Macroeconomics
Monetary economics
Econometrics

Macroeconomics
Monetary Economics
Econometrics

May 1996 (Written) Microeconomic Theory and Macroeconomic Theory
October 1997 (Oral) Macroeconomics and Econometrics

Optimal Monetary Policy in a Business Cycle Model with Staggered Nominal Contracts

Professor Christopher A. Sims
Professor William Brainard
Professor George Hall

May 2001

M. Phil., Economics, Yale University, 1998
M.A., Economics, Yale University, 1996
M.A., Economics, Seoul National University, 1994
B.A., Economics, Seoul National University, 1990

Yale University Dissertation Fellowship, 1999
Yale University Graduate Fellowship, 1995-1998
Magna Cum laude, Seoul National University, 1990

Teaching Assistant, Econometrics and Data Analysis, Fall 2000
Teaching Assistant, Theory of Income Determination and Monetary and Fiscal Policy, Spring 2000 and spring 1999
Teaching Assistant, Introduction to Economics (Macroeconomics), Fall 1998
Teaching Assistant, Econometrics and Data Analysis, Spring 1998
Teaching Assistant, Econometrics and Data Analysis, Fall 1997

Researcher, Korea Institute of Finance, 1994: Performed Statistical and econometric work on Korean financial Markets. Served as a member of the editing board of Economic Trends.

• "Tests for Cointegration in Models with Structural Changes: Theory and Application to the Currency Substitution," mimeo, Seoul National University, 1993.

• "Real Business Cycles and Reality: a Structural Error Correction Model," mimeos, Yale University, 1998.

• "Contract Multiplier Revisited: Solving the Persistence Problem in a Model with Staggered Contracts," mimeo, Yale university, 1999.

• "A Utility Based Optimal Monetary Policy Rule in a New Keynesian DSGE model," in progress.

The dissertation consists of two essays. The first essay examines the ability of staggered nominal contracts to generate sufficiently persistent real effects of monetary disturbances. Since the work of Taylor (1980), staggered contracts have been considered a promising channel through which for nominal shocks to have persistent real effects. The work of Chari et al. (1998), however, challenges this conventional wisdom, arguing that deterministic staggered price contracts a la Taylor is incapable to generate persistent real effects of nominal shocks because of highly pro-cyclical real marginal costs. The challenge has engendered a voluminous literature incorporating either complementary or supplementary devices to achieve greater persistence. The first essay is an addition to the literature, assuming both prices and wages are stochastically staggered in the spirit of Calvo (1983), and reconsiders the persistence problem in the context of a full-pledged business cycle model. The results obtained from impulse responses generally square with the literature, in that the interaction of both rigidities is strong enough to generate persistent real effects of nominal shocks and that wage staggering is a better device producing higher degree of persistence. Analytic solutions for tractable versions of the model confirm these results.

I also compare the implications of Taylor and Calvo staggered contracts in terms of their ability to produce persistence. Two important findings are obtained: First, while staggered price contracts a la Taylor necessarily lead to dampened oscillations (i.e., no persistence per se) in output after monetary disturbance, Calvo staggered price contracts produce a monotonically dampening responses (i.e., possible persistence) of output. This finding implies the pro-cyclicality of real marginal costs is not the only force behind the lack of persistence in Chari et al., because real marginal costs are highly pro-cyclical whether the nature of price staggering is deterministic or stochastic. Second, behind the oscillatory behavior of output and the resulting lack of persistence lies the initial overshooting of optimal prices set by adjusting firms, which occurs only in the case of deterministic price staggering. My interpretation of this finding is deterministic staggered price contracts cast in a business cycle model are not working properly in line with the intuition of Taylor that staggered contracts will bring forth smoothed-out adjustments of prices set by optimizing firms. Staggered wage contracts, either stochastic or deterministic, and stochastic price staggering turn out to be free of this nuisance feature, and hence capable of generating persistence. Based on the results obtained thus far, the essay concludes that staggered price and wage contracts a la Calvo serve as successful complementary channels for the propagation of monetary disturbances.

On the foundation of the model developed in the first essay and inspired by the recent literature on monetary policy rules, the second essay examines the performances of monetary policy rules in terms of a utility measure of the agents inhabiting the economy. I first estimate the model parameters by generalized methods of moments, under the assumption that US monetary policy has been characterized by a generalized version of the Taylor rule in which Federal Funds rate is manipulated in response to the current and lagged economic conditions. The resulting estimates yield reasonable impulse responses toward the interest rate disturbances, such as gradual adjustments of nominal variables and persistence in real variables, and the first and second moments of key system variables are comparable to those of actual data.

From the estimated model with staggered nominal contracts, a utility-based measure of welfare comparison is derived. Most existing literature uses first order approximate solution of the model for the purpose of welfare comparison, but some recent works show the first order approach is not justified even as a local approximation. To address this "spurious welfare reversal" problem, I first derive the second order approximate solution of the model, and the solution thus obtained is used to measure the utility level of the agents. The resulting utility measure is evaluated at the parameter estimates and policy parameters of different monetary policy rules. Against the correct welfare measure thus derived, the essay compares the performance of alternative monetary policy rules.