We study the design of monetary policy in a low inflation environment taking into account the limitations imposed by the zero bound on nominal interest rates. Using numerical dynamic programming methods, we compute optimal policies in a simple, calibrated openeconomy model and evaluate the e#ect of the liquidity trap generated by the zero bound. We consider the possibility that the quantity of base money may a#ect output and inflation even when the interest rate is constrained at zero and explicitly account for the substantial degree of uncertainty regarding such quantity e#ects. As an example of such a quantity e#ect, we focus on the portfolio balance channel through which changes in relative money supplies influence the exchange rate. We find that the optimal policy near price stability is asymmetric, that is, as inflation declines, policy turns expansionary sooner and more aggressively than would be optimal in the absence of the zero bound. As a consequence, the average level of inf...

In the presence of principal-agent problems, published macroeconomic forecasts by professional economists may not measure expectations. Forecasters may use their forecasts in order to manipulate beliefs about their ability. I test a cross-sectional implication of models of reputation and information-revelation. I find that as forecasters become older and more established, they produce more radical forecasts. Since these more radical forecasts are in general less accurate, ex post forecast accuracy grows significantly worse as forecasters become older and more established. These findings are consistent with reputational factors at work in professional macroeconomic forecasts.

This paper provides a review of the theory of the determinants of individual and national thrift that has come to be known as the Life Cycle Hypothesis (LCH) of saving. Applications to some current policy issues are also discussed. Part I deals with the state of the art on the eve of the formulation of the LCH

When a series of individuals with private information announce public predictions, initial conformity can create an "information cascade" in which later predictions match the early announcements. This paper reports an experiment in which private signals are draws from an unobserved urn. Subjects make predictions in sequence and are paid if they correctly guess which of two urns was used for the draws. If initial decisions coincide, then it is rational for subsequent decision makers to follow the established pattern, regardless of their private information. Rational cascades formed in most periods in which such an imbalance occurred. In many economic situations, agents observe private signals of some underlying state and make public decisions. Subsequent decision makers face a dilemma if their own private signal is indicative of a state that is unlikely given the previously observed decisions. An "information cascade" occurs when initial decisions coincide in a way that it is optimal for each of the subsequent individuals to ignore their private signals and follow the established pattern. For example, suppose that a worker is not hired by several potential employers because of poor interview performances. Knowing this, an employer approached subsequently may not hire the worker even if the employer's own assessment is favorable, since this information may be dominated by the unfavorable signals inferred from previous rejections.

This paper studies the full equilibrium dynamics of an economy with financial frictions. Due to highly non-linear amplification effects, the economy is prone to instability and occasionally enters volatile episodes. Risk is endogenous and asset price correlations are high in down turns. In an environment of low exogenous risk experts assume higher leverage making the system more prone to systemic volatility spikes- a volatility paradox. Securitization and derivatives contracts leads to better sharing of exogenous risk but to higher endogenous systemic risk. Financial experts may impose a negative externality on each other by not maintaining adequate capital cushion.

This paper briefly describes recent papers on the economics of rational herding in financial markets. Some models can predict perfect herding, in which rational agents all act alike without any countervailing force. Such herding typically arises either from direct payoff externalities (negative externalities in bank runs; positive externalities in the generation of trading liquidity or in information acquisition), principal-agent problems (based on managerial desire to protect or signal reputation), or informational learning (cascades). The paper also provides a few pointers to related literature and suggests issues to be addressed in future research.

Building on recent developments in behavioral asset pricing, we develop a model in which an increase in the dispersion of investor beliefs under short-selling constraints predicts a rise in stock price above its fundamental value, or bubble. The model predicts managers respond to bubbles by issuing new equity and increasing capital expenditures. We test these predictions (among others) using the variance of analysts’ earnings forecasts – a proxy for the dispersion of investor beliefs – to identify the “bubble ” component in Tobin’s Q. We document the dynamic response to bubble shocks using a panel data VAR. Using recursive orderings of the VAR for additional identification, we …nd that orthogonalized bubble shocks have positive and statistically significant effects on Tobin’s Q, net equity issuance, and real investment, consistent with the predictions of the model.

This paper examines the characteristics of business cycles within and across thirteen countries for more than a century of observations adopting a monetary regime perspective. We search for empirical regularities of business cycle fluctuations during three monetary regimes; the classical gold standard, the interwar period and the post-World War II period. Our empirical results, based on bandpass filtered data, suggest that business cycle fluctuations have remained surprisingly stable across monetary regimes and across countries. In particular, the procyclical pattern for consumption, investment, exports and imports is stable across regimes and countries. We find a rise in the frequency of significant cyclical comovements across countries, possibly reflecting a recent rise in economic integration. Our evidence suggests that both the amplitude and the symmetry of business cycles have changed over time. The post-World War II period is marginally less volatile than the gold standard period while the interwar period is more volatile.

INTRODUCTION The Maastricht route to economic and monetary union (EMU) prescribed that a process of convergence must precede the launching of the common currency into a stable economic environment. In 1991, Europe thus embarked on policies considered conducive to convergence and stability. In retrospect, economic performance over the convergence period was characterised by two key developments: inflation was brought down successfully and price trends converged, on the one hand, while unemployment soared to unprecedented levels, on the other. In addition, mirroring that drastic deterioration in the employment situation, Europe's debt/GDP-ratio increased by some 15% between 1991 to 1997. Our objective is to investigate what lessons may be learned from the experience over the convergence period. A sound diagnosis of the deeper causes of this miserable legacy is crucial. For a failure to properly understand our past follies is bound to lead to false

This paper presents a dynamic, stochastic game-theoretic model of financial fragility. The model has two essential features. First, interrelated portfolios and payment commitments forge financial linkages among agents. Second, iid shocks to investment projects ’ operations at a single date cause some projects to fail. Investors who experience losses from project failures reallocate their portfolios, thereby breaking some linkages. In the Pareto-efficient symmetric equilibrium studied, two related types of financial crises can occur in response. One occurs gradually as defaults spread, causing even more links to break. An economy is more fragile ex post the more severe this financial crisis. The other type of crisis occurs instantaneously when forward-looking investors preemptively shift their wealth into a safe asset in anticipation of the contagion affecting them in the future. An economy is more fragile ex ante the earlier all of its linkages break from such a crisis. The paper also considers whether fragility is worse for larger economies.