Using a Bayesian likelihood approach, we estimate a dynamic stochastic general equilibrium model for the US economy using seven macro-economic time series. The model incorporates many types of real and nominal frictions and seven types of structural shocks. We show that this model is able to compete with Bayesian Vector Autoregression models in out-of-sample prediction. We investigate the relative empirical importance of the various frictions. Finally, using the estimated model we address a number of key issues in business cycle analysis: What are the sources of business cycle fluctuations? Can the model explain the cross-correlation between output and inflation? What are the effects of productivity on hours worked? What are the sources of the "Great Moderation"?

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Shocks and Frictions in US Business Cycles: A Bayesian DSGE Approach

We estimate a dynamic stochastic general equilibrium (DSGE) model for the US economy. The model incorporates many types of real and nominal frictions: sticky nominal price and wage setting, habit formation in consumption, investment adjustment costs, variable capital utilisation and fixed costs in production. It also contains many types of shocks including productivity, labour supply, investment, preference, cost-push and monetary policy shocks. Using Bayesian estimation techniques, the relative importance of the various frictions and shocks in explaining the US business cycle are empirically investigated. We also show that this model is able to outperform standard VAR and BVAR models in out-of-sample prediction.

/pdf/shocks-and-frictions-in-us-business-cycles-a-bayesian-dsge-2gcs6kvruw.pdf

Shocks and frictions in US business cycles: A Bayesian DSGE approach

https://eml.berkeley.edu/~webfac/gorodnichenko/gertler.pdf

A model of unconventional monetary policy

This paper investigates the impact of tax changes on economic activity. We use the narrative record, such as presidential speeches and Congressional reports, to identify the size, timing, and principal motivation for all major post war tax policy actions. This analysis allows us to separate legislated changes into those taken for reasons related to prospective economic conditions and those taken for more exogenous reasons. The behavior of output following these more exogenous changes indicates that tax increases are highly contractionary. The effects are strongly significant, highly robust, and much larger than those obtained using broader measures of tax changes. (JEL E32, E62, H20, N12) Tax changes have been a major public policy issue in recent years. The tax cuts of 2001 and 2003 were passed amid firestorms of debate about their likely effects. Some policymakers claimed that the cuts would both stimulate the economy in the short run and increase normal output in the long run. Others argued that they would raise interest rates and lower confidence and thereby reduce output in both the short run and the long run. That views of the effects of tax changes vary so radically largely reflects the fact that measuring these effects is very difficult. Tax changes occur for many reasons. Some legislated tax changes are passed for philosophical reasons or to reduce an inherited budget deficit. Others are passed because the economy is weak and predicted to fall further, or because a war is in progress and government spending is rising. And many tax changes are not legislated at all, but occur automatically because the tax base varies with the overall level of income, or because of changes in stock prices, inflation, and other nonpolicy forces. Because the factors that give rise to tax changes are often correlated with other developments in the economy, disentangling the effects of the tax changes from the effects of these underlying factors is inherently difficult. There is pervasive omitted variable bias in any regression of output on an aggregate measure of tax changes. This paper suggests one way of dealing with this omitted variable bias. There exists a vast narrative record describing the history and motivation of tax policy changes. We first use this narrative history to separate legislated tax changes from those arising from nonpolicy develop ments. We then use the information on motivation to separate the legislated tax changes into those that are likely to be contaminated by other developments affecting output, and those that can legitimately be used to measure the macroeconomic effects of tax changes. Finally, we use the legitimate observations to derive estimates of the effects of tax changes on output that are likely to be less biased than previous estimates. Section I of the paper elaborates on the conceptual framework for this study. It emphasizes that what we seek to identify from the narrative record are tax changes that are not systematically

/pdf/the-macroeconomic-effects-of-tax-changes-estimates-based-on-2own874tku.pdf

The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks

We argue that the government-spending multiplier can be much larger than one when the zero lower bound on the nominal interest rate binds. The larger the fraction of government spending that occurs while the nominal interest rate is zero, the larger the value of the multiplier. After providing intuition for these results, we investigate the size of the multiplier in a dynamic, stochastic, general equilibrium model. In this model the multiplier effect is substantially larger than one when the zero bound binds. Our model is consistent with the behavior of key macro aggregates during the recent financial crisis.

/pdf/when-is-the-government-spending-multiplier-large-4apdjbeakn.pdf

When Is the Government Spending Multiplier Large

THE CONSEQUENCES FOR THE PROPER conduct of monetary policy of the existence of a lower bound of zero for overnight nominal interest rates has recently become a topic of lively interest. In Japan the call rate (the overnight cash rate analogous to the federal funds rate in the United States) has been within 50 basis points of zero since October 1995, and it has been essentially equal to zero for most of the past four years (figure 1). Thus the Bank of Japan has had little room to further reduce short-term nominal interest rates in all that time. Meanwhile Japan's growth has remained anemic, and prices have continued to fall, suggesting a need for monetary stimulus. Yet the usual remedy--lower short-term nominal interest rates--is plainly unavailable. Vigorous expansion of the monetary base has also seemed to do little to stimulate demand under these circumstances: as figure l also shows, the monetary base is now more than twice as large, relative to GDP, as it was in the early 1990s. [FIGURE 1 OMITTED] In the United States, meanwhile, the federal funds rate has now been reduced to only 1 percent, and signs of recovery remain exceedingly fragile. This has led many to wonder if this country might not also soon find itself in a situation where interest rate policy is no longer available as a tool for macroeconomic stabilization. A number of other countries face similar questions. John Maynard Keynes first raised the question of what can be done to stabilize the economy when it has fallen into a liquidity trap--when interest rates have fallen to a level below which they cannot be driven by further monetary expansion--and whether monetary policy can be effective at all under such circumstances. Long treated as a mere theoretical curiosity, Keynes's question now appears to be one of urgent practical importance, but one with which theorists have become unfamiliar. The question of how policy should be conducted when the zero bound is reached--or when the possibility of reaching it can no longer be ignored--raises many fundamental issues for the theory of monetary policy. Some would argue that awareness of the possibility of hitting the zero bound calls for fundamental changes in the way policy is conducted even before the bound has been reached. For example, Paul Krugman refers to deflation as a "black hole," (1) from which an economy cannot expect to escape once it has entered. A conclusion often drawn from this pessimistic view of the efficacy of monetary policy in a liquidity trap is that it is vital to steer far clear of circumstances in which deflationary expectations could ever begin to develop--for example, by targeting a sufficiently high positive rate of inflation even under normal circumstances. Others are more sanguine about the continuing effectiveness of monetary policy even when the zero bound is reached, For example, it is often argued that deflation need not be a black hole, because monetary policy can affect aggregate spending, and hence inflation, through channels other than central bank control of short-term nominal interest rates. Thus there has been much recent discussion, with respect to both Japan and the United States--of the advantages of vigorous expansion of the monetary base even without any further reduction in interest rates, of the desirability of attempts to shift longer-term interest rates through central bank purchases of longer-maturity government securities, and even of the desirability of central bank purchases of other kinds of assets. Yet if these views are correct, they challenge much of the recent conventional wisdom regarding the conduct of monetary policy, both within central banks and among academic monetary economists. That wisdom has stressed a conception of the problem of monetary policy in terms of the appropriate adjustment of an operating target for overnight interest rates, and the prescriptions formulated for monetary policy, such as the celebrated Taylor rule, (2) are typically cast in these terms. …

/pdf/the-zero-bound-on-interest-rates-and-optimal-monetary-policy-5653juhq4h.pdf

The Zero Bound on Interest Rates and Optimal Monetary Policy

In this paper we present a simple New Keynesian-style model of debt-driven slumps – that is, situations in which an overhang of debt on the part of some agents, who are forced into rapid deleveraging, is depressing aggregate demand. Making some agents debt-constrained is a surprisingly powerful assumption: Fisherian debt deflation, the possibility of a liquidity trap, the paradox of thrift, a Keynesiantype multiplier, and a rationale for expansionary fiscal policy all emerge naturally from the model. We argue that this approach sheds considerable light both on current economic difficulties and on historical episodes, including Japan’s lost decade (now in its 18th year) and the Great Depression itself.

/pdf/debt-deleveraging-and-the-liquidity-trap-a-fisher-minsky-koo-r2e7e4sbdu.pdf

Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo Approach*

ing from monetary frictions and the structure of government liabilities altogether—and instead consider what is the desirable conduct of interest rate policy, and what kind of commitments about this policy are desirable to make in advance. How Severe a Constraint Is the Zero Bound? We turn now to the question of how the existence of the zero bound restricts the degree to which a central bank’s stabilization objectives, with regard to both inflation and real activity, can be achieved, even under ideal policy. The discussion in the previous section established that the zero bound does represent a genuine constraint. It is not true that equilibria that cannot be achieved through a suitable interest rate policy can somehow be achieved through other means, and the zero bound does limit the set of possible equilibrium paths for prices and output, although the quantitative importance of this constraint remains to be seen. Nonetheless, we will see that it is not at all the case that a central bank can do nothing to mitigate the severity of the destabilizing impact of the zero bound. The reason is that inflation and output do not depend solely on the current level of short-term nominal interest rates, or even solely on the history of such rates up until the present (so that the current level of interest rates would be the only thing that could possibly change in response to an unanticipated disturbance). The expected character of future interest rate policy is also a critical determinant of the degree to which the central bank achieves its stabilization objectives, and this allows important scope for policy to be improved upon, even when there is little choice about the current level of short-term interest rates. In fact, the management of expectations is the key to successful monetary policy at all times, not just in those relatively unusual circumstances when the zero bound is reached. The effectiveness of monetary policy has little to do with the direct effect of changing the level of overnight interest rates, since the current cost of maintaining cash balances overnight is of fairly trivial significance for most business decisions. What actually matters is the private sector’s anticipation of the future path of short-term rates, because this determines equilibrium long-term interest rates as well as equilibrium exchange rates and other asset prices—all of which are quite relevant for many current spending decisions, and hence for optimal Gauti B. Eggertsson and Michael Woodford 165 1440-03 BPEA/Eggertsson 07/17/03 08:12 Page 165

/pdf/zero-bound-on-interest-rates-and-optimal-monetary-policy-3cg7u8a73g.pdf

Zero Bound on Interest Rates and Optimal Monetary Policy

Tax cuts can deepen a recession if the short-term nominal interest rate is zero, according to a standard New Keynesian business cycle model. An example of a contractionary tax cut is a reduction in taxes on wages. This tax cut deepens a recession because it increases deflationary pressures. Another example is a cut in capital taxes. This tax cut deepens a recession because it encourages people to save instead of spend at a time when more spending is needed. Fiscal policies aimed directly at stimulating aggregate demand work better. These policies include 1) a temporary increase in government spending; and 2) tax cuts aimed directly at stimulating aggregate demand rather than aggregate supply, such as an investment tax credit or a cut in sales taxes. The results are specific to an environment in which the interest rate is close to zero, as observed in large parts of the world today.

/pdf/what-fiscal-policy-is-effective-at-zero-interest-rates-2u2u0ormuk.pdf

What Fiscal Policy Is Effective at Zero Interest Rates

https://www.federalreserve.gov/pubs/ifdp/2013/1092/ifdp1092.pdf

Gauti B. Eggertsson

Papers

The Zero Bound on Interest Rates and Optimal Monetary Policy

Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo Approach*

Zero Bound on Interest Rates and Optimal Monetary Policy

What Fiscal Policy Is Effective at Zero Interest Rates

Can Structural Reforms Help Europe