Monetary policy under imperfect information and consumer confidence

September 28, 2020

By Jan-Niklas Brenneisen

Although it is generally accepted that consumer confidence measures are informative signals about the state of the economy, theoretical macroeconomic models designed for the analysis of monetary policy typically do not provide a role for them. I develop a framework with asymmetric information in which the efficacy of monetary policy can be improved, when the imperfectly informed central banks include confidence measures in their information set. The beneficial welfare effects are quantitatively substantial in both a stylized New Keynesian model with optimal monetary policy and an estimated medium-scale DSGE model.

Policymakers take consumer confidence into account as long as it provides some additional information. In a typical model, consumer expectations do not, as they are formed on the same information set as that of the policymaker. In this paper, households have some private information, and thus their behavior is informative to the policymaker. Is that realistic? Difficult to say. Policymakers are well-informed and I suspect they ponder their decisions more than households. But the private sector still may know things that have not yet made it into the official statistics. Anyway, this paper is an interesting way to study this question.


Optimal Dynamic Capital Requirements and Implementable Capital Buffer Rules

September 22, 2020

By Matthew B. Canzoneri; Behzad T. Diba; Luca Guerrieri; Arsenii Mishin

We build a quantitatively relevant macroeconomic model with endogenous risk-taking. In our model, deposit insurance and limited liability can lead banks to make risky loans that are socially inefficient. This excessive risk-taking can be triggered by aggregate or sectoral shocks that reduce the return on safer loans. Excessive risk-taking can be avoided by raising bank capital requirements, but unnecessarily tight requirements lower welfare by limiting liquidity producing bank deposits. Consequently, optimal capital requirements are dynamic (or state contingent). We provide examples in which a Ramsey planner would raise capital requirements: (1) during a downturn caused by a TFP shock; (2) during an expansion caused by an investment-specific shock; and (3) during an increase in market volatility that has little effect on the business cycle. In practice, the economy is driven by a constellation of shocks, and the Ramsey policy is probably beyond the policymaker’s ken; so, we also consider implementable policy rules. Some rules can mimic the optimal policy rather well but are not robust to all the calibrations we consider. Basel III guidance calls for increasing capital requirements when the credit to GDP ratio rises, and relaxing them when it falls; this rule does not perform well. In fact, slightly elevated static capital requirements generally do about as well as any implementable rule.

Having toyed with this topic, all I can say is that this is an impressive effort on an important question. The analysis of cyclical capital requirements has long been hampered by inadequate modeling, in part due to difficulties working with these models. This one is really good.

Structuring Mortgages for Macroeconomic Stability

September 14, 2020

By John Y. Campbell, Nuno Clara and João F. Cocco

We study mortgage design features aimed at stabilizing the macroeconomy. We model overlapping generations of mortgage borrowers and an infinitely lived risk-averse representative mortgage lender. Mortgages are priced using an equilibrium pricing kernel derived from the lender’s endogenous consumption. We consider an adjustable-rate mortgage (ARM) with an option that during recessions allows borrowers to pay only interest on their loan and extend its maturity. We find that this maturity extension option stabilizes consumption growth over the business cycle, shifts defaults to expansions, and is welfare enhancing. The cyclical properties of the maturity extension ARM are attractive to a risk-averse lender so the mortgage can be provided at a relatively low cost.


Consumption and Income Inequality across Generations

September 7, 2020

By Giovanni Gallipoli, Hamish Low and Aruni Mitra

We characterize the joint evolution of cross-sectional inequality in earnings, other sources of income and consumption across generations in the U.S. To account for cross-sectional dispersion, we estimate a model of intergenerational persistence and separately identify the influences of parental factors and of idiosyncratic life-cycle components. We find evidence of family persistence in earnings, consumption and saving behaviours, and marital sorting patterns. However, the quantitative contribution of idiosyncratic heterogeneity to cross-sectional inequality is significantly larger than parental effects. Our estimates imply that intergenerational persistence is not high enough to induce further large increases in inequality over time and across generations.

Let me rephrase this fascinating paper. Within a family, there is an important degree of persistence in various economic behaviors across generations: earnings, savings and consumption correlate highly. In addition, there is assortitative mating: high earners tend to marry high earners, etc. We also observe that inequality has increased. Is this due to this inter-generational persistence. While this persistence is strong, it is not strong enough to influence aggregate inequality. Other forces drive that.