Ricardo Reis

Abstracts and papers

Where to Inject Liquidity during a Financial Crisis?
Abstract: Coming soon.
Paper: Local file.

Imperfect Information and Aggregate Supply, with N. Greogry Mankiw.
Abstract: A survey of the recent decade of work on imperfect information models of pricing and the Phillips curve.
Paper: Local file.

Interpreting the Unconventional U.S. Monetary Policy of 2007-09.
Abstract: This paper reviews the unconventional U.S. monetary policy responses to the financial and real crises of 2007-09. It catalogues these policies into three groups: interest-rate policy, quantitative policy, and credit policy. To interpret interest-rate policy, it compares the Federal Reserve's actions with the literature on optimal policy in a liquidity trap. This comparison suggests that policy has been in the direction suggested by theory, but it has not gone far enough. To interpret quantitative policy, it reviews the determination of inflation under different policy regimes. The main danger for inflation coming from the current actions is that the Federal Reserve may lose its independence in choosing monetary policies, while a beneficial side-effect of the crisis is that the Friedman rule can be implemented by paying interest on reserves. To interpret credit policy, it presents a new model of capital market imperfections and their interaction with real investment decisions with different financial institutions and a role for legacy assets, mark-to-market, and leverage. The model suggests that providing credit to traders in securities markets is a more effective response to a financial crisis than it is to extend credit to the originators of loans.
Paper: Local file.

Dynamic Measures of Inflation.
Abstract: A brief non-technical survey of my work on this area
Paper: Local file. Published NBER version

Correlated Disturbances and U.S. Business Cycles
Abstract: The dynamic stochastic general equilibrium (DSGE) models used to study business cycles typically assume that exogenous disturbances are independent with a simple structure for serial correlation. This paper relaxes this tight restriction, by allowing for disturbances that have a rich contemporaneous and dynamic correlation structure. Our first contribution is a new Bayesian econometric method that uses conjugate conditionals to make the estimation of DSGE models with correlated disturbances feasible and quick. Our second contribution is a re-examination of the sources of U.S. business cycles, using two canonical models, one real and the other monetary. We find that when we allow for correlated disturbances, the estimates of crucial parameters are more in line with other evidence, the impulse responses are closer to the results from vector autoregressions, and government spending and technology disturbances play a larger role in the business cycle, while changes in markups are unimportant.
Paper: Local file.

A Dynamic Measure of Inflation
Abstract: This paper shows that conventional measures of cost-of-living in.ation, based on static models of consumption, su¤er from two problems. The first is an intertemporal substitution bias, as these measures neglect the ability of consumers to borrow and lend in response to price changes. The second problem is the omission of intertemporal prices, which capture relevant relative prices for a consumer who lives for many periods. The paper proposes a dynamic price index (DPI) that solves these problems. Theoretically, it shows that the DPI is forward-looking, responds by more to persistent shocks, includes assets prices, and distinguishes between durable and non-durable goods' prices. A constructed DPI for the United States from 1970 to 2008 differs markedly from the CPI, it is close to serially uncorrelated, it is mostly driven by the prices of houses and bonds, and is twice as high as the CPI in 2008.
Paper: Local file. NBER Working paper 11746.
Older version: Circulated under title "A Cost-of-Living Dynamic Price Index, with an Application to Indexing Retirement Accounts, CEPR Working paper 5394.
Media coverage: The Economist (13th October 2005).

Optimal Monetary Policy Rules in an Estimated Sticky-Information Model .
Abstract:This paper uses a dynamic stochastic general-equilibrium (DSGE) model with sticky information as a laboratory to study monetary policy. It characterizes the model's predictions for macro-dynamics and optimal policy at prior parameters, and then uses data on five U.S. macroeconomic series to update the parameters and provide an estimated model that can be used for policy analysis. The model answers a few policy questions: How does sticky information affect optimal monetary policy? What is the optimal interest-rate rule? What is the optimal elastic price-level targeting rule? How does parameter uncertainty affect optimal policy? Are the conclusions for the Euro-area different?
Paper: Final version. Journal article

Relative Goods' Prices, Pure Inflation and the Phillips Correlation, with Mark W. Watson.
Abstract:This paper uses a dynamic factor model for the quarterly changes in consumption goods' prices in the U.S. since 1959 to separate them into three independent components: idiosyncratic relative-price changes, a low-dimensional index of aggregate relative-price changes, and an index of equiproportional changes in all inflation rates, that we label "pure" inflation. We use the estimates to answer two questions. First, what share of the variability of inflation is associated with each component, and how are they related to conventional measures of monetary policy and relative-price shocks? Second, what drives the Phillips correlation between inflation and measures of real activity?
Paper: Local file. NBER Working paper 13615,
Older version: Circulated under title "Relative Goods' Prices and Pure Inflation," as: CEPR discussion paper 6593.

A Sticky-Information General-Equilibrium Model for Policy Analysis.
Abstract: This paper presents a dynamic stochastic general-equilibrium model with a single friction in all markets: sticky information. In this economy, agents are inattentive because of costs of acquiring, absorbing and processing information, so that the actions of consumers, workers and firms are slow to incorporate news. This paper presents the details of how an economy with pervasive inattentiveness functions, and develops a set of algorithms that solve the model quickly. It then applies these to estimate the model using data for the United States post-1986 and for the Euro-area post-1993, and to conduct counterfactual policy experiments. The end result is a laboratory that is rich enough to account for the dynamics of at least five macroeconomic series (inflation, output, hours, interest rates, and wages), and which can be used to inform applied monetary policy.
Paper: Final version.

Measuring Changes in the Value of the Numeraire, with Mark W. Watson.
Abstract: This paper estimates a common component in many price series that has an equiproportional effect on all prices. Changes in this component can be interpreted as changes in the value of the numeraire since, by definition, they leave all relative prices unchanged. The first aim of the paper is to measure these changes. The paper provides a framework for identifying this component, suggests an estimator for the component based on a dynamic factor model, and assesses its performance relative to alternative estimators. Using 187 U.S. time-series on prices, we estimate changes in the value of the numeraire from 1960 to 2006, and further decompose these changes into a part that is related to relative price movements and a residual ‘exogenous’ part. The second aim of the paper is to use these estimates to investigate two economic questions. First, we show that the size of exogenous changes in the value of the numeraire helps distinguish between different theories of pricing, and that the U.S. evidence argues against several strict theories of nominal rigidities. Second, we find that changes in the value of the numeraire are significantly related to changes in real quantities, and discuss interpretations of this apparent non-neutrality.
Paper: Local file.

Using VARs to Identify Models of Fiscal Policy: A Comment on Perotti
Abstract: This note comments on Perotti's (2008) estimates of the impact of a government spending shock on the economy. In the process, it makes two points. First, it notes that with enough freedom to pick the dynamics of policy variables, the neoclassical model can generate any set of observations for the non-policy variables. Second, it proposes a method to identify the policy dynamics in theoretical models by using the estimated impulse responses of the policy variables from VARs, and in this way generate testable predictions of the model for the non-policy variables.
Paper: Final version. See also the longer working paper here or as WWS discussion paper 234.

Sticky Information in General Equilibrium, with N. Gregory Mankiw.
Abstract: This paper develops and analyzes a general-equilibrium model with sticky information. The only rigidity in goods, labor, and financial markets is that agents are inattentive, sporadically updating their information sets, when setting prices, wages, and consumption. After presenting the ingredients of such a model, the paper develops an algorithm to solve this class of models and uses it to study the model's dynamic properties. It then estimates the parameters of the model using U.S. data on five key macroeconomic time series. It finds that information stickiness is present in all markets, and is especially pronounced for consumers and workers. Variance decompositions show that monetary policy and aggregate demand shocks account for most of the variance of inflation, output, and hours.
Paper: Final version, journal article. See also the longer working paper version here or as NBER Working paper 12605.

The Brevity and Violence of Contractions and Expansions, with Alisdair McKay.
Abstract: Early studies of business cycles argued that contractions in economic activity were briefer (shorter) and more violent (rapid) than expansions. This paper systematically investigates this claim and in the process discovers a robust new business cycle fact: contractions in employment are briefer and more violent than expansions but we cannot reject the null of equal brevity and violence for expansions and contractions in output. The difference arises because employment typically lags output around peaks but they coincide in their troughs. We discuss the performance of existing business cycle models in accounting for this fact, and conclude that none can fully account for it. We then show that a business cycle model with asymmetric adjustment costs on employment and a choice of when to scrap old technologies can account for the business cycle fact both qualitatively and quantitatively.
Paper: Final version, journal article. See also the (unpublished) appendix.

The Analytics of Monetary Non-Neutrality in the Sidrauski Model.
Abstract: This note analytically characterizes the equilibrium dynamics of the Sidrauski model and reaches three conclusions regarding monetary policy: (i) it is typically not neutral, (ii) in some cases, it is not neutral even in the steady state, and (iii) a policy that has the nominal interest rate falling over time may sustain higher output and consumption forever.
Paper: Final version, journal article.

Pervasive Stickiness, with N. Gregory Mankiw.
Abstract: This paper explores a macroeconomic model of the business cycle in which stickiness of information is pervasive. We start from a familiar benchmark classical model and add to it the assumption that there is sticky information on the part of consumers, workers, and firms. We evaluate the model against three key facts that describe short-run fluctuations: the acceleration phenomenon, the smoothness of real wages, and the gradual response of real variables to shocks. We find that pervasive stickiness is required to fit the facts. We conclude that models based on stickiness of information offer the promise of fitting the facts on business cycles while adding only one new plausible ingredient to the classical benchmark.
Paper: Final version, journal article. See also the (unpublished) appendix, or the longer working paper versions here, or as NBER Working paper 12024, or as CEPR Working paper 5521, or as HIER discussion paper 2111.

Understanding the Greenspan Standard, with Alan S. Blinder.
Paper: Final version, online book.

The Time-Series Properties of Aggregate Consumption: Implications for the Costs of Fluctuations
Abstract: The properties of the stochastic process followed by aggregate consumption affect the estimates of the costs of fluctuations. This paper pursues two approaches to modelling consumption dynamics and measuring how much society dislikes fluctuations, one statistical and one economic. The statistical approach estimates the properties of consumption and calculates the costs of having consumption fluctuating around its mean growth. The paper finds that persistence is a crucial determinant of the costs and that the high persistence in the data severely distorts conventional measures. It shows how to compute valid estimates and confidence intervals. The economic approach uses a calibrated model of optimal consumption and measures the costs of eliminating income shocks. This uncovers a further cost of uncertainty, through its impact on precautionary savings and investment. The two approaches lead to costs of fluctuations that are higher than the common wisdom, between 0.5% and 5% of per capita consumption.
Paper: Final version, journal article.

Inattentive Consumers.
Abstract: This paper studies the consumption decisions of agents who face costs of acquiring, absorbing and processing information. These consumers rationally choose to only sporadically update their information and re-compute their optimal consumption plans. In between updating dates, they remain inattentive. This behavior implies that news disperses slowly throughout the population, so events have a gradual and delayed effect on aggregate consumption. The model predicts that aggregate consumption adjusts slowly to shocks, and is able to explain the excess sensitivity and excess smoothness puzzles. In addition, individual consumption is sensitive to ordinary and unexpected past news, but it is not sensitive to extraordinary or predictable events. The model further predicts that some people rationally choose to not plan, live hand-to-mouth, and save less, while other people sporadically update their plans. The longer are these plans, the more they save. Evidence using U.S. aggregate and microeconomic data generally supports these predictions.
Paper: Local file, journal article. The longer and older working paper version can be found as NBER Working Paper 10883, or as CEPR Working paper 5053, or as WWS Discussion Paper 232.

Inattentive Producers.
Abstract: I present and solve the problem of a producer who faces costs of acquiring, absorbing, and processing information. I establish a series of theoretical results describing the producer's behavior. First, I find the conditions under hich she prefers to set a plan for the price she charges, or instead prefers to set a plan for the quantity she sells. Second, I show that the agent rationally chooses to be inattentive to news, only sporadically updating her information. I solve for the optimal length of inattentiveness and characterize its determinants. Third, I explicitly aggregate the behavior of many such producers. I apply these results to a model of inflation. I find that the model can fit the quantitative facts on post-war inflation remarkably well, that it is a good forecaster of future inflation, and that it survives the Lucas critique by fitting also the pre-war facts on inflation moderately well.
Paper: Published version, journal article.
(You might also want to see Jinnai (2007). He approximates the solution of the model around a different point, and finds that the predicted length of inattentiveness is even more in line with the micro evidence than Table 2 in my paper suggested.)

Disagreement about Inflation Expectations, with N. Gregory Mankiw and Justin Wolfers.
Abstract: Analyzing 50 years of inflation expectations data from several sources, we document substantial disagreement among both consumers and professional economists about expected future inflation. Moreover, this disagreement shows substantial variation through time, moving with inflation, the absolute value of the change in inflation, and relative price variability. We argue that a satisfactory model of economic dynamics must speak to these important business cycle moments. Noting that most macroeconomic models do not endogenously generate disagreement, we show that a simple "sticky-information" model broadly matches many of these facts. Moreover, the sticky-information model is consistent with other observed departures of inflation expectations from full rationality, including autocorrelated forecast errors and insufficient sensitivity to recent macroeconomic news.
Paper: Published version.

Monetary Policy for Inattentive Economies,with Laurence Ball and N. Gregory Mankiw.
Abstract: This paper is a contribution to the analysis of optimal monetary policy. It begins with a critical assessment of the existing literature, arguing that most work is based on implausible models of inflation-output dynamics. It then suggests that this problem may be solved with some recent behavioral models, which assume that price setters are slow to incorporate macroeconomic information into the prices they set. A specific such model is developed and used to derive optimal policy. In response to shocks to productivity and aggregate demand, optimal policy is price level targeting. Base drift in the price level, which is implicit in the inflation targeting regimes currently used in many central banks, is not desirable in this model. When shocks to desired markups are added, optimal policy is flexible targeting of the price level. That is, the central bank should allow the price level to deviate from its target for a while in response to these supply shocks, but it should eventually return the price level to its target path. Optimal policy can also be described as an elastic price standard: the central bank allows for the price level to deviate from its target when output is expected to deviate from its natural rate.
Paper: Published version, journal article. See also the longer working paper version as NBER discussion paper 9491, or as HIER discussion paper 1997 for the proofs.

Sticky Information: A Model of Monetary Non-neutrality and Structural Slumps, with N. Gregory Mankiw.
Abstract: This paper explores a model of wage adjustment based on the assumption that information disseminates slowly throughout the population of wage setters. This informational frictional yields interesting and plausible dynamics for employment and inflation in response to exogenous movements in monetary policy and productivity. In this model, disinflations and productivity slowdowns have a parallel effect: They both cause the path of employment to fall below the level that would prevail under full information. The model implies that, in the face of productivity change, a policy of targeting either nominal income or the nominal wage leads to more stable employment than does a policy of targeting the price of goods and services. Finally, we examine U.S. time series and find that, as the model predicts, unemployment fluctuations are associated with both inflation and productivity surprises.
Paper: Published version.

Sticky Information Versus Sticky Prices: A Proposal to Replace the New Keynesian Phillips Curve , with N. Gregory Mankiw.
Abstract: This paper examines a model of dynamic price adjustment based on the assumption that information disseminates slowly throughout the population. Compared to the commonly used sticky-price model, this sticky-information model displays three, related properties that are more consistent with accepted views about the effects of monetary policy. First, disinflations are always contractionary (although announced disinflations are less contractionary than surprise ones). Second, monetary policy shocks have their maximum impact on inflation with a substantial delay. Third, the change in inflation is positively correlated with the level of economic activity.
Paper: Published version, link to journal.

Costs of banking system instability: some empirical evidence, with Glenn Hoggarth and Victoria Sapporta.
Abstract: This paper assesses the cross-country 'stylised facts' on empirical measures of the losses incurred during periods of banking crises. Firstly, the direct resolution costs to the government are considered, and then the broader costs to the welfare of the economy (proxied by losses in GDP). The cumulative output losses incurred during crisis periods are found to be large, roughly 15%-20% of annual GDP, on average. In contrast to previous research, it is also found that output losses incurred during crises in developed countries are as high, or higher, on average, than those in emerging market economies. Moreover, output losses during crisis periods in developed countries also appear to be significantly larger -- 10%-15% -- than in neighbouring countries that did not at the time experience severe banking problems. In emerging market economies, by contrast, banking crises appear to be costly only when accompanied by a currency crisis. These results seem robust to allowing for macroeconomic conditions at the outset of crisis -- in particular low and declining output growth -- that have also contributed to future output losses during episodes.
Paper: Published version, link to journal.

What Measure of Inflation Should a Central Bank Target? with N. Gregory Mankiw.
Abstract: This paper assumes that a central bank commits itself to maintaining an inflation target and then asks what measure of the inflation rate the central bank should use if it wants to maximize economic stability. The paper first formalizes this problem and examines its microeconomic foundations. It then shows how the weight of a sector in the stability price index depends on the sector's characteristics, including size, cyclical sensitivity, sluggishness of price adjustment, and magnitude of sectoral shocks. When a numerical illustration of the problem is calibrated to U.S. data, one tentative conclusion is that a central bank that wants to achieve maximum stability of economic activity should use a price index that gives substantial weight to the level of nominal wages.
Paper: Published version, link to journal.

Where Is the Natural Rate? Rational Policy Mistakes and Persistent Deviations of Inflation from Target.
Abstract: Empirical research has shown that there is large uncertainty concerning the value of the natural rate of unemployment at any point in time. I incorporate this feature in a model of monetary policy where the policymaker targets an inflation rate and the natural rate of unemployment and solve for the optimal policy. Two interesting new results emerge. First, under a realistic shock profile, the model generates long-lasting deviations of inflation from target, providing an alternative (but also a complement) to the popular Barro-Gordon framework. Second, the economy exhibits large inflation persistence and can have very rich inflation dynamics. The model is able to account for approximately one third of the increase in inflation in the United States in the late 1970s, and suggests an explanation for the low inflation of the late 1990s. Moreover, I present empirical evidence for the US and other countries that support the model including a new empirical finding: across countries there is a positive statistical relation between the persistence of unemployment and inflation.
Paper: Published version. Erratum.

The Persistence of Inflation in the United States, with Frederic Pivetta.
Abstract: Has the persistence of inflation in the U.S. changed since 1965? We estimate the persistence of inflation over time, using different measures and estimation procedures, and produce confidence intervals for our estimates and formal tests of unchanged persistence. We find that inflation persistence has been high and approximately unchanged in the U.S. over our sample period. Furthermore, we reconcile our results with other studies that reached different conclusions.
Paper: Published version, link to journal.