This article establishes the existence of multiple equilibria in infinite-horizon open economy models in which the value of tradable and non-tradable endowments serves as collateral. In this environment, the economy displays self-fulfilling financial crises in which pessimistic views about the value of collateral induce agents to deleverage. Under plausible calibrations, there exist equilibria with underborrowing. This result stands in contrast to the overborrowing result stressed in the related literature. Underborrowing emerges in the present context because in economies that are prone to self-fulfilling financial crises, individual agents engage in excessive precautionary savings as a way to self-insure.

This paper studies the effects of natural rate shocks on output and inflation. It estimates a semi-structural model inspired by the DSGE literature. A decline in the natural rate is found to lower trend output and to be contractionary and deflationary in the short run. When the economy is constrained by the zero lower bound (ZLB), these results are consistent with the secular stagnation hypothesis. However, negative natural rate shocks are found to depress the trend of output even outside of the ZLB, calling for a more general theory. A model with liquidity scarcity is proposed as a first step.

The combination of a fixed exchange rate and downward nominal wage rigidity creates a real rigidity. In turn, this real rigidity makes the economy prone to involuntary unemployment during external crises. This paper presents a graphical analysis of alternative policy strategies aimed at mitigating this source of inefficiency. First- and second-best monetary and fiscal solutions are analyzed. Second-best solutions are prudential, whereas first-best solutions are not.

This paper analyzes the inefficiencies arising from the combination of fixed exchange rates, nominal rigidity, and free capital mobility. We document that nominal wages are downwardly rigid in emerging countries. We develop an open-economy model that incorporates this friction. The model predicts that the combination of a currency peg and free capital mobility creates a negative externality that causes overborrowing during booms and high unemployment during contractions. Optimal capital controls are shown to be prudential. For plausible calibrations, they reduce unemployment by around 5 percentage points. The optimal exchange rate policy eliminates unemployment and calls for large devaluations during crises.

A traditional argument against a balanced-budget fiscal policy rule is that it amplifies business cycles by stimulating aggregate demand during booms via tax cuts and higher public expenditures and by reducing demand during recessions through a corresponding fiscal contraction. This paper suggests an additional source of instability that may arise from this type of fiscal policy rule. It shows that, within the standard neoclassical growth model, a balanced-budget rule can make expectations of higher tax rates self-fulfilling if the fiscal authority relies heavily on changes in labor income taxes to eliminate short-run fiscal imbalances.

This paper generalizes the standard habit-formation model to an environment in which agents form habits over individual varieties of goods as opposed to over a composite consumption good. We refer to this preference specification as “deep habit formation”. Under deep habits, the demand function faced by individual producers depends on past sales. This feature is typically assumed ad hoc in customer-market and brand-switching-cost models. A central result of the paper is that deep habits give rise to countercyclical mark-ups, which is in line with the empirical evidence. This result is important, because ad hoc formulations of customer-market and switching-cost models have been criticized for implying procyclical and hence counterfactual mark-up movements. Under deep habits, consumption and wages respond procyclically to government-spending shocks. The paper provides econometric estimates of the parameters pertaining to the deep-habit model.

A growing empirical and theoretical literature argues in favor of specifying monetary policy in the form of Taylor-type interest rate feedback rules. That is, rules whereby the nominal interest rate is set as an increasing function of inflation with a slope greater than one around an intended inflation target. This paper shows that such rules can easily lead to chaotic dynamics. The result is obtained for feedback rules that depend on contemporaneous or expected future inflation. The existence of chaotic dynamics is established analytically and numerically in the context of calibrated economies. The battery of fiscal policies that has recently been advocated for avoiding global indeterminacy induced by Taylor-type interest-rate rules (such as liquidity traps) are shown to be unlikely to provide a remedy for the complex dynamics characterized in this paper.

This paper characterizes conditions under which interest-rate feedback rules that set the nominal interest rate as an increasing function of the inflation rate induce aggregate instability by generating multiple equilibria. It shows that these conditions depend not only on the monetary-fiscal regime (as emphasized in the fiscal theory of the price level) but also on the way in which money is assumed to enter preferences and technology. It provides a number of examples in which, contrary to what is commonly believed, active monetary policy gives rise to multiple equilibria and passive monetary policy renders the equilibrium unique.

Once the zero bound on nominal interest rates is taken into account, Taylor‐type interest rate feedback rules give rise to unintended self‐fulfilling decelerating inflation paths and aggregate fluctuations driven by arbitrary revisions in expectations. These undesirable equilibria exhibit the essential features of liquidity traps since monetary policy is ineffective in bringing about the government’s goals regarding the stability of output and prices. This paper proposes several fiscal and monetary policies that preserve the appealing features of Taylor rules, such as local uniqueness of equilibrium near the inflation target, and at the same time rule out the deflationary expectations that can lead an economy into a liquidity trap.