Research
Expectations and the Neutrality of Interest Rates
April 25 2024. What is the basic theory of inflation under interest rate targets? Do higher interest rates lower inflation, and if so, how? The Paper> Slides>
April 24 2024. (Rewrite). The paper>
Abstract: Our central banks set interest rates, and do not even pretend to control money supplies. How do interest rates affect inflation? We finally have a complete economic theory of inflation under interest rate targets and unconstrained liquidity. Its long-run properties mirror those of monetary theory: Inflation can be stable and determinate under interest rate targets, including a peg, analogous to a k-percent rule.
Uncomfortably, stability means that higher interest rates eventually raise inflation, just as higher money growth eventually raises inflation. Sticky prices generate some short-run non-neutrality: Higher nominal interest rates can raise real rates and lower output. A model in which higher nominal interest rates temporarily lower inflation, without a change in fiscal policy, is a harder task. I exhibit one such model, but it paints a more limited picture than standard beliefs. Generically, without a change in fiscal policy, monetary policy can only move inflation from one time to another.
The last decade has provided a near-ideal set of natural experiments to distinguish the principal theories of inflation. Inflation did not show spirals or indeterminacies at the long zero bound. The large monetary-fiscal expansion of the covid era produced a temporary spurt of inflation. The same money unleashed in quantitative easing had no such effect.
This paper resulted from a talk at the “Foundations of Monetary Policy” conference celebrating 50 years since the publication of ``Expectations and the Neutrality of Money,'' Federal Reserve Bank of Minneapolis, September 2022. Slides Video of my presentation at the Hoover Economics Policy Working group, Dec 14 2022. Programs (updated 4/17/2024).
Fiscal Histories
Nov 7 2022. Journal of Economic Perspectives 36 (4) p. 125–146. I use fiscal theory to interpret historical episodes. Last Manuscript. Click the title for more information.
Nov 7 2022. Journal of Economic Perspectives 36 (4) p. 125–146. I use fiscal theory to interpret historical episodes, including the long quiet zero bound, the gold standard and its end, foreign exchange pegs, the 1970s and 1980s, currency crashes, and the present inflation. That approach lets us see how fiscal theory works, and how it can be useful. Lots of low-hanging thesis topic fruit here! Data and Programs. Last Manuscript (local link).
Inflation Past, Present and Future: Fiscal Shocks, Fed Response, and Fiscal Limits
May 23 2022. An essay, underlying my presentation at the Hoover Monetary Policy Conference May 6 20-22. There is a model by which the Fed is not behind the curve. Is it right? Stopping inflation will require coordinated fiscal and monetary policy.
Final, Oct 12, 2022. In Michael D. Bordo, John H. Cochrane, and Joyn Taylor, eds, How Monetary Policy Got Behind the Curve—and How To Get Back. Stanford, CA: Hoover Institution Press 2022 p. 63-114.
An essay, underlying my presentation at the Hoover Monetary Policy Conference May 6 20-22. There is a model by which the Fed is not behind the curve. Is it right? Stopping inflation will require coordinated fiscal and monetary policy.
Portfolios for long-term investors
Jan 13 2022. Review of Finance 2021 This is an essay on portfolios, based on a keynote talk at the NBER conference, ``New Developments in Long-Term Asset Management” Jan 21 2021. Read the paper. Slides for the talk
Jan 13 2022. Review of Finance, 26(1), 1-42 (2022). This is an essay on portfolio theory and practice, which evolved from a keynote talk at the NBER conference, ``New Developments in Long-Term Asset Management” Jan 21 2021. Portfolio practice looks almost nothing like portfolio theory. I offer two ideas: look at the stream of payouts or dividends directly, and ask what the function of asset markets is, and what your role in them is. The average investor holds the market portfolio. How are you different? A lot of fascinating asset pricing hasn’t yet made its way into portfolio theory, and I think about how to do that. Complete the model, and add interesting heterogeneity.
Read the paper (free access link to published version)
doi link. Last Manuscript (but the free access link should work)
The Fiscal Theory of the Price Level: An Introduction and Overview (article)
12/10/2021. I try to boil down the economic analysis in the 600 page book to a readable article with no equations.
12/12/2021. I try to boil down the book to a readable article with no equations, focused on how economists would use FTPL. This was a draft of an article for Journal of Economic Perspectives, but the JEP article went in another direction entirely, so I leave this in case a nontechnical introduction to the economic analysis in the book is useful.
The Fiscal Roots of Inflation
Published June 2022. Review of Economic Dynamics 45:22-40. Unexpected inflation comes basically all from discount rates: a higher real interest rate devalues government debt via inflation. Big deficits and lower inflation are not a puzzle: discount rates decline. Click the title for more details.
Published June 2022. Review of Economic Dynamics 45:22-40. I apply an asset pricing style return variance decomposition to the government debt valuation equation. Unexpected inflation comes basically all from discount rates: a higher real interest rate devalues government debt via inflation. Big deficits and lower inflation are not a puzzle: discount rates decline. Long term bonds soak up a lot of fiscal shocks, smoothing inflation forward. I also decompose recession related shocks, deficit and discount rate shocks. zip file containing programs and data.
A Fiscal Theory of Monetary Policy with Partially-Repaid Long-Term Debt
Published June 2022. Review of Economic Dynamics 45:22-40. Fiscal theory of monetary policy means interest rate targets, sticky prices, and fiscal theory. This paper adds long term debt and the crucial novelty: a surplus process by which the government borrows now and promises future surpluses to repay the debt, yet fiscal policy is active. The model generates reasonable response functions to fiscal and monetary policy shocks, and solves a long-standing problem in fiscal theory models. Click title for more information.
Published June 2022. Review of Economic Dynamics 45:22-40. Fiscal theory of monetary policy means interest rate targets, sticky prices, and fiscal theory. This paper adds long term debt and the crucial novelty: a surplus process by which the government borrows now and promises future surpluses to repay the debt, yet fiscal policy is active. The model generates reasonable response functions to fiscal and monetary policy shocks, and solves a long-standing problem in fiscal theory models. This, the “fiscal roots of inflation” and “the value of debt” are companions. Zip file with programs
r<g
February 2021. r<g is an essay on why we still have to repay debts despite r<g. Based on comments on Ricdardo Reis’ r<g paper spring 2021 NBER EFG. Click the title for longer description. Read the essay>
February 28 2021. Updated July 28 2021. r<g is an essay on the topic of debt and deficits. Sorry, debts must be repaid. It’s based on comments on Ricardo Reis’ r<g paper given at the spring 2021 NBER EFG, and comments on Neil Mehrotra and Dmitriy Sergeyev’s paper at the summer institute.
Abstract:
A situation that the rate of return on government bonds r is less than the economy's average growth rate g seems to promise that borrowing has no fiscal cost. r<g is irrelevant for the current US fiscal problems. r<g cannot begin to finance current and projected deficits. r<g does not resolve already exponentially-growing debt. r<g can finance small deficits, but large deficits still need to be repaid by subsequent surpluses. The appearance of explosive present values comes by using perfect-certainty discount formulas with returns drawn from an uncertain world. Present values can be well behaved despite r<g. The r<g opportunity is like the classic strategy of writing put options, which fails in the most painful state of the world.
Strategic Review and Beyond: Rethinking Monetary Policy and Independence
This was the 2020 Homer Jones Memorial Lecture at the Federal Reserve Bank of St. Louis. Video of the lecture and more here. The article, (html) (pdf) (local pdf) in the Federal Reserve Bank of St. Louis Review, Second Quarter 2020, 102(2), pp. 99-119. Many thanks to the St. Louis Fed, and gracious host Jim Bullard.
This was the 2020 Homer Jones Memorial Lecture at the Federal Reserve Bank of St. Louis. Video of the lecture and more here. The article, (html) (pdf) (local pdf) in the Federal Reserve Bank of St. Louis Review, Second Quarter 2020, 102(2), pp. 99-119. Many thanks to the St. Louis Fed, and gracious host Jim Bullard.
Rethinking Production Under Uncertainty
Published (advance access) Review of Asset Pricing Studies July 2020. I investigate a representation of technology in which producers can transform output across states of nature. This representation lets us write down a complete production-based asset pricing model, in which the discount factor equals marginal rates of transformation.
Published (advance access) Review of Asset Pricing Studies July 2020. I investigate a representation of technology in which producers can transform output across states of nature. This representation lets us write down a complete production-based asset pricing model, in which the discount factor equals marginal rates of transformation.
The Value of Government Debt
Here I apply an asset pricing style price/dividend variance decomposition to the government debt valuation equation, to break the debt / GDP ratio into expected future surpluses and expected growth-adjusted discount rates. Variation in the value of debt / GDP is about half future surpluses and half discount rates. Growth variation does not show up.
Here I apply an asset pricing style price/dividend variance decomposition to the government debt valuation equation, to break the debt / GDP ratio into expected future surpluses and expected growth-adjusted discount rates. Variation in the value of debt / GDP is about half future surpluses and half discount rates. Growth variation does not show up. Zip file with programs and data.
Michelson-Morley, Fisher, and Occam: The Radical Implications of Stable Inflation at the Zero Bound.
2018. NBER Macroeconomics Annual 32 (1) 113-226, Jonathan A. Parker and Michael Woodford Eds. The fact that inflation is quiet and stable at zero rates cleanly invalidates the standard old-Keynesian model, which predicts a deflation spiral, and almost as cleanly invalidates new-Keynesian sunspots. New Keynesian price stickiness plus fiscal theory selection works well, and solves the puzzles of new-Keynesian models with selection by post-bound active policy. Stable inflation suggests a higher rate will raise inflation. That conclusion is hard to escape, even temporarily. The fiscal theory with long term debt does it. Even that does not rescue traditional views of monetary policy. A shortish nontechnical summary. Data and Programs. Last manuscript with online appendix. Published version (pdf) at the University of Chicago Press website. Full text html of the published version.
2018. NBER Macroeconomics Annual 32 (1) 113-226, Martin Eichenbaum and Jonathan A. Parker Eds. The fact that inflation is quiet and stable at zero rates cleanly invalidates the standard old-Keynesian model, which predicts a deflation spiral, and almost as cleanly invalidates new-Keynesian sunspots. New Keynesian price stickiness plus fiscal theory selection works well, and solves the puzzles of new-Keynesian models with selection by post-bound active policy. Stable inflation suggests a higher rate will raise inflation. That conclusion is hard to escape, even temporarily. The fiscal theory with long term debt does it. Even that does not rescue traditional views of monetary policy. A shortish nontechnical summary. Data and Programs. Last manuscript with online algebra appendix . Published version (pdf) at the University of Chicago Press website. Full text html of the published version. Video of the paper presentation at NBER.
Stepping on a Rake: the Fiscal Theory of Monetary Policy
European Economic Review 101, 354-375. The fiscal theory of the price level can describe monetary policy: interest rate targets, quantitative easing, and forward guidance. With long term debt, a higher interest rate can produce temporarily lower inflation. The paper starts with a completely frictionless environment, and then replicates Chris Sims's "stepping on a rake" paper, which has the latter result along with elaborations that smooth out the impulse-response functions. I boil Sims down to the central ingredient,long term debt. The replication is useful if you want to know how Sims derived his model or solved it; also useful as a guide to solving continuous-time sticky-price models with jumps. matlab program archive
European Economic Review 101, 354-375. The fiscal theory of the price level can describe monetary policy: interest rate targets, quantitative easing, and forward guidance. With long term debt, a higher interest rate can produce temporarily lower inflation. The paper starts with a completely frictionless environment, and then replicates Chris Sims's "stepping on a rake" paper, which has the latter result along with elaborations that smooth out the impulse-response functions. I boil Sims down to the central ingredient,long term debt. The replication is useful if you want to know how Sims derived his model or solved it; also useful as a guide to solving continuous-time sticky-price models with jumps. matlab program archive
The New-Keynesian Liquidity Trap
Journal of Monetary Economics. 92, 47-63. Online appendix at the first link or here. matlab program. In standard solutions, new-Keynesian models produce a deep recession with deflation at the zero bound. Useless government spending, technical regress, and capital destruction have large positive multipliers. The recession, deflation and policy paradoxes are larger when prices are less sticky, and news has larger effects for events further in the future. These features are all artifacts of equilibrium selection. For the same interest-rate policy, equilibria that limit a downward jump of inflation on news of the trap, for the same interest rate policy, reverse all these predictions. They predict mild inflation, little output variation, and negative multipliers during the liquidity trap. Their predictions approach the frictionless model smoothly, and promises in the far-off future have less effect today. A big deflation requires that the government raise taxes or cut spending a lot to pay a windfall to bondholders. Such fiscal considerations suggest the equilibria with limited jumps and effects.
Journal of Monetary Economics. 92, 47-63. Online appendix available at the first link or here. matlab program. In standard solutions, new-Keynesian models produce a deep recession with deflation at the zero bound. Useless government spending, technical regress, and capital destruction have large positive multipliers. The recession, deflation and policy paradoxes are larger when prices are less sticky, and news has larger effects for events further in the future. These features are all artifacts of equilibrium selection. For the same interest-rate policy, equilibria that limit a downward jump of inflation on news of the trap, for the same interest rate policy, reverse all these predictions. They predict mild inflation, little output variation, and negative multipliers during the liquidity trap. Their predictions approach the frictionless model smoothly, and promises in the far-off future have less effect today. A big deflation requires that the government raise taxes or cut spending a lot to pay a windfall to bondholders. Such fiscal considerations suggest the equilibria with limited jumps and effects.
The Fama Portfolio
2017. University of Chicago Press. Edited with Toby Moskowitz. Collection of Gene Fama papers, with introductions by myself, Toby, Ken French, Bill Schwert, René Stulz, Cliff Asness, John Liew, Ray Ball, Dennis Carlton, Cam Harvey, Lan Liu, Amit Seru and Amir Sufi. The introductions explain why the papers are so important and how we think about the issues today. My essays are here, other essays may be on other authors' webpages. For everything else you'll have to buy the book or e book. My essays (most joint with Toby):
Preface;
Efficient Markets and Empirical Finance;
Luck vs. Skill;
Risk and Return;
Return Forecasts and Time Varying Risk Premiums;
Our Colleague.
2017. University of Chicago Press. Edited with Toby Moskowitz. Collection of Gene Fama papers, with introductions by myself, Toby, Ken French, Bill Schwert, René Stulz, Cliff Asness, John Liew, Ray Ball, Dennis Carlton, Cam Harvey, Lan Liu, Amit Seru and Amir Sufi. The introductions explain why the papers are so important and how we think about the issues today. My essays are here, other essays may be on other authors' webpages. For everything else you'll have to buy the book or e book. My essays (most joint with Toby):
Preface;
Efficient Markets and Empirical Finance;
Luck vs. Skill;
Risk and Return;
Return Forecasts and Time Varying Risk Premiums;
Our Colleague.
Macro-Finance
2017. Review of Finance 21(3): 945-985. Links: Publisher (doi) , Last manuscript. This is a review paper. I survey many current frameworks including habits, long run risks, idiosyncratic risks, heterogenous preferences, rare disasters, probability mistakes, and debt or institutional finance. I stress how all these approaches produce quite similar results and mechanisms: the market's ability to bear risk varies over time, with business cycles. I speculate with some simple models that time-varying risk premiums can produce a theory of risk-averse recessions, produced by varying risk aversion and precautionary saving, rather than Keynesian flow constraints or new-Keynesian intertemporal substitution. The July 2016 manuscript contains a long section with thoughts on how to make a macro model based on time varying risk premiums, that got cut from the above final version. (This is the "manuscript" referenced in the paper.) The Data and programs (zip, matlab). The slides for the talk. A very nice post on the Review of Finance Blog summarizing the paper, by Alex Edmans, the editor. Typo: equation (17) is wrong. The same equation, (3) is right.
2017. Review of Finance 21(3): 945-985. Links: Publisher (doi) , Last manuscript. This is a review paper. I survey many current frameworks including habits, long run risks, idiosyncratic risks, heterogenous preferences, rare disasters, probability mistakes, and debt or institutional finance. I stress how all these approaches produce quite similar results and mechanisms: the market's ability to bear risk varies over time, with business cycles. I speculate with some simple models that time-varying risk premiums can produce a theory of risk-averse recessions, produced by varying risk aversion and precautionary saving, rather than Keynesian flow constraints or new-Keynesian intertemporal substitution. The July 2016 manuscript contains a long section with thoughts on how to make a macro model based on time varying risk premiums, that got cut from the above final version. (This is the "manuscript" referenced in the paper.) The Data and programs (zip, matlab). The slides for the talk. A very nice post on the Review of Finance Blog summarizing the paper, by Alex Edmans, the editor. Typo: equation (17) is wrong. The same equation, (3) is right.
A New Structure for U.S. Federal Debt
November 2015 In David Wessel, Ed., The $13 Trillion Question: Managing the U.S. Government's Debt, pp. 91-146. Washington DC: Brookings Institution Press. Last manuscript. I propose a restructuring of U. S. Federal debt. All debt should be perpetual, paying coupons forever with no principal payment. The debt should be composed of 1) Fixed-value, floating-rate, electronically transferable debt. Such debt looks like a money-market fund, or reserves at the Fed, to an investor. 2) Nominal perpetuities: This debt pays a coupon of $1 per bond, forever. 3) Indexed perpetuities: This debt pays a coupon of $1 times the current consumer price index (CPI). 4) All debt should be free of income, estate, capital gains, and other taxes. 5) long term debt should have explicitly variable coupons. 6) Swaps. The Treasury should adjust maturity structure, interest rate and inflation exposure of the Federal budget by transacting in simple swaps among these securities.
November 2015 In David Wessel, Ed., The $13 Trillion Question: Managing the U.S. Government's Debt, pp. 91-146. Washington DC: Brookings Institution Press. Last manuscript. I propose a restructuring of U. S. Federal debt. All debt should be perpetual, paying coupons forever with no principal payment. The debt should be composed of 1) Fixed-value, floating-rate, electronically transferable debt. Such debt looks like a money-market fund, or reserves at the Fed, to an investor. 2) Nominal perpetuities: This debt pays a coupon of $1 per bond, forever. 3) Indexed perpetuities: This debt pays a coupon of $1 times the current consumer price index (CPI). 4) All debt should be free of income, estate, capital gains, and other taxes. 5) long term debt should have explicitly variable coupons. 6) Swaps. The Treasury should adjust maturity structure, interest rate and inflation exposure of the Federal budget by transacting in simple swaps among these securities.
After the ACA: Freeing the market for health care
In The Future of Healthcare Reform in the United States Edited by Anup Malani and Michael H. Schill, p 161-201, University of Chicago Press. An essay on health care, first presented at the conference, The Future of Health Care Reform in the United States, at the University of Chicago Law School. Most of the policy discussion is focused on health insurance. But the health care market is dysfuctional, and needs to be fixed as well. Where are the Southwest Airlines, Walmart and Apple of health care, bringing cost saving, efficiency, and innovation? I argue that we need a big freeing up of health care markets. I also focus more than usual on supply restrictions. It doesn't do much good for people to pay with their own money if suppliers cannot respond to that demand. Last manuscript in case of copyright problems with the published version above.
In The Future of Healthcare Reform in the United States Edited by Anup Malani and Michael H. Schill, p 161-201, University of Chicago Press. An essay on health care, first presented at the conference, The Future of Health Care Reform in the United States, at the University of Chicago Law School. Most of the policy discussion is focused on health insurance. But the health care market is dysfuctional, and needs to be fixed as well. Where are the Southwest Airlines, Walmart and Apple of health care, bringing cost saving, efficiency, and innovation? I argue that we need a big freeing up of health care markets. I also focus more than usual on supply restrictions. It doesn't do much good for people to pay with their own money if suppliers cannot respond to that demand. Last manuscript in case of copyright problems with the published version above.
The Fragile Benefits of Endowment Destruction
November 2015. Journal of Political Economy 123(5) 1214-1226. With John Y. Campbell. (JSTOR / JPE Link.) A rejoinder to Ljungqvist and Uhlig "Comment on the Campbell-Cochrane Habit Model" (formerly titled "Optimal Endowment Destruction under Campbell-Cochrane Habit Formation"). The benefits of endowment destruction depend sensitively on how you discretize the model. Lesson: It's better to use the the continuous time version and make sure discretizations make sense. There is a nice lesson on how to extend diffusion models to jumps too. Computer program.
November 2015. Journal of Political Economy 123(5) 1214-1226. With John Y. Campbell. (JSTOR / JPE Link.) A rejoinder to Ljungqvist and Uhlig "Comment on the Campbell-Cochrane Habit Model" (formerly titled "Optimal Endowment Destruction under Campbell-Cochrane Habit Formation"). The benefits of endowment destruction depend sensitively on how you discretize the model. Lesson: It's better to use the the continuous time version and make sure discretizations make sense. There is a nice lesson on how to extend diffusion models to jumps too. Computer program.
A Response to Sims (2013)
January 2015. Chris Sims' (2013) "Paper Money" seems to include a criticism of my "Determinacy and Identification with Taylor Rules." In fact, there is no fundamental disagreement between the two papers.
January 2015. Chris Sims' (2013) "Paper Money" seems to include a criticism of my "Determinacy and Identification with Taylor Rules." In fact, there is no fundamental disagreement between the two papers.