UC Riverside

This dissertation contributes to two areas of Macroeconomics: (1) welfare effects of inflation and (2) monetary policy and asset prices. The first chapter focuses on examining the redistributional effects of inflation in the United States in a cash-in-advance economy framework. Most literature on the welfare effects of inflation has largely focused on the aggregate welfare effects of inflation without much assessment about it's redistributional effects. The first chapter examines, quantitatively, how different income brackets in the U.S. would be impacted in terms of consumption and asset positions if long-run inflation were to rise.

The second and third chapters focus on the latter strand of macroeconomics. Recently, central bankers around the world have been debating on what should be the appropriate response of monetary policy to large swings in asset prices. In this spirit, chapter 2 examines what would have happened if the Federal Reserve had reacted to stock price misalignments prior to crashes and major financial crises such as the Great Recession by extending the standard New Keynesian model to include asset prices. First, the proposed model is used to estimate the response of monetary policy to the stock market using Bayesian techniques. We find that the Federal Reserve did not react to U.S. stock market fluctuations during the Great moderation period. We then undertake a counterfactual experiment in which we assume that the Federal Reserve targets stock price misalignments in addition to inflation and output gap. Our policy experiment suggests that had the Federal Reserve raised their policy rate in response to rising stock prices, the boom-bust cycle of stock prices would have been substantially reduced and surprisingly, this would not have been associated with a decrease in average output. For example, the exuberance of the dotcom in the late 1990s and the boom in stock prices associated with the housing market in the mid 2000s would have been milder. Further, the severity of the Great Recession in terms of output loss would have been significantly lower had the policy rate been reactive to rising stock prices prior to the crisis. In the wake of the Great Recession, this chapter contributes to the current debate on whether central banks should target asset price misalignments.

The third chapter extends the the second chapter to include financial intermediaries to emphasize the role of credit spreads that serve as an important business cycle propagation mechanism. This chapter asks three related questions. First, to what extent has the Federal Reserve adjusted interest rates in response to movements in credit spreads in the past and whether this response has evolved overtime. Second, how does the presence of financial intermediaries that are a source of credit growth, contribute to the fluctuations in the macroeconomy in the face of a monetary policy shock. Third, what effect does a financial shock that tends to increase credit spreads have on macro variables in the economy?