We study monetary policy when private credit markets are incomplete. The macroeconomy we study has a large private credit market, in which participant households use non-state contingent nominal contracts (NSCNC). A second, small group of households only uses cash, supplied by the monetary authority, and cannot participate in the credit market. There is an aggregate shock. We …nd that, despite the substantial heterogeneity, the monetary authority can provide for optimal risk-sharing in the private credit market and thus overcome the NSCNC friction via a counter-cyclical price level rule. The countercyclical price level rule is not unique. To pin down a unique monetary policy rule, we consider two secondary goals for the monetary authority, (i) expected in ‡ation targeting and, (ii) nominal GDP targeting. We examine the impact of each of these approaches on the price level rule and other nominal variables in the economy.
This paper develops a simple business-cycle model in which financial shocks have large macroeconomic effects when private agents are gradually learning their uncertain environment. When agents update their beliefs about the parameters that govern the unobserved process driving financial shocks to the leverage ratio, the responses of output and other aggregates under adaptive learning are significantly larger than under rational expectations. In our benchmark case calibrated using US data on leverage, debt-to-GDP and land value-to-GDP ratios for 1996Q1-2008Q4, learning amplifies leverage shocks by a factor of about three, relative to rational expectations. When fed with actual leverage innovations observed over that period, the learning model predicts a sizeable recession in 2008-10, while its rational expectations counterpart predicts a counter-factual expansion. In addition, we show that procyclical leverage reinforces the amplification due to learning and, accordingly, that macro-prudential policies enforcing countercyclical leverage dampen the effects of leverage shocks.
We study abstract macroeconomic systems in which expectations play an important role. Consistent with the recent literature on recursive learning and expectations, we replace the agents in the economy with econometricians. Unlike the recursive learning literature, however, the econometricians in the analysis here are Bayesian learners. We are interested in the extent to which expectational stability remains the key concept in the Bayesian environment. We isolate conditions under which versions of expectational stability conditions govern the stability of these systems just as in the standard case of recursive learning. We conclude that Bayesian learning schemes, while they are more sophisticated, do not alter the essential expectational stability …ndings in the literature.
We study the effects of monetary policy on the labor market across different sectors. We find that the employment response is stronger for firms in manufacturing and construction relative to firms in services. The result also holds within small and large firms. Moreover, within sectors, the employment growth in large firms responds more than it does in small firms after monetary contractions; it does so less after monetary expansions. Finally, we find that the differences in employment growth between small and large firms are greater for firms in the manufacturing and construction sectors compared to those in the service sector.
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