"Talk of the Town" Award
Finance Down Under Conference, 2016
"NYSE Euronext Capital Markets Best Paper Award"
FEDS Working Paper Series
Abstract: The key insight from this analysis is that monetary policy should be responding more to negative shocks than positive shocks: optimal monetary policy is asymmetric. Moreover, if we take the stance that asset prices indicate a high cost of exposure to long-run risk and model this long-run risk carefully, this has very interesting implications for monetary policy that ripple through a surprisingly broad set of dimensions. There is an intuitive result that a Ramsey planner might wish to attenuate long-run risks. Less intuitively, I show that a Ramsey policymaker will induce a tolerance for skewness and a higher average inﬂation rate than is typically advocated in the literature. A variety of factors contribute to these results. First, deep non-linearities in the model entail that the policymaker behaves asymmetrically in its countercyclical policies. Second, the presence of capital generates longer-run eﬀects (hysteresis) and additional tradeoﬀs, which implies that “countercyclical” in this model takes on a lower frequency theme. And third, imperfect competition leads to the pursuit of a higher average inﬂation rate to oﬀset the related welfare costs.