The Taylor Principle and Inflation Targeting without a Phillips Curve (with Konstantin Platonov)
We build a Perpetual Youth version of the neoclassical monetary model and find that the current Taylor Principle is neither necessary nor sufficient for determinacy. Instead, the lower bound for the response to inflation depends on the response of monetary policy to output. The model generates inflation persistence without artificial barriers for price re-setting and without a Phillips curve. We fit the model to U.S. data and compare alternative monetary policies to the observed policy. We find that monetary policy that seeks to stabilize economic variables' responses to shocks should focus on a single target – inflation. Rather than “divine coincidence”, the reason for the single-focus advantage in stabilization is the removal of self-defeating forces within the Taylor rule that affect households’ expectations and, as a result, prolong dynamic responses to shocks.
Job Market Paper (updated Nov. 10)
Financial Efficiency and the Lucas Puzzle
I present a model that provides a theoretical solution to the Lucas Puzzle using Financial Efficiency, which is a time-varying component of TFP. The model predicts that a financially underdeveloped economy is to benefit from financial integration through FDI capital inflow only if it experiences faster technological growth, or faster Financial Development than the developed economy. Taking the model to the data of the U.S. and India, I find that Financial Efficiency in the U.S. declined sharply after World War II but has been rising since 1970. A sharp increase in India's Financial Efficiency since 2000 provides a test for the theoretical prediction above and its congruence with the empirical part of the model. Therefore, the sharp increase in India's Gross Capital Formation and Foreign Direct Investment from the data during the same period serve as external validation of the model.
I ask what are the dynamics and effects of fractional-reserve bank credit on the real economy. I introduce a simple general equilibrium model in the tradition of “debt-deflation” literature that relaxes a no-credit requirement and allows savings and capital to emerge from the micro-foundations of the model, using bank credit to bridge the gap between them. I find that the Real Multiplier, which I use to model the effects of fractional-reserve, amplifies both financial and productivity shocks. On the other hand, asset prices in the model respond strongly to productivity shocks but much less so to financial shocks. I find that long term monetary stimuli that reduce the real interest rate may lead to immediate output increases but at a cost of stagnation and even negative growth.
Inequality and Production Elasticity
I address a contention regarding capital deepening when the labor share of income declines and the elasticity of substitution is above unity. I demonstrate the incentive for technical change that increases inequality, and how investments in new technology create temporal misalignment between a decrease in the labor share of income and capital deepening. I show how the decline in the saving rate that occurred during the 1980’s and 1990’s resolves the contention regarding capital deepening. I find that elasticity of substitution below unity is less consistent with the decline in the labor share of income.
A second contention is whether the elasticity of substitution is above or below unity. I perform a time-varying state-space estimation of the temporal evolution of elasticity. I find that the elasticity between capital and labor has been fluctuating slightly above unity since 1980, which is consistent with my theoretical findings.