal discount factors with positive probability player 1 is a type who chooses the commitment action after every history we show that player 1 s payoff converges to the maximally feasible payoff when the discount factor converges to one this contrasts with failures of reputation effects for equal discount factors that have been demonstrated in the literature journal of economic literature classification number c71

the inexorable and mysterious tradeoff between inflation and unemployment this paper discusses the short run tradeoff between inflation and unemployment although this tradeoff remains a necessary building block of business cycle theory economists have yet to provide a completely satisfactory explanation for it according to the consensus view among central bankers and monetary economists a contractionary monetary shock raises unemployment at least temporarily and leads to a delayed and gradual fall in inflation standard dynamic models of price adjustment however cannot explain this pattern of responses reconciling the consensus view about the effects of monetary policy with models of price adjustment remains an outstanding puzzle for business cycle theorists several years ago i gave myself a peculiar assignment i decided to try to summarise all of economics in ten simply stated principles the purpose of this task was to introduce students to the economic way of thinking in the first chapter of my textbook principles of economics i figured if god could boil all of moral philosophy down to ten commandments i should be able to do much the same with economic science most of the ten principles i chose were microeconomic and hard to argue with they involved the importance of tradeoffs marginal analysis the benefits of trade market efficiency market failure and so on i allocated the last three principles to macroeconomics the first of these was a country s standard of living depends on its ability to produce goods and services which i viewed as the foundation of all growth theory the second was prices rise when the government prints too much money which i took to be the essence of classical monetary theory the last of my ten principles is the subject of today s lecture society faces a short run tradeoff between inflation and unemployment perhaps not surprisingly this statement turned out to be controversial when my publisher sent out the manuscript for review a few readers objected

euler equations and money market interest rates a challenge for monetary policy models standard macroeconomic models equate the money market rate targeted by the central bank with the interest rate implied by a consumption euler equation we use u s data to calculate the interest rates implied by euler equations derived from a number of specifications of household preferences correlations between these euler equation rates and the federal funds rate are generally negative regression results and impulse response functions imply that the spreads between the euler equation rates and the federal funds rate are systematically linked to the stance of monetary policy our findings pose a fundamental challenge for models that equate the two

precautionary demand for money in a monetary business cycle model we investigate the quantitative implications of precautionary demand for money for business cycle dynamics of velocity of money and other nominal aggregates there is a standing challenge in monetary macroeconomics to account for business cycle dynamics of nominal variables as previous business cycle models that have tried to incorporate demand for money have failed to generate realistic predictions in this regard our stance is that part of this failure results from the fact that demand for money in those previous models is deterministic since agents in them face only aggregate risk whereas we believe idiosyncratic risk to be important as well we conduct the exercise inside a monetary search model as our additional goal is to put to the test a recent generation of such frictional models to examine whether their quantitative predictions are realistic and whether they generate additional insight into business cycle data that non search models of money cannot generate on the first question our results suggest that precautionary demand for money plays a substantial role in accounting for business cycle behavior of velocity of money and other nominal variables such as inflation and nominal interest rates on the second question our preliminary results indicate that the search frictions generate discernible though small quantitative effects helping the model account for relevant properties of the data but not very significantly the biggest quantitative potential for search frictions in this setting is in the dynamic implications they generate for inventories and markups in the retail sector assessment of this potential is in progress

state dependent pricing and the dynamics of money and output standard macroeconomic models of price stickiness assume that each firm leaves its price unchanged for a fixed amount of time we present an alternative model in which the pricing decision depends on the state of the economy we find a method of aggregating individual price changes that allows a simple characterization of macroeconomic variables the model produces a positive money output correlation and an empirical phillips curve in addition the impact of monetary shocks depends crucially on the current level of output which points to a natural connection between state dependent microeconomics and state dependent macroeconomics i introduction there is a long tradition in macroeconomics of attributing the real effects of nominal demand shocks to nominal price stickiness in this view if there is no change in prices when nominal demand rises then quantities must bear the burden of adjustment hence nominal price rigidity provides the friction needed for nominal demand shocks to be transmitted to the real economy standard models of this transmission mechanism such as fischer 1977 and taylor 1980 are based on the assumption that each firm leaves its price unchanged for a fixed amount of time the main reason for considering such time dependent pricing rules is their analytic tractability constraining firms to adjust their prices at prespecified times both simplifies the derivation of equilibrium strategies and allows the use of powerful time series techniques to analyze aggregate dynamics the main disadvantage of the timedependent approach is that between price adjustments firms are not allowed to respond even to extreme changes of circumstance this makes it difficult to know whether the qualitative effects of money in these models are the result of nominal rigidities per se or of the exogenously imposed pattern of price changes an alternative approach to modeling price stickiness is to allow the price setting decision to depend on the actual state of the

reputation and experimentation in repeated games with two long run players this paper considers reputation effects in a repeated game between two long run players one of whom is relatively patient and may be committed to a fixed strategy which punishes the opponent for increasingly long periods whenever inappropriate actions are taken by following this commitment strategy the more patient player can induce a sufficiently patient opponent to experiment to see whether the commitment strategy is also being followed off the equilibrium path this can guarantee the more patient player in any nash equilibrium a payoff close to the highest feasible payoff consistent with the individual rationality of the other player for an arbitrary degree of patience of the less patient player a weaker result is established the more patient player is guaranteed an average equilibrium payoff close to the static stackelberg payoff this latter result generalizes that of schmidt 1993 who established the same result for the restricted class of games of conflicting interests

financial market segmentation and choice of exchange rate regimes we study the choice of exchange rate regime in a small open economy with segmented asset markets subjected to financial sector shocks we show that the state contingent optimal policy facilitates risk sharing between asset market participants and non participants and is countercyclical our results establish that contrary to existing literature flexible exchange rates mimic optimal policy and welfare dominates fixed exchange rates

liquidity and exchange rates abstract we present a two country extension of lucas s 1988a work on cash in advance constraints in asset markets in the model there is temporary separation between the goods and asset markets and money is used for transactions in both we first find that the exchange rate level depends on the share of money used for asset transactions a greater share appreciates the currency second stochastic open market operations increasing the domestic bonds supply appreciate the domestic currency third the liquidity effects of bond supply shocks cause an excess volatility of nominal exchange rates even when their fundamental value is constant

reputation and dynamic stackelberg leadership in infinitely repeated games abstract the paper studies a repeated game in which a long run player without discounting faces another long run player with strict discounting the game is perturbed so that there is uncertainty in the patient player s strategy choice she may be a rational player but she may also be one of many irrational types who are committed to various repeated game strategies the rational patient player s equilibrium payoff in this perturbed game is analyzed in particular it is shown that the lower bound on her payoff in the set of extensive form trembling hand perfect equilibria is given by her stackelberg payoff in a dynamics sense journal of economic literature classification numbers c72 d82

money interest rates and exchange rates with endogenously segmented markets we analyze the effects of money injections on interest rates and exchange rates when agents must pay a baumol tobin style fixed cost to exchange bonds and money asset markets are endogenously segmented because this fixed cost leads agents to trade bonds and money infrequently when the government injects money through an open market operation only those agents that are currently trading absorb these injections through their impact on these agents consumption these money injections affect real interest rates and real exchange rates the model generates the observed negative relation between expected inflation and real interest rates as well as persistent liquidity effects in interest rates and volatile and persistent exchange rates

rare disasters and exchange rates we propose a new model of exchange rates which yields a theory of the forward premium puzzle our explanation combines two ingredients the possibility of rare economic disasters and an asset view of the exchange rate our model is frictionless has complete markets and works for an arbitrary number of countries in the model rare worldwide disasters can occur and affect each country s productivity each country s exposure to disaster risk varies over time according to a mean reverting process ri sky countries command high risk premia they feature a depreciated exchange rate and a high interest rate as their risk premium mean reverts their exchange rate appreciates therefore currencies of high interest rate countries appreciate on average to make the notion of disaster risk more implementable we show how options prices might in principle uncover latent disaster risk and help forecast exchange rate movements we then extend the framework to incorporate two factors a disaster risk factor and a business cycle factor we calibrate the model and obtain quantitatively realistic values for the volatility of the exchange rate the forward premium puzzle regression coefficients and near random walk exchange rate dynamics finally we solve a model of stock markets across countries which yields a series of predictions about the joint behavior of exchange rates bonds options and stocks across countries the evidence from the options market appears to be supportive of the model jel e43 e44 f31 g12 g15

the effects of population aging on the relationship among aggregate consumption saving and income as is well known the us population has grown much older and is expected to continue to age the share of adults age 65 or older 16 percent in 1980 has been rising steadily and is projected by the us census bureau to reach 22 percent by 2020 given differences in saving rates and marginal propensities to consume mpc s over the life cycle demographic shifts could materially affect the relationship among macroeconomic aggregates such as income consumption and saving a key question is how large these effects might be some past studies have used time series data to try to quantify these effects for example see alan s blinder 1975 but demographics change more gradually than other determinants of aggregate spending making it difficult to obtain precise estimates of the effects from such data our paper contributes to the literature by drawing lessons on how population aging might change the relationship between macroeconomic aggregates from household level data household level data enhance our ability to identify the effects because of the rich variation in consumption saving and income that we observe across households

interest rates and currency prices in a two country world abstract this paper is a theoretical study of the determination of prices interest rates and currency exchange rates set in an infinitely lived two country world which is subject both to stochastic endowment shocks and to monetary instability formulas are obtained for pricing all equity claims nominally denominated bonds and currencies and these formulas are related to earlier closely related results in the theories of money finance international trade

international risk sharing with endogenously segmented asset markets abstract asset price data imply a large degree of international risk sharing while aggregate consumption data do not we show that a model with trade in goods and endogenously segmented asset markets can account for this puzzling discrepancy active households who pay a fixed cost to transfer money into or out of assets share risk within and across countries and their marginal utility growth prices assets so asset prices imply high risk sharing inactive households consume their current income and do not share risk so aggregate consumption which averages across all households reflects lower risk sharing the model also provides a resolution to the backus smith kollmann puzzle

liquidity monetary policy and unemployment a new monetarist approach we discover a consumption channel of monetary policy in a model with money and government bonds when the central bank withdraws government bonds short term or long term through open market operations it lowers returns on bonds the lower return has a direct negative impact on consumption by households that hold bonds and an indirect negative impact on consumption by households that hold money as a result firms earn less profits from production which leads to higher unemployment the existence of such a consumption channel can help us understand the effects of unconventional monetary policy

reputation and perfection in repeated common interest games abstract we consider a wide class of repeated common interest games perturbed with one sided incomplete information one player the informed player might be a commitment type playing the pareto dominant action as discounting which is assumed to be symmetric and the prior probability of the commitment type go to zero it is shown that the informed player can be held close to her minmax payoff even when perfection is imposed on the equilibrium journal of economic literature classification numbers c73 d83

international risk cycles abstract recent work in international finance suggests that exchange rate puzzles can be accounted for if 1 aggregate uncertainty is time varying and 2 countries have heterogeneous exposures to a world aggregate shock we embed these features in a standard two country real business cycle framework and calibrate the model to equity risk premia in low and high interest rates countries unlike traditional real business cycle models our model generates volatile exchange rates a large currency forward premium excess comovement of asset prices relative to quantities and an imperfect correlation between relative consumption growth and exchange rates our model implies however that high interest rate countries have smoother quantities equity returns and interest rates than low interest rate countries contrary to the data

endogenous market participation and the general equilibrium value of money we study the monetary theory implications of fixed costs associated with trade in private assets we show that with heterogeneous endowment profiles it is possible for an endogenous subset of agents to hold currency even when it is dominated in return by a competing asset with respect to positive issues in monetary theory the model implies that changes in the steady state growth rate of the money supply have a negative effect on real interest rates because of endogenous market participation measures on the normative side we show that there may be an equity efficiency trade off from monetary deflation

reputation in long run relationships we model a long run relationship as an infinitely repeated game played by two equally patient agents in each period the agents play an extensive form stage game of perfect information with either locally non conflicting interests or strictly conflicting interests there is incomplete information about the type of player 1 while player 2 s type is commonly known we show that a sufficiently patient player 1 can leverage player 2 s uncertainty about his type to secure his highest pay off compatible with player 2 s individual rationality in any perfect bayesian equilibrium of the repeated game copyright 2012 oxford university press

model uncertainty and the forward premium puzzle abstract this paper studies the forward premium puzzle in a setting where investors doubt the specification of their models and thus engage in robust portfolio strategies hansen and sargent 2008 it shows that an empirically plausible concern for model misspecification can explain the forward premium puzzle in particular the paper shows that hansen and jagannathan 1991 volatility bounds can be attained with both reasonable degrees of risk aversion and reasonable detection error probabilities hence observed excess returns in the foreign exchange market appear to be primarily driven by a model uncertainty premium

menu costs and phillips curves this paper develops a model of a monetary economy in which individual firms are subject to idiosyncratic productivity shocks as well as general inflation sellers can change price only by incurring a real menu cost we calibrate this cost and the variance and autocorrelation of the idiosyncratic shock using a new u s data set of individual prices due to klenow and kryvtsov the prediction of the calibrated model for the effects of high inflation on the frequency of price changes accords well with international evidence from various studies the model is also used to conduct numerical experiments on the economy s response to various shocks in none of the simulations we conducted did monetary shocks induce large or persistent real responses

selection and monetary non neutrality in time dependent pricing models for a given frequency of price adjustment monetary non neutrality is smaller if older prices are disproportionately more likely to change selection for the age of prices provides a complete characterization of price setting frictions in time dependent models selection for older prices is weaker and non neutralities are larger if the hazard function of price adjustment is less strongly increasing selection is weaker if there is heterogeneity in price stickiness finally selection is weaker if durations of price spells are more variable in particular the taylor 1979 model exhibits maximal selection for older prices whereas the calvo 1983 model exhibits no selection

profits risk and uncertainty in foreign exchange markets this paper examines the properties of nominal profits from speculation in dollar dominated forward contracts using a representative agent cash in advance model modified to allow for heteroscedasticity in the exogenous processes the model is simulated by estimating exogenous processes from the data and the remaining free parameters with a simulated method of moments technique simulated expected profits are variable heteroskedastic and serially correlated but the magnitude of these second moments fall short of those of the predictable component of observed profits on the u s dollar as in the actual data simulated forward rates display biasedness in predicting simulated future spot rates

interest rates and inflation a consensus has emerged among practitioners that the instrument of monetary policy ought to be the short term interest rate that policy should be focused on the control of inflation and that inflation can be reduced by increasing short term interest rates at the center of this consensus is a rejection of the quantity theory such a rejection is a difficult step to take given the mass of evidence linking money growth inflation and interest rates increases in average rates of money growth are associated with equal increases in average inflation rates and interest rates these observations need not rule out a constructive role for the use of short term interest rates as a monetary instrument one possibility is that increasing short term rates in the face of increases in inflation is just an indirect way of reducing money growth sell bonds and take money out of the system another possibility is that while control of monetary aggregates is the key to low long run average inflation rates an interest rate policy can improve the short run behavior of interest rates and prices the shortrun connections among money growth inflation and interest rates are very unreliable so there is much room for improvement these possibilities are surely worth exploring but doing so requires new theory the analysis needed to reconcile interest rate policies with the evidence on which the quantity theory of money is grounded cannot be found in old textbook diagrams

risk uncertainty and exchange rates this paper is motivated by two facts failure of log linear empirical exchange rate models of the 1970 s and the observed variability of risk premiums in the forward market rational maximizing models predict that changes in conditional variances of monetary policies government spendings and income growths affect risk premiums and induce conditional volatility of exchange rates i examine theoretically how changes in these exogenous conditional variances affect the level of the current exchange rate and attempt to quantify the extent that this channel explains exchange rate volatility using autoregressive conditional heteroscedastic models

what drives spreads in the euro area government bond market spreads between euro area government bond yields are related to short term interest rates which are in turn related to market liquidity to cyclical conditions and to investors incentives to take risk in theory lower interest rates are associated with lower degrees of risk aversion and smaller government bond spreads empirically the eurosystem s short term interest rates are positively related to those spreads which our econometric model finds to include significant and policy relevant default risk and liquidity risk components simone manganelli and guido wolswijk

financial innovations money demand and the welfare cost of inflation in the 1990s the empirical relation between money demand and interest rates began to fall apart we analyze to what extent improved access to money markets can explain this break down for this purpose we construct a microfounded monetary model with a money market which provides insurance against liquidity shocks by offering short term loans and by paying interest on money market deposits we calibrate the model to u s data and find that improved access to money markets can explain the behavior of money demand very well furthermore we show that by allocating money more efficiently better access to money markets decrease the welfare cost of inflation substantially

money liquidity and welfare abstract this paper develops an analytically tractable bewley model of money demand to shed light on some important questions in monetary theory such as the welfare cost of inflation it is shown that when money is a vital form of liquidity to meet uncertain consumption needs the welfare costs of inflation can be extremely large with log utility and parameter values that best match both the aggregate money demand curve suggested by lucas 2000 and the variance of household consumption agents in our model are willing to reduce consumption by 3 4 to avoid 10 annual inflation the astonishingly large welfare costs of inflation arise because inflation increases consumption risk by eroding the buffer stock insurance value of money thus hindering consumption smoothing at the household level such an inflation induced increase in consumption risk at the micro level cannot be captured by representative agent models or the bailey triangle although the development of financial intermediation can mitigate the problem with realistic credit limits the welfare loss of moderate inflation still remains several times larger than estimations based on the bailey triangle our findings provide a strong justification for adopting a low inflation target by central banks especially in developing countries where money is the major form of household financial wealth

optimal inattention to the stock market inattentive agents update their information sporadically and thus respond belatedly to news we generate optimally inattentive behavior by assuming that to observe the value of his investment portfolio the consumer must pay a cost that is proportional to the portfolio s contempo raneous value it is optimal for the consumer to check his investment portfolio at equally spaced points in time consuming from a riskless trans actions account in the interim the riskless transactions account that finances consump tion guarantees that funds are never unwittingly exhausted we show that the optimal interval of time between consecutive observations of the value of the portfolio is the unique positive solution to a nonlinear equation quantitatively even a small observation cost one basis point of wealth implies a substantial eight month decision interval under conventional parameter values

time varying risk interest rates and exchange rates in general equilibrium under mild assumptions the data indicate that time varying risk is the primary force driving nominal interest rate differentials on currency denominated bonds this finding is an immediate implication of the fact that exchange rates are roughly random walks a general equilibrium monetary model with an endogenous source of risk variation a variable degree of asset market segmentation can produce key features of actual interest rates and exchange rates in this model the endogenous segmentation arises from a fixed cost for agents to exchange money for assets as inflation varies so does the benefit of asset market participation and that changes the fraction of agents participating these effects lead the risk premium to vary systematically with the level of inflation this model produces variation in the risk premium even though the fundamental shocks have constant conditional variances

the folk theorem with imperfect public information the authors study repeated games in which players observe a public outcome that imperfectly signals the actions played they provide conditions guaranteeing that any feasible individually rational payoff vector of the stage game can arise as a perfect equilibrium of the repeated game with sufficiently little discounting the central condition requires that there exist action profiles with the property that for any two players no two deviations one by either player give rise to the same probability distribution over public outcomes the results apply to principal agent partnership oligopoly and mechanism design models and to one shot games with transferable utilities copyright 1994 by the econometric society

maintaining a reputation against a long lived opponent we consider a game between a patient player 1 and a nonmyopic but less patient opponent player 2 as usual in reputation models we suppose that the patient player s type is private information and that he may be a commitment type who is locked into playing a particular strategy we investigate the extent to which an uncommitted or normal type of patient player can exploit his less patient opponent s uncertainty to maintain a reputation for playing like a commitment type

money and exchange rates in the grossman weiss rotemberg model abstract we analyze the impact of monetary policy on inflation interest rates and exchange rates in a model with segmented asset markets developed by grossman and weiss 1983 and rotemberg 1984 1985 we find parameters for which real and nominal exchange rates in this model are 1 much more volatile than interest rates inflation rates and money growth rates 2 highly correlated with each other and 3 highly persistent while this model fails to match the data in other important respects it illustrates a potentially useful approach to modelling exchange rate behavior

transactions costs and portfolio choice in a discrete continuous time setting abstract this paper makes the following observation concerning a new formulation of the consumption and portfolio choice model of merton 1971 with transaction costs suppose an investor observes his or her current wealth only when making a transaction that transactions are costly and that decisions to transact can be made at any time based on all current information if at each transaction the agent is charged a fixed fraction of current portfolio value an optimal policy exists and the optimal interval of time between transactions is fixed independent of time and current wealth

liquidity loanable funds and real activity abstract this paper develops a general equilibrium model of two traditional explanations of the monetary black box linking money and real activity the liquidity effect and the loanable funds effect these effects are modeled with a monetary production economy in which central bank injections of cash are funnelled into the economy through the credit market since only borrowers have direct access to the newly injected cash monetary injections cause nominal interest rates to fall if firms are borrowers then monetary injections also increase current and future real activity

humps and bumps in lifetime consumption in this article we argue that the life cycle model that allows demographics to affect household preferences and relaxes the assumption of certainty equivalence can generate hump shaped consumption profiles over age that are very similar to those observed in household level data sources and in particular match the differences in shape across different education groups liquidity constraints or myopia are not required to explain the empirical features of observed life cycle patterns

long and plosser meet bewley and lucas abstract we develop an n sector business cycle network model a la long and plosser 1983 featuring heterogenous money demand a la bewley 1980 and lucas 1980 despite incomplete markets and a well defined distribution of real money balances across heterogeneous households the bewley lucas long plosser model remains analytically tractable with closed form solutions relying on the tractability we establish several important results i the economy s input output network linkages become endogenously time varying over the business cycle thanks to the endogenous time varying distribution of money demand and its influence on cross sector allocations of commodities ii despite flexible prices transitory money injections can generate highly persistent effects on sectoral output also thanks to the time varying distribution of money demand and its effect on input output coefficients iii although money injection is distributed equally across households by design the real effects are asymmetric across production sectors e g the impact of money is strongest on downstream sectors that purchase intermediate goods from the rest of the economy but weakest on upstream sectors that supply intermediate goods to the other sectors in sharp contrast to the case of sectoral technology shocks and government spending shocks our model also provides a micro foundation for the labor wedge and shows that movements in the distribution of money demand can explain the cyclical behavior of the labor wedge

interest rates and prices in an inventory model of money with credit abstract using a segmented market model that includes state dependent asset market decisions along with access to credit we analyze the impact that transactions credit has on interest rates and prices the availability of credit allows agents to significantly smooth consumption reduce the movements in velocity prices become quite flexible and liquidity effects are dampened as credit costs decline in the model so does the effectiveness of monetary policy we also investigate the recessionary consequences of a shock to the cost of credit and find that the model s predictions align well with the empirical evidence

sudden stops financial frictions and the banking sector abstract financial crises typically feature a large fall in total factor productivity tfp in emerging economies about 40 of domestic credit is provided by banks theories have largely focused on how exogenous changes in domestic interest rates impact the economy in this paper i explore the role of banks intermediation in exacerbating allocative inefficiency i build a small open economy model in which banks are the only domestic agents with access to international capital markets during sudden stops a shock to the world interest rate decreases banks credit supply and raises the domestic interest rate on loans firms with working capital financing needs experience an increase in the cost of production this worsens the misallocation and generates an endogenous fall in tfp and output the model is calibrated to mexico before the 1995 crisis the model predicts a 6 9 fall in tfp and a 5 fall in investment to gdp ratio which closely matches the effects observed in the data

accounting for forward rates in markets for foreign currency absteract forward and spot exchange rates between major currencies imply large standard deviations of both predictable returns from currency speculation and of the equilibrium price measure the intertemporal marginal rate of substitution representative agent theory with time additive preferences cannot account for either of these properties we show that the theory does considerably better along these dimensions when the representative agent s preferences exhibit habit persistence but that the theory fails to reproduce some of the other properties of the data in particular the strong autocorrelation of forward premiums since the advent of flexible exchange rates in the early 1970s a large body of statistical work has established that forward rates for major currencies are not optimal predictors of future spot rates relevant evidence is reported in studies by baillie lippens and mcmahon 1983 bekaert 1991 bilson 1981 boothe and longworth 1984 cumby 1988 cumby and obstfeld 1984 fama 1984 gregory and mccurdy 1984 hansen and hodrick 1983 hodrick and srivastava 1984 and korajczyk and viallet 1990 a more complete list of references is provided by hodrick 1987 these papers indicate that returns from speculation in forward and spot currency markets are predictable and that the predictable components vary considerably over time a number of alternative explanations have been offered for the predictable variation in foreign currency market excess returns kaminsky 1988 korajczyk 1985 and krasker 1980 suggest that infrequent extreme events may make returns appear predictable in small samples the so called peso problem lewis 1989 argues that rational learning following infrequent changes in the process governing equilibrium prices can explain part of the ex post predictability of currency returns froot and frankel 1989 and froot and thaler 1990 examine the hypothesis that market forecasts of future spot

maintaining a reputation when strategies are imperfectly observed this paper studies reputation effects in games with a single long run player whose choice of stage game strategy is imperfectly observed by his opponents we obtain lower and upper bounds on the long run player s payoff in any nash equilibrium of the game if the long run player s stage game strategy is statistically identified by the observed outcomes then for generic payoffs the upper and lower bounds both converge as the discount factor tends to 1 to the long run player s stackelberg payoff which is the most he could obtain by publicly committing himself to any strategy

trickle down consumption abstract we document that nonrich households consume a larger share of their current income when exposed to higher top income and consumption levels permanent income wealth effects and upward local price pressures cannot provide the sole explanation for this finding instead we show that the budget shares that nonrich households allocate to more visible goods and services rise with top income levels consistent with status maintaining explanations for our primary finding nonrich households might have saved up to 3 more annually by the mid 2000s had incomes at the top grown at the same rate as median income since the early 1980s

inventory theoretic money demand and relative price dynamics we construct a two goods inventory theoretic money demand model and find that the model implies in a monetary contraction the decline in the prices of low cash intensity goods durables or luxuries outpaces that of high cash intensity goods nondurables or necessities using u s data we show that our model s predictions are consistent with the data

consumption and real exchange rates in dynamic economies with non traded goods abstract we examine the possibility that non traded goods may account for several striking features of international macroeconomic data large persistent deviations from purchasing power parity small correlations of aggregate consumption fluctuations across countries and substantial international real interest rate differentials a dynamic exchange economy is used to show that non traded goods in principle can account for each of these phenomena in the theory there is a close relation between fluctuations in consumption ratios and those in bilateral real exchange rates but we find little evidence for this relation in time series data for eight oecd countries

globally correlated nominal fluctuations fluctuations in nominal variables aggregate price levels and nominal interest rates are documented to be substantially more synchronized across countries at business cycle frequencies than fluctuations in real output a transparent mechanism accounting for this striking feature of the nominal environment is described and quantitatively evaluated it is based on the interaction between small cross country spillovers of shocks taylor rules and domestic no arbitrage conditions the mechanism is robust to various parameterizations and extensions aligning the model with other important aspects of domestic and international fluctuations furthermore its key features are consistent with cross country forecasts from consensus survey

a theory of the nominal term structure of interest rates a model of the nominal term structure of interest rates is developed that has a positive and stationary process for the interest rate and delivers closed form expressions for the prices of discount bonds and european options on bonds unlike the one state variable version of the cox ingersoll and ross 1985 model this model even in its one state variable version allows the term premium to change sign as a function of the state and the term to maturity and also allows for shapes of the yield curve that are observed in the u s data but that are disallowed in the cox ingersoll and ross model article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

reputation and equilibrium characterization in repeated games with conflicting interests a two person game is of conflicting interests if the strategy to which player one would most like to commit herself holds player two down to his minimax payoff suppose there is a positive prior probability that player one is a commitme nt type who will always play this strategy then player one will get a t least her commitment payoff in any nash equilibrium of the repeated game if her discount factor approaches one this result is robust against further perturbations of the informational structure and in striking contrast to the message of the folk theorem for games with incomplete information copyright 1993 by the econometric society

optimal monetary policy with heterogeneous money holdings abstract we study the optimal anticipated policy in a pure currency economy with flexible prices and a non degenerate distribution of money holdings the economy features a business cycle and lump sum monetary injections have distributional effects that depend on the state of the cycle we parsimoniously characterize the dynamics of the economy and study the optimal regulation of the money supply as a function of the state under commitment the optimal policy prescribes monetary expansions in recessions when insurance is most needed by the cash poor unproductive agents conversely the optimal policy prescribes monetary contractions during booms so that the inflationary effect of the occasional expansions is undone

durable consumption and asset management with transaction and observation costs this paper provides a contribution to the recent growing literature on rational inattention we start by testing the implications of recent rational inattention models of asset management liquidity holdings and savings using two novel datasets some predictions of these models are at odds with the data which motivates us to introduce a new model that shifts the focus from non durable to durable consumption and features both information and adjustment costs the focus on non durable consumption which departs from the previous literature is key to improve the fit of the model the investor s behavior in our setup combines elements of what the literature refers to as state dependent and time dependent adjustments the model allows us to quantify the information and transactions costs that are consistent with observed patterns of information review and asset trades a calibration of the model shows that very small information costs are sufficient to reproduce the relatively high frequency of observation that is found in the data we test a novel prediction of the model on the relationship between assets trades and durable goods trades and find it aligned with the data

is more information always better a case in credit markets this paper studies the impact of behavioral and non behavioral information contained in consumer credit reports on the credit market a repeated game of incomplete information between a borrower and a sequence of lenders is considered lenders beliefs regarding the borrower s type depend on the borrower s historical loan performance and other informative signals it is established that for low beliefs strategic defaults occur in equilibrium as the borrower defaults on his loans despite having the ability to repay them further as the ancillary signals become increasingly informative of the borrower s type the range of beliefs over which strategic defaults occur expands this increase in strategic defaults highlights an unintended negative effect of allowing informative signals to influence beliefs on the upside the informative signals allow lenders to learn the borrower s type more quickly

the role of saving and investment in exchange rate determination under alternative monetary mechanisms abstract we argue that the demand for national currencies depends on existing payment arrangements for imports and exports therefore exchange rate movements depend on these arrangement as a result the relationship between exchange rate movements and various macroeconomic aggregates like saving and investment depend on what we call the monetary mechanism these points are explicitly demonstrated by studying two extreme monetary mechanisms one in which all payments are done with the seller s currency and one in which all payments are done with the buyer s currency

heterogeneous consumers segmented asset markets and the real effects of monetary policy this paper proposes a novel mechanism by which changes in the distribution of money holdings have real effects specifically i develop a flexible price model of segmented asset markets that generates real aggregate effects of monetary policy through the dependence of optimal markups on the heterogeneity of money holdings because varieties of consumption bundles are purchased sequentially newly injected money disseminates slowly throughout the economy via second round effects the model predicts a short term inflation output trade off a liquidity effect countercyclical markups and procyclical wages after monetary shocks among other correlations of financial variables it also reproduces the empirical negative relationship between changes in the money supply and markups

the time variation of risk and return in foreign exchange markets a general equilibrium perspective this article successively introduces variable velocity durability and habit persistence in a standard two country general equilibrium model and explores their effects on the variability of exchange rate changes forward premiums and the foreign exchange risk premium a new feature of the model is that agents make decisions at a weekly frequency and face conditionally heteroskedastic shocks nevertheless even the most complex model fails to deliver sufficiently variable risk premiums without causing forward premiums and exchange rates to be excessively variable unlike previous models the model can roughly match the persistence of forward premiums article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

when does uncovered interest parity hold a consensus is emerging that returns to the currency carry trade are driven by two factors one of these is probably consumption risk but there is widespread disagreement about the identity of the remaining factor this paper bolsters the case for volatility being the unknown factor a structural model that specifies that monetary volatility is the second factor is tested for 56 monetary regimes using the artificial economy methodology the negative slope in the fama regression arises when monetary volatility is low and the precautionary savings motive dominates the intertemporal substitution motive when monetary volatility is high the fama slope is positive in line with uncovered interest parity we conclude that given the predominance of precautionary savings the degree of monetary volatility explains whether uncovered interest parity holds

why money growth determines inflation in the long run answering the woodford critique woodford 2007 argues that it is not appropriate to regard inflation in the steady state of new keynesian models as determined by steady state money growth woodford instead argues that the intercept term in the monetary authority s interest rate policy rule determines steady state inflation in this paper i offer an alternative interpretation of steady state behavior according to which it is appropriate to regard steady state inflation as determined by steady state money growth the argument relies on traditional interpretations of the central bank s power in the long run and appeals to model properties that are common to textbook and new keynesian analysis according to this argument the only way the central bank can control interest rates in the long run is via affecting inflation and its only means available for determining inflation is by determining the money growth rate

dynamic compensation contracts with private savings this article studies a dynamic agency problem in which a risk averse agent can save privately in the optimal contract i cash compensations exhibit downward rigidity to failures ii permanent pay raises occur when the agent s historical performance is sufficiently good iii and when the agent is dismissed due to poor performance he walks away with severance pay to support his post firing consumption at the current compensation level thus the theory can simultaneously explain the popularity of optionslike compensation contracts and the increasing incidence of forced turnovers with sizeable severance pay jel d86 j31 j33

a cohort analysis of saving behavior by u s households the aim of this paper is to shed some light in the decline in personal saving rates in the united states in the 1980s for a such a purpose the paper analyses the only u s data set containing information on consumption and income at the household level the consumer expenditure surveys cex from 1980 to 1991 because the cex is not a panel most of the analysis is conducted using average cohort techniques the paper identifies a typical age profile for saving rates such a profile is hump shaped and peaks around age 57 the paper also argues that such a profile was shifted down for the cohorts born between 1920 and 1939 relative to the younger and older cohorts considered these cohorts are the parents of the baby boom generation the paper also argues that these cohort effects can account for a non neglible proportion of the decline in aggregate saving because these cohorts were during the 1980s in the ages when saving rates are typically highest the result is robust to the consideration of several controls and holds for several definitions of consumption the only exception is when durable expenditure is considered as saving rather than consumption

reputation and equilibrium selection in games with a patient player a single long run player plays a simultaneous move stage game against a sequence of opponents who play only once but observe all previous play let the stackelberg strategy be the pure strategy to which the long run player would most like to commit himself if there is positive prior probability that the long run player will always play the stackelberg strategy then his payoff in any nash equilibrium exceeds a bound that converges to the stackelberg payoff as his discount factor approaches one when the stage game is not simultaneous move this result must be modified to account for the possibility that distinct strategies of the long run player are observationally equivalent

quantitative asset pricing implications of endogenous solvency constraints we study the asset pricing implications of an economy where solvency constraints are endogenously determined to deter agents from defaulting while allowing as much risk sharing as possible we solve analytically for efficient allocations and for the corresponding asset prices portfolio holdings and solvency constraints for a simple example then we calibrate a more general model to u s aggregate as well as idiosyncratic income processes we find equity premia risk premia for long term bonds and sharpe ratios of magnitudes similar to the u s data for low risk aversion and a low time discount factor article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

perils of unconventional monetary policy abstract unconventional monetary policy by relaxing restrictions on the composition of the balance sheet of the central bank compromises control over the stochastic path of inflation or in open economies over the stochastic path of exchange rates if the composition of the balance sheet is unrestricted then the path of inflation is indeterminate this is the case under pure quantitative easing where the target is the size of real money balances in contrast credit easing policies restrict the composition of the portfolio by targeting a specific expansion in the maturity profile of bonds bought and thus can implement a determinate path of inflation the composition of the portfolios traded by monetary fiscal authorities also determines premia in asset and currency markets

speculative runs on interest rate pegs abstract we analyze a new class of equilibria that emerges when a central bank conducts monetary policy by setting an interest rate as an arbitrary function of its available information and letting the private sector set the quantity traded these equilibria involve a run on the central bank s interest target whereby money grows fast private agents borrow as much as possible against the central bank and the shadow interest rate is different from the policy target we argue that these equilibria represent a particular danger when banks hold large excess reserves such as is the case following periods of quantitative easing our analysis suggests that successfully managing the exit strategy requires additional tools beyond setting interest rate targets and paying interest on reserves in particular freezing excess reserves or fiscal policy intervention may be needed to fend off adverse expectations

sluggish responses of prices and inflation to monetary shocks in an inventory model of money demand we examine the responses of prices and inflation to monetary shocks in an inventory theoretic model of money demand we show that the price level responds sluggishly to an exogenous increase in the money stock because the dynamics of households money inventories leads to a partially offsetting endogenous reduction in velocity we also show that inflation responds sluggishly to an exogenous increase in the nominal interest rate because changes in monetary policy affect the real interest rate in a quantitative example we show that this nominal sluggishness is substantial and persistent if inventories in the model are calibrated to match u s households holdings of m2

inflation and welfare in the steady state this is a paper on expected inflation and welfare in steady state equilibrium the demand for money is an inventory demand with an endogenous payment period the clower constraint is not imposed higher inflation reduces welfare by reducing consumption as people devote more of their real income to maintaining lower average money holdings high inflation does not necessarily promote an increase in the capital stock the mundell tobin effect is absent the policy conclusion is standard deflate at the rate of time preference because capital is held socially optimal consumption falls short of its golden rule level if inside money is allowed it drives out fiat money and welfare is again at a maximum

how important are the international financial market imperfections for the foreign exchange rate dynamics a study of the sterling exchange rate the uk has been a net debtor over the past two decades and the sterling exchange rates are sensitive to any chaos that might occur in the financial market this paper examines the importance of the international financial imperfections in the sterling exchange rate dynamics we build a small open economy dsge model with the constrained international financial institutions that intermediate capital flows and derive tractable analytical solutions the constraint works to introduce a wedge between lending and borrowing rates which compensates financiers for their currency risk taking the model has been estimated by using a simulation based indirect inference approach which provides a natural framework for testing the hypothesis implied by the model we find that the model cannot be rejected by the uk data shocks to financial forces are the main driving forces behind the large and sudden depreciation of the sterling exchange rates in the aftermath of the collapse of lehman brothers and the brexit vote furthermore the optimal policy rules have been proposed

state dependent pricing and the general equilibrium dynamics of money and output economists have long suggested that nominal product prices are changed infrequently because of fixed costs in such a setting optimal price adjustment should depend on the state of the economy yet while widely discussed statedependent pricing has proved difficult to incorporate into macroeconomic models this paper develops a new tractable theoretical state dependent pricing framework we use it to study how optimal pricing depends on the persistence of monetary shocks the elasticities of labor supply and goods demand and the interest sensitivity of money demand

comment on long and plosser meet bewley and lucas abstract feng dong and yi wen introduce money into the long and plosser multi sector real business cycle model money exists as a liquid asset that allows households to respond to idiosyncratic preference shocks despite the resulting heterogeneity in consumption a constant marginal utility of leisure implies that households eliminated differences in their wealth each period i argue that this framework implies excessive consumption volatility at the household level

reputation in the long run with imperfect monitoring abstract we study an infinitely repeated game where two players with equal discount factors play a simultaneous move stage game player one monitors the stage game actions of player two imperfectly while player two monitors the pure stage game actions of player one perfectly player one s type is private information and he may be a commitment type drawn from a countable set of commitment types who is locked into playing a particular strategy under a full support assumption on the monitoring structure we prove a reputation result for stage games with a strong stackelberg action if there is positive probability that player one is a particular type whose commitment payoff is equal to player one s highest payoff consistent with the players individual rationality then a patient player one secures this type s commitment payoff in any bayes nash equilibrium of the repeated game in contrast if the type s commitment payoff is strictly less than player one s highest payoff consistent with the players individual rationality then the worst perfect bayesian equilibrium payoff for a patient player one is equal to his minimax payoff

dynamics of a floating exchange rate regime we study the full equilibrium dynamics of a two country world economy with a floating exchange rate traded and nontraded goods and explicit modeling of the use of money the resulting exchange rate equation depends on several details of the economic structure such as the supply structure and propensities to spend on various goods although real exchange rate movements have the usual association with the current account the ordinary exchange rate may appreciate or depreciate when there are deficits on current account even when the quantities of money do not change deviations from purchasing power parity and the fisher equation are shown to be the rule rather than the exception

a simple general equilibrium version of the baumol tobin model this paper presents a simple general equilibrium model that includes optimizing choices of the frequency of trips to the bank the model is used to analyze the effect of inflation on the capital stock the interest elasticity of money demand the optimum quantity of money and the welfare costs of inflationary finance

liquidity and real activity in a simple open economy model abstract this paper analyzes the ability of an open economy version of lucas s 1990 liquidity model to account for properties of international data the focus is on the model s ability to account for exchange rate dynamics and measured effects of monetary policy shocks on exchange rates interest rates and real activities across countries the model generates a prediction that a positive domestic monetary innovation is associated with nominal and real currency depreciations however the model s predictions with respect to nominal and real exchange rate volatilities are low

open market operations abstract in an open market operation the central bank swaps currency for bonds we show how injecting money in this way is different from transfers the way policy is usually formulated the model captures liquidity explicitly by modeling the roles of assets in frictional exchange under various specifications for market structure and the acceptability or pledgeability of assets we discuss implications for the fisher and quantity equations the possibility of negative nominal yields liquidity traps and market segmentation when liquidity is endogenized using information theory multiple equilibria emerge with different policy predictions interest on reserves and quantitative easing are discussed

interpreting the forward premium anomaly one of the central issues in international finance concerns the forward premium anomaly changes in spot exchange rates are inversely related to the premium of forward rates over spot rates the authors construct a numerical example of a theoretical economy with this property and discuss its potential as an explanation of the anomaly