Bernardino Adão

The Monetary Transmission Mechanism: Is It Relevant for Policy?

We study environments with sticky prices, wages or portfolios where it is feasible and optimal to use monetary policy to replicate the allocation under full flexibility. In these environments the optimal policy does not depend on the scope of the frictions. In this sense, the strength of the monetary transmission mechanism is irrelevant for the conduct of monetary policy. So, asymmetries in the strength of the transmission mechanisms do not impose a cost on a common policy.

Monetary policy with state contingent interest rates

What instruments of monetary policy must be used in order to implement a unique equilibrium? This paper revisits the issues addressed by Sargent and Wallace (1975) on the multiplicity of equilibria when policy is conducted with interest rate rules. We show that the appropriate interest rate instruments under uncertainty are state- contingent interest rates, i.e. the nominal returns on state-contingent nominal assets. A policy that pegs state-contingent nominal interest rates, and sets the initial money supply, implements a unique equilibrium. These results hold whether prices are flexible or set in advance.

Monetary policy with single instrument feedback rules

We consider a standard cash in advance monetary model with flexible prices or prices set in advance and show that there are interest rate or money supply rules such that equilibria are unique. The existence of these single instrument rules depends on whether the economy has an infinite horizon or an arbitrarily large but finite horizon.

Interest rate spreads implicit in options: Spain and Italy against Germany

The options premiums are frequently used to obtain probability density functions (pdfs) for the prices of the underlying assets. When these assets are bank deposits or notional Government bonds it is possible to compute probability measures of future interest rates. Recently, in the literature there have been many papers presenting methods of how to estimate pdfs from options premiums. Nevertheless, as far as we know, the estimation of probabilities of forward interest rate functions is an issue that has not been analysed before. In this paper, we propose such a method, that can be used to study the evolution of the expectations about interest rate convergence. We look at the cases of Spain and Italy against Germany, before the adoption of a single currency, and conclude that the expectations on the short-term interest rates convergence of Spain and Italy vis-à-vis Germany had a somewhat different trajectory, with higher expectations of convergence for Spain.

Government financing, inflation, and the financial sector

We calculate the effects of an increase in government spending under two financing alternatives: labor income taxes or inflation. A standard cash-inadvance model implies that it is optimal to finance the increase in spending with inflation rather than with taxes. However, when we allow agents to select the moment in which they rebalance their portfolio, this conclusion is reversed. The welfare cost of financing the government with inflation becomes higher. The robustness of this result is studied by considering government spending in the form of transfers or consumption expenditures and alternative definitions of seigniorage. JEL Codes: E52, E62, E63.We calculate the effects of an increase in government spending financed with labor income taxes or inflation. Government spending takes the form of government consumption or transfers. Agents increase the use of financial services to avoid losses from inflation. The financial sector increases with inflation, in accordance with the data. In standard cash-in-advance models, in the presence of government transfers, it is optimal to finance the government with inflation. In our framework, it is optimal to use taxes. We reverse the result from standard cash-in-advance models. The reason is the additional costs from the increase in the financial sector.

The Effect of Firm Cash Holdings on Monetary Policy

Firm cash holdings increased substantially from 1980 to 2013. The overall distribution of firm cash holdings changed in the same period. We study the implications of these changes for monetary policy. We use Compustat data and a model with financial frictions that allows the calculation of the monetary policy effects according to the distribution of cash holdings. We find that the interest rate channel of the transmission of monetary policy has become more powerful, as the impact of monetary policy over real interest rates increased. With the observed changes in firm cash holdings, the real interest rate takes 3.4 months more to return to its initial value after a shock to the nominal interest rate.

Sub-Optimality of the Friedman Rule with Distorting Taxes

We find that the Friedman rule is not optimal with real government transfers and distortionary taxation. As transfers cannot be taxed, a positive nominal net interest rate is the indirect way to tax the additional income derived from transfers. This result holds for heterogeneous agents, standard homogeneous preferences, and constant returns to scale production functions. The presence of real transfers changes the standard optimal taxation result of uniform taxation. Higher transfers imply higher optimal inflation rate. We calibrate a model with transfers to the US economy and obtain optimal values for inflation substantially above the Friedman rule.

Entry Mistakes with Strategic Pricing

This paper concerns entry mistakes when the incumbent practices strategic pricing. Due to an agency problem between the owner and the manager of the entrant firm there may be equilibria with too much entry that are preferred by both the entrant and the incumbent. This result is surprising because it would be expected that the entrant would prefer to know the type of incumbent in the industry before he takes his decision.