Martín Uribe

Monetary Policy and Multiple Equilibria

In this paper, we characterize conditions under which interest rate feedback rules whereby the nominal interest rate is set as an increasing function of the inflation rate generate multiple equilibria. We show that these conditions depend not only on the fiscal regime (as emphasized in the fiscal theory of the price level) but also on the way in which money is assumed to enter preferences and technology. We analyze this issue in flexible and sticky price environments. We provide a number of examples in which, contrary to what is commonly believed, active monetary policy in combination with a fiscal policy that preserves government solvency gives rise to multiple equilibria and passive monetary policy renders the equilibrium unique.

Risk Matters: The Real Effects of Volatility Shocks

This paper shows how changes in the volatility of the real interest rate at which small open emerging economies borrow have a quantitatively important effect on real variables like output, consumption, investment, and hours worked. To motivate our investigation, we document the strong evidence of time-varying volatility in the real interest rates faced by a sample of four emerging small open economies: Argentina, Ecuador, Venezuela, and Brazil. We postulate a stochastic volatility process for real interest rates using T-bill rates and country spreads and estimate it with the help of the Particle filter and Bayesian methods. Then, we feed the estimated stochastic volatility process for real interest rates in an otherwise standard small open economy business cycle model. We calibrate eight versions of our model to match basic aggregate observations, two versions for each of the four countries in our sample. We find that an increase in real interest rate volatility triggers a fall in output, consumption, investment, and hours worked, and a notable change in the current account of the economy.

Balanced-Budget Rules, Distortionary Taxes, and Aggregate Instability

A traditional argument against a balanced‐budget fiscal policy rule is that it amplifies business cycles by stimulating aggregate demand during booms via tax cuts and higher public expenditures and by reducing demand during recessions through a corresponding fiscal contraction. This paper suggests an additional source of instability that may arise from this type of fiscal policy rule. It shows that, within the standard neoclassical growth model, a balanced‐budget rule can make expectations of higher tax rates self‐fulfilling if the fiscal authority relies heavily on changes in labor income taxes to eliminate short‐run fiscal imbalances. Calibrated versions of the model show that indeterminacy occurs for income tax rates that are empirically plausible for the U.S. economy and other Group of Seven countries.

Optimal Fiscal and Monetary Policy in a Medium-Scale Macroeconomic Model

In this paper, we study Ramsey-optimal fiscal and monetary policy in a medium-scale model of the U.S. business cycle. The model features a rich array of real and nominal rigidities that have been identified in the recent empirical literature as salient in explaining observed aggregate fluctuations. The main result of the paper is that price stability appears to be a central goal of optimal monetary policy. The optimal rate of inflation under an income-tax regime is 1/2 percent per year, with a volatility of 1.1 percent. This result is surprising given that the model features a number of frictions-particularly nonstate-contingent nominal public debt, no lump-sum taxes, and sticky wages-that, in isolation, would call for a volatile rate of inflation. Under an income-tax regime, the optimal income-tax rate is quite stable, with a mean of 30 percent and a standard deviation of 1.1 percent. Simple monetary and fiscal rules are shown to implement a competitive equilibrium that mimics well the one induced by the Ramsey policy. When the fiscal authority is allowed to tax capital and labor income at different rates, optimal fiscal policy is characterized by a large and volatile subsidy on capital.

Avoiding Liquidity Traps

Once the zero bound on nominal interest rates is taken into account, Taylor-type interest-rate feedback rules give rise to unintended self-fulfilling decelerating inflation paths and aggregate fluctuations driven by arbitrary revisions in expectations. These undesirable equilibria exhibit the essential features of liquidity traps, as monetary policy is ineffective in bringing about the governments goals regarding the stability of output and prices. This paper proposes several fiscal and monetary policies that preserve the appealing features of Taylor rules, such as local uniqueness of equilibrium near the inflation target, and at the same time rule out the deflationary expectations that can lead an economy into a liquidity trap.

Price Level Determinacy and Monetary Policy Under a Balanced-Budget Requirement

This paper analyzes the implications of a balanced-budget fiscal policy rule for price-level determination in a cash-in-advance economy under three alternative monetary policy regimes. It shows that the price level is indeterminate under a nominal interest rate peg and determinate under a money growth rate peg. Under a feedback rule that sets the nominal interest rate as a non-negative and non-decreasing function of the inflation rate, the price level is indeterminate for both low and high values of the inflation elasticity of the feedback rule and determinate for intermediate values. We also study balanced-budget rules that allow for bounded secondary surpluses or deficits. Comparing our results to those emphasized in the fiscal theory of the price level, it becomes clear that a key consideration for price-level determination is whether fiscal policy is specified as an exogenous sequence of primary surpluses/deficits or, alternatively, as an exogenous sequence of secondary surpluses/deficits.

Hysteresis in a simple model of currency substitution

A simple model of currency substitution is developed in which the private cost of performing transactions in the foreign currency depends upon the aggregate degree of dollarization. This feature generates multiple steady states and hysteresis in an otherwise standard cash-in-advance model of a small open economy. In particular, a temporary increase in the rate of inflation can drive the economy to a dollarized equilibrium in which the velocity of circulation of domestic currency is permanently higher.

Exchange-rate-based inflation stabilization: The initial real effects of credible plans

This paper presents a dynamic general equilibrium model of a small, open, monetary economy in order to analyze the short-run effects of credible stabilization plans that fix the nominal exchange rate in a regime of free convertibility. In this model inflation acts as a tax on domestic market transactions. In particular, it generates a wedge between the rate of return on investment in domestic capital and the rate of return on investment in foreign assets. The model stresses the importance of adjustment costs (including gestation lags) in explaining the precise character of the initial dynamics. The main stylized facts of this type of programs namely an initial phase characterized by several months of real exchange rate appreciation, trade balance deterioration and expansion in aggregate demand and production, followed by a deflationary slowdown in real activity, are replicated without resorting to credibility problems, sticky prices, adaptive expectations, or gradual disinflation schemes. Finally, the model is calibrated using long-run relations from the Argentinean economy, and its quantitative predictions are compared to the initial effects of that countrys Convertibility Plan of April 1991.

Downward Nominal Wage Rigidity, Currency Pegs, and Involuntary Unemployment

This paper analyzes the inefficiencies arising from the combination of fixed exchange rates, nominal rigidity, and free capital mobility. We document that nominal wages are downwardly rigid in emerging countries. We develop an open-economy model that incorporates this friction. The model predicts that the combination of a currency peg and free capital mobility creates a negative externality that causes overborrowing during booms and high unemployment during contractions. Optimal capital controls are shown to be prudential. For plausible calibrations, they reduce unemployment by around 5 percentage points. The optimal exchange rate policy eliminates unemployment and calls for large devaluations during crises.

The effect of uncertainty on the demand for medical care, health capital and wealth

We analyze the effect of the uncertainty of the incidence of illness on the demand for medical care and on the accumulation of health capital and wealth over the retirement years. We use a simplified version of a dynamic Grossman household production model to characterize patterns of an individuals precautionary behavior. Elderly individuals respond to uncertainty by smoothing their expected utility over time by making specific patterns of purchases of medical care and consumption. We examine these patterns for individuals with different degrees of risk aversion.