Carlos Carvalho

Heterogeneity in Price Stickiness and the Real Effects of Monetary Shocks

There is ample evidence that the frequency of price adjustments differs substantially across sectors. This paper introduces sectoral heterogeneity in price stickiness into an otherwise standard sticky price model to study how it affects the dynamics of monetary economies. Qualitative and quantitative results from a realistic calibration for the U.S. economy show that monetary shocks tend to have larger and more persistent real effects in heterogeneous economies, when compared to identical-firms economies with similar degrees of nominal and real rigidity. In the presence of strategic complementarities in price setting, sectors with lower frequencies of price adjustment have a disproportionate effect on the aggregate price level. In order to better approximate the dynamics of the calibrated heterogeneous economy, an identical-firms model requires a frequency of price changes that is up to three times lower than the average of the heterogeneous economy.

Endogenous Time-Dependent Rules and Inflation Inertia

In this paper, we endogenize fixed price time-dependent rules to examine the output effects of monetary disinflation. We derive the optimal rules in and out of inflationary steady states, and develop a methodology to aggregate individual pricing rules which vary through time. Because of strategic complementarities, we have to solve both problems simultaneously. This allows us to reassess the output costs of monetary disinflations, including aspects such as the roles of the initial level of inflation, and of the degree of strategic complementarity in price. Finally, we relax the strict assumption of pure time-dependent rules by allowing price-setters to re-evaluate their rules at the time disinflation is announced.

Sectoral Price Facts in a Sticky-Price Model

We develop a multi-sector sticky-price DSGE (dynamic stochastic general equilibrium) model that can endogenously deliver differential responses of prices to aggregate and sectoral shocks. Input-output production linkages induce across-sector pricing complementarities that contribute to a slow response of prices to aggregate shocks. In turn, input-market segmentation at the sectoral level induces within-sector pricing substitutability, which helps the model deliver a fast response of prices to sector-specific shocks. Estimating the factor-augmented vector autoregression specification of Boivin, Giannoni, and Mihov (2009) on data generated by a parameterized version of our model, we find results that resemble what they obtain with disaggregated data for the U.S. economy. We then employ Bayesian methods to estimate the model using aggregate and sectoral data, and find that it accounts extremely well for a wide range of sectoral price facts.

Do People Understand Monetary Policy

We combine questions from the Michigan Survey about future inflation, unemployment, and interest rates to investigate whether households are aware of the basic features of U.S. monetary policy. Our findings provide evidence that some households form their expectations in a way that is consistent with a Taylor (1993)-type rule. We also document a large degree of variation in the pattern of responses over the business cycle. In particular, the negative relationship between unemployment and interest rates that is apparent in the data only shows up in households׳ answers during periods of labor market weakness.

Heterogeneous Price-Setting Behavior and Aggregate Dynamics: Some General Results

We analyze the effects of heterogeneity in price setting behavior in time-dependent sticky price and sticky information models characterized by quite general adjustment hazard functions. In a large class of models that includes the most commonly used price setting specifications, heterogeneity leads monetary shocks to have larger real effects than in one-sector economies with the same frequency of adjustments. Quantitatively, the effects of heterogeneity in models calibrated to match the recent empirical evidence on pricing behavior are large, even in the absence of strategic complementarity in price setting. We find that the degree of monetary non-neutrality in the calibrated heterogeneous economies can be as large as in an otherwise identical one-sector economy with roughly three times more nominal rigidity.

Do people understand monetary policy

We combine questions from the Michigan Survey about future inflation, unemployment, and interest rates to investigate whether households are aware of the basic features of U.S. monetary policy. Our findings provide evidence that some households form their expectations in a way that is consistent with a Taylor (1993)-type rule. We also document a large degree of variation in the pattern of responses over the business cycle. In particular, the negative relationship between unemployment and interest rates that is apparent in the data only shows up in households׳ answers during periods of labor market weakness.

Policy Initiatives in the Global Recession: What Did Forecasters Expect?

The global recession of 2008-09 led to monetary and fiscal policy responses by central banks and government authorities that were often unconventional in size and scope. A study of expansionary measures employed during the recession suggests that overall, the policies were likely effective in shaping the outlook for a recovery, as forecasters raised their expectations of inflation and GDP growth after the policies’ implementation. From this perspective, the policies stimulated economic activity and prevented deflationary pressures during the financial crisis.

Loss aversion, asymmetric market comovements, and the home bias

Loss aversion has been used to explain why a high equity premium might be consistent with plausible levels of risk aversion. The intuition is that the different utility impact of wealth gains and losses leads loss-averse investors to behave similarly to investors with high risk aversion. But if so, should these agents not perceive larger gains from international diversification than standard expected-utility preference agents with plausible levels of risk aversion? They might not, because comovements in international stock markets are asymmetric: Correlations are higher in market downturns than in upturns. This asymmetry dampens the gains from diversification relatively more for loss-averse investors. We analyze the portfolio problem of such an investor who has to choose between home and foreign equities in the presence of asymmetric comovement in returns. Perhaps surprisingly, in the context of the home bias puzzle we find that the loss-averse investors behave similarly to those with standard expected-utility preferences and plausible levels of risk aversion. We argue that preference specifications that appear to perform well with respect to the equity premium puzzle should be subjected to this “test.�?

Demographics and Real Interest Rates: Inspecting the Mechanism

The demographic transition can affect the equilibrium real interest rate through three channels. An increase in longevity---or expectations thereof---puts downward pressure on the real interest rate, as agents build up their savings in anticipation of a longer retirement period. A reduction in the population growth rate has two counteracting effects. On the one hand, capital per-worker rises, thus inducing lower real interest rates through a reduction in the marginal product of capital. On the other hand, the decline in population growth eventually leads to a higher dependency ratio (the fraction of retirees to workers). Because retirees save less than workers, this compositional effect lowers the aggregate savings rate and pushes real rates up. We calibrate a tractable life-cycle model to capture salient features of the demographic transition in developed economies, and find that its overall effect is a reduction of the equilibrium interest rate by at least one and a half percentage points between 1990 and 2014. Demographic trends have important implications for the conduct of monetary policy, especially in light of the zero lower bound on nominal interest rates. Other policies can offset the negative effects of the demographic transition on real rates with different degrees of success.

Monetary Policy and Real Exchange Rate Dynamics in Sticky-Price Models

We study how real exchange rate dynamics are aected by monetary policy in dynamic, sto- chastic, general equilibrium, sticky-price models. Our analytical and quantitative results show that the source of interest rate persistence -policy inertia or persistent policy shocks -is key. When the monetary policy rule has a strong interest rate smoothing component, these models fail to generate high real exchange rate persistence in response to monetary shocks, as policy iner- tia hampers their ability to generate a hump-shaped response to such shocks. Moreover, in the presence of persistent monetary shocks, increasing policy inertia may decrease real exchange rate persistence.