Working papers

Asset Price Learning and Optimal Monetary Policy, with Colin Caines

We characterize optimal monetary policy when agents are learning about endogenous asset prices, but are close to rational otherwise. Boundedly rational expectations induce inefficient equilibrium asset price fluctuations which translate into inefficient aggregate demand fluctuations. We find that the optimal policy raises interest rates when expected capital gains, and the level of current asset prices, is high. The optimal policy stabilizes inflation and the output gap, but does not eliminate deviations of asset prices from their fundamental value. When monetary policymakers are information-constrained, optimal policy can be reasonably approximated by simple interest rate rules that incorporate capital gains.

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  • Dynare add-on for solving learning models with conditionally model-consistent expectations

A Likelihood-Based Comparison of Macro
Asset Pricing Models, with Andrew Chen and Rebecca Wasyk

Many consumption-based models succeed in matching long lists of asset price moments. We show that the empirical fit is much worse in full-information estimations. We estimate a model with long-run risks, habit, and a residual using Bayesian methods. We find that long-run risks account for less than 25% of the variance of the price-dividend ratio. Habit's contribution is negligible. The residual is highly persistent, however. Filtered versions of our decomposition that focus on business-cycle frequencies find a much smaller residual. Business-cycle variation of the price-dividend ratio is 50% long-run growth, 20% long-run volatility, and 5% surplus consumption. These results are robust to the prior, including priors that assume long-run risks in consumption and highly persistent habit.

A Factor Structure of Disagreement

We document how disagreement among professional forecasters comoves across variables. Instead of compressing disagreement into statistics of dispersion, we directly use individual response data in a panel dynamic factor model to summarize the comovement of disagreement in the Survey of Professional Forecasters. We offer an interpretation of the extracted factors through a heterogeneous information model. Up until the Great Moderation, the factors describe negative comovement of individual output and inflation expectations, which is interpreted as disagreement about the supply side of the economy. In recent years and particularly during the Great Recession, the comovement has turned positive, which is interpreted as disagreement about the demand side of the economy. Disagreement about monetary policy plays a minor role. We also document that nowcast and medium-term forecast disagreement is systematically related.

The Role of Learning for Asset Prices and Business Cycles 

Revision requested, Journal of Monetary Economics

I examine the implications of learning-based asset pricing in a model in which firms face credit constraints that depend partly on their market value. Agents learn about stock prices, but have conditionally model-consistent expectations otherwise. The model jointly matches key asset price and business cycle statistics, while the combination of financial frictions and learning produces powerful feedback between asset prices and real activity, adding substantial amplification. The model reproduces many patterns of forecast error predictability in survey data that are inconsistent with rational expectations. A reaction of the monetary policy rule to asset price growth increases welfare under learning.

Unemployment Insurance and International Risk Sharing, with Stéphane Moyen and Nikolai Stähler

Revision requested, European Economic Review

We discuss how cross-country unemployment insurance can be used to improve international risk sharing. We use a two-country business cycle model with incomplete financial markets and frictional labor markets where the unemployment insurance scheme operates across both countries. Cross-country insurance through the unemployment insurance system can be achieved without affecting unemployment outcomes. The Ramsey-optimal policy however prescribes a more countercyclical replacement rate when international risk sharing concerns enter the unemployment insurance trade-off. We calibrate our model to Eurozone data and find that optimal stabilizing transfers through the unemployment insurance system are sizable and mainly stabilize consumption in the periphery countries, while optimal replacement rates are countercylical overall. We also find that debt-financed national policies are a poor substitute for fiscal transfers.

The Effect of Asset Price Learning in RBC and Labour Search Models

It is plausible that subjective investor beliefs play a role in determining asset prices, but do they also affect the business cycle? I add learning about stock prices to the canonical real business cycle and the labour search and matching models. In so doing, I develop a new method to model small departures from rational expectations, which I call conditionally model-consistent expectations. Adding learning to the real business cycle model improves some asset price properties but leads to counterfactual comovement between consumption, output and stock prices. The search model with learning however has realistic business cycle and asset price properties and a sizeable amount of amplification. In particular, adding learning substantially reduces the need to rely on wage rigidity to explain the observed magnitude of unemployment fluctuations.