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Confidence and the Propagation of Demand Shocks
George-Marios Angeletos, Massachusetts Institute of Technology and NBER
Chen Lian, University of California, Berkeley and NBER
Cosmin L. Ilut, Duke University and NBER

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.


This paper was distributed as Working Paper 27702, where an updated version may be available.

Dynamic Rational Inattention and the Phillips Curve
Hassan Afrouzi, Columbia University
Choongryul Yang, Federal Reserve Board
Mirko Wiederholt, Sciences Po

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.

Payments Crises and Consequences
Qian Chen, Beijing Technology and Business University
Christoffer Koch, Federal Reserve Bank of Dallas
Padma Sharma, Federal Reserve Bank of Kansas City
Gary Richardson, University of California, Irvine and NBER
Gabriel Chodorow-Reich, Harvard University and NBER

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.


This paper was distributed as Working Paper 27733, where an updated version may be available.

The Fed Takes on Corporate Credit Risk: An Analysis of the Efficacy of the SMCFF
Simon Gilchrist, New York University and NBER
Bin Wei, Federal Reserve Bank of Atlanta
Vivian Yue, Emory University and NBER
Egon Zakrajšek, Bank for International Settlements
Carolin Pflueger, University of Chicago and NBER

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.

Average Inflation Targeting and Household Expectations
Olivier Coibion, University of Texas at Austin and NBER
Yuriy Gorodnichenko, University of California, Berkeley and NBER
Edward S. Knotek, Federal Reserve Bank of Cleveland
Raphael Schoenle, Brandeis University
Gauti B. Eggertsson, Brown University and NBER

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.

Big G
Lydia Cox, Harvard University
Gernot Müller, University of Tuebingen
Ernesto Pastén, Central Bank of Chile
Raphael Schoenle, Brandeis University
Michael Weber, University of Chicago and NBER
Valerie A. Ramey, University of California, San Diego and NBER

"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.


This paper was distributed as Working Paper 27034, where an updated version may be available.


Miguel Acosta, Columbia University
Derin Aksit, Johns Hopkins University
Sadhika Bagga, University of Texas at Austin
Francesca Bastianello, Harvard University
Tu Cao, University of Wisconsin-Madison
Laura Castillo-Martinez, Duke University
Nisha Chikhale, University of Wisconsin
Min Fang, University of Rochester
Paul Fontanier, Harvard University
Tryggvi Gudmundsson, IMF
Andrew Jalil, Occidental College
Chen Kan, University of Rochester
Ezgi Kurt
Shaowen Luo, Virginia Polytechnic Institute and State University
Alex Martin, Massachusetts Institute of Technology
Johannes Matschke, University of California at Davis
Laura C. Murphy, Northwestern University
Thuy Lan Nguyen, Federal Reserve Bank of San Francisco
Jacob Orchard, University of California at San Diego
Pascal Paul, Federal Reserve Bank of San Francisco
Stefano Pica, Boston University
Pavel Solis, John Hopkins University
Daniel K. Tarullo, Harvard University
Isabel Vansteenkiste, European Central Bank
Jasmine Xiao, University of Notre Dame
Choongryul Yang, Federal Reserve Board
Linyan Zhu, University of California at San Diego

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