Adam Smith Business School

Dr Alp Simsek, Yale University

'A note on temporary supply shocks with aggregate demand inertia' (co-authored by R. J. Caballero) and 'Monetary policy and asset price overshooting: A rationale for the wall/main street disconnect' (co-authored by R. J. Caballero)
Thursday 10 February, 3pm - 4.30pm
Zoom online seminar

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Abstract

A note on temporary supply shocks with aggregate demand inertia

We study optimal monetary policy during temporary supply contractions, using a simple New Keynesian model with aggregate demand inertia and expansionary policy constraints. In this setting, it is optimal to run the economy hot during the temporary supply contraction. This result follows from an intertemporal breakdown of the divine coincidence of monetary policy: a positive output gap during the low-supply phase shrinks the negative output gap that is expected to emerge once aggregate supply recovers and the expansionary policy becomes constrained. However, optimal monetary policy does not remain loose throughout the low-supply phase. Since aggregate demand has inertia, an optimising central bank frontloads interest rate cuts and then normalises the interest rate once it succeeds in building aggregate demand momentum. Finally, if inflation also has inertia, e.g., due to backward-looking inflation expectations, the central bank still overheats the economy during the temporary supply shock but gradually cools it down over time.

Monetary policy and asset price overshooting: A rationale for the wall/main street disconnect

We analyse optimal monetary policy when asset prices influence aggregate demand with a lag. In this environment, when there is a current or anticipated output gap, the central bank optimally overshoots asset prices (i.e., significantly reduces discount rates to increase asset prices). Asset price overshooting leads to a temporary disconnect between the performance of financial markets and the real economy, but it also accelerates the recovery. A more intense overshooting policy weakens the relationship between inflation and the output gap (i.e., it flattens the Phillips curve). We quantify the policy-induced overshooting through risk-free rates in the Covid-19 recession and find that actual overshooting significantly exceeded the overshooting implied by a Taylor rule benchmark. Our calibrated model suggests this additional overshooting substantially accelerated the recovery. Finally, we show that policy-induced overshooting, along with monetary policy constraints, can shed light on the cyclical variation in the response of asset prices to macroeconomic news.

Biography

For the academic year 2021-22, Alp Simsek is a Visiting Lecturer at the Yale School of Management. He is also a Faculty Research Fellow at the National Bureau of Economic Research (NBER) and a Research Fellow at the Centre for Economic Policy Research (CEPR). Previously, he was an Assistant Professor at Harvard University and an Associate Professor at MIT. Alp received his Bachelors degrees from MIT in 2004, a Master's degree from MIT in 2005, and his PhD from MIT in 2010. He was a recipient of the National Science Foundation CAREER award in 2015. Alp's research, advising, and teaching interests are centered in macroeconomics and finance, and extend into international and behavioral finance. In his research, he studies the connections between financial markets and the macroeconomy, with an emphasis on the fluctuations driven by beliefs and speculation. While he is primarily an applied theorist, he also engages with data to test the mechanisms that he emphasises.

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Further information: business-events@glasgow.ac.uk 

First published: 9 February 2022