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- supported by NSF grant 2149193 -
Data: Treasury Risk Stagflation Indicators (January 2023)
AFA Inflation Panel Slides (January 2023)
This paper explains changes in nominal and real bond risks in a New Keynesian model of monetary policy, where habit formation preferences generate endogenously time-varying risk premia. In the 1979.Q4-2001.Q1 calibration, a strong monetary policy response to volatile supply shocks leads to ``stagflations'', the inflation-output correlation is negative, and the nominal bond-stock correlation is positive. In the 2001.Q2-2019.Q4 calibration, demand shocks are dominant, leading to a positive inflation-output correlation, and a negative nominal bond-stock correlation. Combining 1980s-style supply shocks with a 2000s-style monetary policy rule does not turn model nominal bond betas positive, consistent with post-pandemic evidence.
Perceptions about Monetary Policy, with Michael Bauer and Adi Sunderam, 2022
- supported by NSF grant 2149193 -
We estimate perceptions about the Fed's monetary policy rule from micro data on professional forecasters. The perceived rule varies significantly over time, with important consequences for monetary policy and bond markets. Over the monetary policy cycle, easings are perceived to be quick and surprising, while tightenings are perceived to be gradual and data-dependent. Consistent with the idea that forecasters learn about the policy rule from policy decisions, the perceived monetary policy rule responds to high-frequency monetary policy surprises. Variation in the perceived rule impacts financial markets, explaining changes in the sensitivity of interest rates to macroeconomic announcements and affecting risk premia on long-term Treasury bonds. It also helps explain forecast errors for the future federal funds rate. We interpret these findings through the lens of a model with forecaster heterogeneity and learning from observed policy decisions.
Inflation and Asset Returns, with Anna Cieslak, 2022, prepared for Annual Review of Financial Economics
The past half-century has seen major shifts in inflation expectations, how inflation comoves with the business cycle, and how stocks comove with Treasury bonds. Against this backdrop, we review the economic channels and empirical evidence on how inflation is priced in financial markets. Not all inflation episodes are created equal. We therefore discuss asset pricing implications of ``good” and ``bad” inflation from the vantage point of macroeconomic shocks that drive the economy. We conclude by providing an outlook for future research and the implications for the newly rising inflation.
The Dark Side of Conservative Central Banks: A Model of Political Turnover and the Central Bank, with Wioletta Dziuda, 2022
We present a two-period model, where an apolitical central bank affects electoral outcomes. The central bank minimizes a standard quadratic loss function in inflation and unemployment along an expectational Phillips curve, where the elected government's quality acts as a supply shock. In the model, a central bank with a strong price stability mandate shifts the fully rational electoral mean-variance trade-off towards the incumbent of known quality and away from the challenger of unknown quality, thereby allowing lower quality incumbents to be reelected. Intuitively, because the incumbent's quality is less uncertain she benefits more from the reduction in the inflation bias, and suffers less from the increase in unemployment volatility, when the central bank is focused on stabilizing inflation. We test key model predictions using data on elections and central bank laws from developed countries and in a difference-in-differences design around the introduction of the Euro. In line with the model, we show that political leaders are more likely to be reelected if the central bank governor is directly appointed by the executive, and when the central bank has a mandate focused exclusively on price stability.