# Browsing by Author "Schmitt-Grohe, Stephanie"

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Item Open Access Essays in International Macroeconomics(2007-05-10T16:01:33Z) Liu, XuanThis dissertation consists of two essays in international macroeconomics. The first essay shows that optimal fiscal and monetary policy is time consistent in a standard small open economy. Further, there exist many maturity structures of public debt capable of rendering the optimal policy time consistent. This result is in sharp contrast with that obtained in the context of closed-economy models. In the closed economy, the time consistency of optimal monetary and fiscal policy imposes severe restrictions on public debt in the form of a unique term structure of public debt that governments can leave to their successors at each point in time. The time consistent result is robust: optimal policy is time consistent when both real and nominal bonds have finite horizons. While in a closed economy, governments must have both nominal and real bonds, and have at least real bonds over an infinite horizon to render optimal policy time consistent. The second essay uses a dynamic stochastic general equilibrium model to theoretically rationalize the empirical finding that sudden stops have weaker effects on outputs when the small open economy is more open to trade. First, welfare costs of sudden stops are decreasing in trade openness. The reason is that when the economy is more open to trade, the economy will have less volatile capital, which leads to less volatile output. In terms of welfare, when the small open economy is more open to trade, the welfare costs of sudden stops will be smaller. Second, sudden stops may be welfare improving to the small open economy. This is because when the representative household is a net borrower in the international capital market, its consumption will be negatively correlated with country spread. Since utility is a concave function of consumption, it must be a convex function of country spread. That is, when the country spread is more volatile, the mean utility is higher. The two findings are robust: they hold with one sector economy model, and two sector economy models with homogenous capital and heterogenous capital. In addition, this paper shows that a counter-cyclical tariff rate policy is not welfare-improving.Item Open Access Explaining the Effects of Fiscal Shocks(2010) Zubairy, SarahThis dissertation is motivated by the fact that while the literature has had a great deal of success in developing empirical models for monetary policy analysis, the same can not be said for fiscal policy. This work advances our understanding of various issues in identification and modeling of fiscal policy shocks. In particular, the first two chapters work towards building a compelling empirical model for fiscal policy evaluation and the last chapter addresses the importance of fiscal shocks, along with monetary shocks in explaining aggregate macroeconomic fluctuations.

Chapter 1 identifies and explains the effects of a government spending shock. In response to a structural unanticipated government spending shock, output, hours, consumption and wages all rise, whereas investment falls on impact. An estimated dynamic general equilibrium model featuring deep habit formation successfully explains these effects. In particular, deep habits give rise to countercyclical markups and thus act as transmission mechanism for the effects of government spending shocks on private consumption and wages. In addition, I show that deep habits significantly improve the fit of the model compared to a model with habit formation at the level of aggregate goods.

While Chapter 1 considers public spending financed by lump-sum taxes, Chapter 2 further extends the framework to allow for distortionary taxes, and a more careful modeling of the government financing behavior. I use full information Bayesian techniques to estimate this dynamic stochastic equilibrium model, and characterize the dynamics of the economy in the case of both spending and tax changes. I estimate fiscal multipliers and find the multiplier for government spending to be 1.12, and the maximum impact is when the spending shock hits the economy. In addition, the model predicts a positive but small response of private consumption to increased government spending. The multipliers for labor and capital tax on impact are 0.13 and 0.33, respectively. The effects of tax cuts, on the other hand, take time to build, and exceed the stimulative effects of higher spending at horizons of 12-20 quarters. The expansionary effects of tax cuts are primarily driven by the response of investment. I also carry out several counterfactual exercises to show how alternative financing methods and expected monetary policy have consequences for the size of fiscal multipliers. In addition, I simulate the effects of the American Recovery and Reinvestment Act of 2009 in the context of this empirical model.

The final chapter, which is joint work with Barbara Rossi, analyzes the role of government spending shocks along with monetary policy shocks in explaining macroeconomic fluctuations, in a structural vector autoregression (VAR) where both shocks are identified simultaneously. Our main finding is that government spending shocks are relatively more important in explaining medium cycle fluctuations (defined between 32 and 200 quarters) and monetary shocks play a larger role in explaining business cycle frequencies (between 8 and 32 quarters). We also find that failing to recognize that both monetary and fiscal policy simultaneously affect macroeconomic variables might incorrectly attribute fluctuations to the wrong source.

Item Open Access Optimal Monetary Policy and Oil Price Shocks(2008-04-25) Kormilitsina, AnnaThis dissertation is comprised of two chapters. In the first chapter, I investigate the role of systematic U.S. monetary policy in the presence of oil price shocks. The second chapter is devoted to studying different approaches to modeling energy demand.

In an influential paper, Bernanke, Gertler, and Watson (1997) and (2004) argue that systematic monetary policy exacerbated the recessions the U.S. economy experienced in the aftermath of post World War II oil price shocks. In the first chapter of this dissertation, I critically evaluate this claim in the context of an estimated medium-scale model of the U.S. business cycle. Specifically, I solve for the Ramsey optimal monetary policy in the medium-scale dynamic stochastic general equilibrium model (henceforth DSGE) of Schmitt-Grohe and Uribe (2005). To model the demand for oil, I use the approach of Finn (2000). According to this approach, the utilization of capital services requires oil usage. In the related literature on the macroeconomic effects of oil price shocks, it is common to calibrate structural parameters of the model. In contrast to this literature, I estimate the parameters of my DSGE model. The estimation strategy involves matching the impulse responses from the theoretical model to responses predicted by an empirical model. For estimation, I use the alternative to the classical Laplace type estimator proposed by Chernozhukov and Hong (2003). To obtain the empirical impulse responses, I identify an oil price shock in a structural VAR (SVAR) model of the U.S. business cycle. The SVAR model predicts that, in response to an oil price increase, GDP, investment, hours, capital utilization, and the real wage fall, while the nominal interest rate and inflation rise. These findings are economically intuitive and in line with the existing empirical evidence. Comparing the actual and the Ramsey optimal monetary policy response to an oil price shock, I find that the optimal policy allows for more inflation, a larger drop in wages, and a rise in hours compared to those actually observed. The central finding of this Chapter is that the optimal policy is associated with a smaller drop in GDP and other macroeconomic variables. The latter results therefore confirm the claim of Bernanke, Gertler and Watson that monetary policy was to a large extent responsible for the recessions that followed the oil price shocks. However, under the optimal policy, interest rates are tightened even more than what is predicted by the empirical model. This result contrasts sharply with the claim of Bernanke, Gertler, and Watson that the Federal Reserve exacerbated recessions by the excessive tightening of interest rates in response to the oil price increases. In contrast to related studies that focus on output stabilization, I find that eliminating the negative response of GDP to an oil price shock is not desirable.

In the second chapter of this dissertation, I compare two approaches to modeling energy sector. Because the share of energy in GDP is small, models of energy have been criticized for their inability to explain sizeable effects of energy price increases on the economic activity. I find that if the price of energy is an exogenous AR(1) process, then the two modeling approaches produce the responses of GDP similar in size to responses observed in most empirical studies, but fail to produce the timing and the shape of the response. DSGE framework can solve the timing and the shape of impulse responses problem, however, fails to replicate the size of the impulse responses. Thus, in DSGE frameworks, amplifying mechanisms for the effect of the energy price shock and estimation based calibration of model parameters are needed to produce the size of the GDP response to the energy price shock.