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

The Role of Learning for Asset Prices and Business Cycles

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

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.

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

We estimate asset pricing models with multiple risks: long-run growth, long-run volatility, habit, and a residual. The Bayesian estimation accounts for the entire likelihood of consumption, dividends, and the price-dividend ratio. We find that the residual represents at least 80% of the variance of the price-dividend ratio. Moreover, it tracks most recognizable features of stock market history such as the 1990's boom and bust. Long run risks and habit contribute primarily in crises. The dominance of the residual comes from the low correlation between asset prices and real growth and volatility. We discuss theories which are consistent with our results.

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.

Work in Progress

The Structure of Disagreement