UC Berkeley

Recent economic experiences have demonstrated the importance of understanding departures from frictionless markets and perfect information-processing for the field of macroeconomics. The global financial crisis has highlighted the importance of financial frictions for macroeconomic policy. With conventional monetary policy unable to stabilize the economy in the wake of the global financial crisis, central banks turned to unconventional tools. Understanding how these tools worked through interactions with financial market disruptions is crucial for designing and implementing policies to deal with the next crisis. The first two chapters show theoretically how unconventional policy worked, and test these predictions in the data.

The rise of political polarization over the past decades raises important questions about how households form macroeconomic beliefs, and how this departs from the typical rationality assumptions embedded in textbook macroeconomic models. The final chapter shows theoretically how imperfect information-processing leads to a divergence of macroeconomic beliefs across households. Empirically, growing disagreement about macroeconomic outcomes is found in survey data; moreover, this disagreement leads to differential consumptions decisions following political shocks.

Chapter 1 embeds a model of the term structure of interest rates featuring market segmentation and limits to arbitrage within a New Keynesian model to study unconventional monetary policy. Because the transmission of monetary policy depends on private agents with limited risk-bearing capacity, financial market disruptions reduce the efficacy of both conventional policy as well as forward guidance. Conversely, financial crises are precisely when large scale asset purchases are most effective. Policymakers can take advantage of the inability of financial markets to fully absorb these purchases, which can push down long-term interest rates and help stabilize output and inflation.

Chapter 2 seeks to understand empirically the effects of large-scale asset purchase programs recently implemented by central banks. In joint work with Yuriy Gorodnichenko, we study how markets absorb large demand shocks for risk-free debt. Using high-frequency identification, we exploit the structure of the primary market for U.S. Treasuries to isolate demand shocks. These shocks are sizable, leading to large movements in Treasury yields and impacting corporate borrowing rates. Informed by a preferred habitat model of the term structure, we test for "local" demand effects and find evidence consistent with theoretical predictions. Crucially, this local effect is strongest when financial markets are disrupted. Our estimates are consistent with the view that quantitative easing worked mainly via market segmentation, with a potentially limited role for other channels.

Chapter 3 explores the role of political polarization in shaping the economic expectations and consumption behavior of households. In joint work with Rupal Kamdar, we first develop a rational inattention model in which heterogeneous households must decide how to obtain information. Theoretically, we show there is a "paradox of information" where falling information costs exacerbate disagreement. Next, using survey data, we find evidence that political polarization has increased dispersion in macroeconomic beliefs. Disagreement is particularly acute following a general election when the presidential party switches; moreover, this effect has been increasing since the 1980s. Finally, we also find that polarization feeds into consumption decisions. Using high-frequency spending data at the zip code level in California, we find Republican-leaning regions exhibit substantially larger consumption following the 2016 election.