Monetary policy and the great recession

The Great Recession is arguably the most important macroeconomic event of the last three decades. Large Increase in Uncertainty About the Future: The Great Recession and its subsequent slow recovery have been marked by a large increase in uncertainty about the future. Uncertainty peaked at the end of 2008 and has remained volatile over the past few years. Zero Bound on Nominal Interest Rates: The Federal Reserve plays a key role in offsetting the negative impact of fluctuations in the economy. Since the end of 2008, the Federal Reserve has been unable to lower its nominal policy rate due to the zero lower bound on nominal interest rates. The zero lower bound represents a significant constraint monetary policy's ability to fully stabilize the economy. Unprecedented Use of Forward Guidance: Even though the Federal Reserve remains constrained by the zero lower bound, the monetary authority can still affect the economy through expectations about future nominal policy rates. By providing agents in the economy with forward guidance on the future path of policy rates, monetary policy can stimulate the economy even when current policy rates remain constrained. Throughout the Great Recession and the subsequent recovery, the Federal Reserve provided the economy with explicit statements about the future path of monetary policy. Large Fiscal Expansion: During the Great Recession, the United States engaged in a very large program of government spending and tax reductions. Many economists argue that the benefits of increasing government spending are significantly higher when the monetary authority is constrained by the zero lower bound. The goal of this dissertation is to better understand how these various elements contributed to the macroeconomic outcomes during and after the Great Recession. In addition to understanding each of the elements above in isolation, a key component of this analysis focuses on the interaction between the above elements. A key unifying theme between all of the elements is the role in monetary policy. In modern models of the macroeconomy, the monetary authority is crucial in determining how a particular economic mechanism affects the macroeconomy. In the first and second chapters, I show that monetary policy plays a key role in offsetting the negative effects of increased uncertainty about the future. My third chapter highlights how assumptions about monetary policy can change the impact of various shocks and policy interventions. For example, suppose the fiscal authority wants to increase national output by increasing government spending. A key calculation in this situation is the fiscal multiplier, which is dollar increase in national income for each dollar of government spending. I show that fiscal multipliers are dramatically affected by the assumptions about monetary policy even if the monetary authority is constrained by the zero lower bound. The unique nature of the elements discussed above makes analyzing their contribution difficult using standard macroeconomic tools. The overall goal of this dissertation is to use and develop tools in computational macroeconomics to help better understand the Great Recession. Each of the chapters outlined below examine at least one of the topics listed above and its impact in explaining the macroeconomics of the Great Recession. In particular, the essays highlight the role of the monetary authority in generating the observed macroeconomic outcomes over the past several years. Can increased uncertainty about the future cause a contraction in output and its components? My first chapter examines the role of uncertainty shocks in a one-sector, representative-agent, dynamic, stochastic general-equilibrium model. When prices are flexible, uncertainty shocks are not capable of producing business-cycle comovements among key macroeconomic variables. With countercyclical markups through sticky prices, however, uncertainty shocks can generate fluctuations that are consistent with business cycles. Monetary policy usually plays a key role in offsetting the negative impact of uncertainty shocks. If the central bank is constrained by the zero lower bound, then monetary policy can no longer perform its usual stabilizing function and higher uncertainty has even more negative effects on the economy. The second chapter continues to explore the interactions between the zero lower bound and increased uncertainty about the future. From a positive perspective, the essay further shows why increased uncertainty about the future can reduce a central bank's ability to stabilize the economy. The essay also examines the normative implications of uncertainty and shows how monetary policy can attenuate the negative effects of higher uncertainty. In my third chapter, I examine how assumptions about monetary policy affect the economy at the zero lower bound. Even when current policy rates are zero, I argue that assumptions regarding the future conduct of monetary policy are crucial in determining the effects of real fluctuations at the zero lower bound.