Essays on Business Cycles and Stabilization Policy

This dissertation is a collection of essays on fiscal policy, monetary policy and the international transmission of business cycle shocks. Chapter 1 highlights the importance of distinguishing durable and nondurable goods when conducting countercyclical fiscal policy. It shows that the fiscal multiplier for purchases of durable goods is much smaller than the multiplier for nondurable goods. Standard models predict small durables multipliers because private sector purchases of durable goods are highly intertemporally substitutable and therefore easily crowded out. Empirical estimates based on U.S. data confirm this result. In aggregate time series data output rises by about 50 cents less if the government purchases 1;Chapter 2, joint with Christopher L. House, shifts focus to monetary policy and analyzes the optimal Taylor rule in a standard New Keynesian model. If the central bank can observe the output gap and inflation without error, then it is typically optimal to respond infinitely strongly to observed deviations from the central bank's targets. If it observes inflation and the output gap with error, the central bank will temper its responses so as not to impart unnecessary volatility to the economy. If the Taylor rule is expressed in terms of estimated output and inflation then it is optimal to respond infinitely strongly to estimated deviations from the targets. Under such a Taylor rule the estimates of inflation and the output gap should be perfectly negatively correlated. In the data, inflation and the output gap are weakly correlated, suggesting that the central bank is systematically underreacting.;Chapter 3, joint with Aaron Flaaen and Nitya Pandalai-Nayar, studies the cross-country transmission of shocks. Using the 2011 Tohoku earthquake as a natural experiment, the study shows that firms reliant on Japanese intermediates experienced significant drops in production after the disruption. These findings imply that supply chains are sufficiently inflexible to play an important role in the international transmission of shocks.