Essays on Macroeconomics and Monetary Policy

This dissertation consists of three papers examining monetary policy transition to the macroeconomy. It makes use of both theoretical and empirical methods. Motivated by structural changes in the financial sector and the central bank's policy conduct in the last decades, this dissertation reappraises monetary policy's impact on the real economy. While the first two chapters focus on conventional monetary policy using the short-term interest rate as the primary policy tool, the third chapter shifts towards unconventional monetary policy using the central bank's balance sheet. Such policies came to prominence when the policy rate reached the effective lower bound during the 2007-2009 global financial crisis.

The first chapter analyzes the implications of the recent rise in bank concentration for the effectiveness of monetary policy. I study how the structure of the banking system affects the transmission of monetary policy for stabilization and the credit cycle. First, I use branch-level data on deposit and loan rates to evaluate how monetary policy pass-through depends on the level of local bank competition and bank capitalization. I show that banks operating in high-concentration markets, as well as under-capitalized banks, adjust short-term lending rates more in response to changes in the policy rate, especially when the policy rate moves upwards. Second, I build a theoretical model with heterogeneous banks that rationalizes the empirical findings and explains the underlying mechanism. In the model, monopolistic competition in local deposit and loan markets, along with bank capital requirements, impose frictions on the pass-through to the real economy. Counterfactual analyses highlight that the recent rise in bank concentration strengthened the pass-through by two channels, which I label the market power and capital allocation channel. Finally, I demonstrate that both channels strengthen monetary policy transmission to output and investment, amplify the credit cycle, and lead to a flattening of the Phillips curve.

The second chapter, written in conjunction with Rüdiger Bachmann and Eric Sims, focuses on identifying monetary policy shocks. We propose a new approach to estimate monetary policy shocks that exploits exogenous variation in the central bank's policy rate. In particular, we use the nowcast errors of the central bank with respect to the output gap and inflation as instrumental variables to isolate exogenous variation in the policy rate. We then compute the effects of the shock on the real economy using local projection methods. The results indicate that a contractionary monetary policy shock has a limited effect on output but a persistent effect on prices. In contrast to alternative identification approaches, there is no price puzzle when analyzing the period from 1987 to 2008. Further, we validate the identification approach in an augmented New Keynesian model assuming that the central bank observes current output and inflation with nowcast errors.

The third chapter, co-authored with Ronald Mau and Jonathan Rawls, turns to unconventional monetary policy and studies the interaction between the central bank's main policy tools - the interest rate and balance sheet. First, we derive the welfare loss function in a simple New Keynesian model with a role for the central bank's balance sheet. We show that in this model, term premium volatility enters the welfare loss function along with the standard inflation and output gap volatility terms. We then study optimal monetary policy for three cases using a single or dual policy tools, (i) the interest rate as the primary tool, (ii) the interest rate and the balance sheet together, and (iii) the balance sheet is the only tool. We reach several conclusions. First, we find that with optimal policy rate behavior under discretion, an exogenous balance sheet expansion is deflationary and lowers the implied path of the short-term policy rate. At the effective lower bound (ELB), optimal policy lengthens the ELB event duration following an exogenous balance sheet expansion. This serves as a potential theoretical rationalization for the so-called 'signaling channel' of central bank asset purchases. Second, with endogenous balance sheet policy in addition to the policy rate, the central bank can simultaneously stabilize inflation, the output gap, and the term premium. Finally, we show that endogenous balance sheet policy rules exist that support a permanent policy rate peg.