NBER Monetary Economics Program Meeting Fall 2020

Angeletos and Lian revisit the question of why shifts in aggregate demand drive business cycles. Their theory combines intertemporal substitution in production with rational confusion (or bounded rationality) in consumption. The first element allows aggregate supply to respond to shifts in aggregate demand without nominal rigidity. The second introduces a "confidence multiplier," namely a positive feedback loop between real economic activity, consumer expectations of permanent income, and investor expectations of returns. This mechanism amplifies the business-cycle fluctuations triggered by demand shocks (but not those triggered by supply shocks). It helps investment to comove with consumption and it allows front-loaded fiscal stimuli to crowd in private spending.

"Big G" typically refers to aggregate government spending on a homogeneous good. Cox, Müller, Pastén, Schoenle, and Weber open up this construct by analyzing the entire universe of procurement contracts of the US. federal government and establish five facts. First, government spending is granular. It is concentrated in relatively few firms and sectors. Second, relative to private expenditures its composition is biased. Third, procurement contracts are short-lived and sectoral spending is only moderately persistent. Fourth, idiosyncratic variation dominates fluctuations in spending. Last, government spending is concentrated in sectors with relatively sticky prices. Accounting for these facts within a stylized New Keynesian model offers new insights into the fiscal transmission mechanism: fiscal shocks hardly impact inflation, little crowding out of private expenditure occurs, and the multiplier tends to be larger compared to a one-sector benchmark, aligning the model with the empirical evidence.

Gilchrist, Wei, Yue, and Zakrajšek evaluate the efficacy of the Secondary Market Corporate Credit Facility (SMCCF), a program designed to stabilize the corporate bond market in the wake of the Covid-19 shock. The Fed announced the SMCCF on March 23 and expanded the program on April 9. Regression discontinuity estimates imply that these announcements reduced credit spreads on bonds eligible for purchase 70 basis points. The researchers refine this analysis by constructing a sample of bonds--issued by the same set of companies -- which differ in their SMCCF eligibility. A difference-in-differences analysis shows that both announcements had large effects on credit spreads, narrowing spreads 20 basis points on eligible bonds relative to their ineligible counterparts within the same set of issuers across the two announcement periods. The March 23 announcement also reduced bid-ask spreads ten basis points within ten days of the announcement. By lowering credit spreads and improving liquidity, the April 9 announcement had an especially pronounced effect on "fallen angels." The actual purchases lowered credit spreads by an additional five basis points and bid-ask spreads by two basis points. These results confirm that the SMCCF made it easier for companies to borrow in the corporate bond market.

Afrouzi and Yang develop a tractable method for solving Dynamic Rational Inattention Problems (DRIPs) in LQG settings and propose an attention driven theory of the Phillips curve as an application of the general framework. They show that within a general equilibrium flexible price model with dynamic rational inattention, the slope of the Phillips curve is endogenous to systematic aspects of monetary policy. In the model, when the monetary authority is more committed to stabilizing nominal variables, rationally inattentive firms find it optimal to pay less attention to monetary policy shocks. Therefore, when monetary policy is more hawkish, the Phillips curve is flatter and inflation expectations are more anchored. In a quantitative exercise, the researchers calibrate the general equilibrium model with TFP and monetary policy shocks to post-Volcker US data and find that the model can match the higher volatility of inflation and GDP in pre-Volcker era as non-targeted moments, and the mechanism quantifies a 75% decline in the slope of the Phillips curve in the post-Volcker period.

Banking-system shutdowns during contractions scar economies. Four times in the last forty years, governors suspended payments from state-insured depository institutions. Suspensions of payments in Nebraska (1983), Ohio (1985), and Maryland (1985), which were short and occurred during expansions, had little measurable impact on macroeconomic aggregates. Rhode Island’s payments crisis (1991), which was prolonged and occurred during a recession, lengthened and deepened the downturn. Unemployment increased. Output declined, possibly permanently relative to what might have been. Chen, Koch, Sharma, and Richardson document these effects using a novel Bayesian method for synthetic control that characterizes the principal types of uncertainty in this form of analysis. The findings suggest policies that ensure banks continue to process payments during contractions – including the bailouts of financial institutions in 2008 and the unprecedented support of the financial system during the COVID crisis – have substantial value.

Using a daily survey of US households, Coibion, Gorodnichenko, Knotek, and Schoenle study how the Federal Reserve's announcement of its new strategy of average inflation targeting affected households' expectations. Starting with the day of the announcement, there is a very small uptick in the minority of households reporting that they had heard news about monetary policy relative to prior to the announcement, but this effect fades within a few days. Those hearing news about the announcement do not seem to have understood the announcement: they are no more likely to correctly identify the Fed's new strategy than others, nor are their expectations different. When the researchers provide randomly selected households with pertinent information about average inflation targeting, their expectations still do not change in a different way than when households are provided with information about traditional inflation targeting.