Essays on Keynesian Models of Closed and Open Economies PDF Download

Author: Konstantin Platonov
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Languages : en
Pages : 129

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Book Description
My dissertation contributes to the macroeconomics of self-fulfilling prophecies. It demonstrates the importance of shocks to beliefs in accounting for aggregate fluctuations. The dissertation consists of three chapters. The first chapter is a paper joint with Roger E.A. Farmer. We integrate Keynesian economics with general equilibrium theory in a new way. We develop a simple graphical apparatus, the IS-LM-NAC framework, that can be used by policy makers to understand how policy affects the economy. A new element, the No-Arbitrage-Condition (NAC) curve, connects the interest rate to current and expected future values of the stock market and it explains how 'animal spirits' influence economic activity. Our framework provides a rich new approach to policy analysis that explains the short-run and long-run effects of policy. The second chapter studies implications of self-fulfilling beliefs in open economies. Uncovered interest parity states that the carry trade should deliver zero profit, on average. The data robustly reject this hypothesis. In a large sample of countries, high interest rate currencies earn excess returns at short horizons and negative excess returns at longer horizons. I rationalize this observation in a two-country overlapping generations model with complete markets that features multiple dynamic equilibria. Because newborns cannot make decisions about consumption and savings before they are born, there is a set of self-fulfilling beliefs of the currently alive generations about the decisions of the future newborns. I utilize the multiplicity of dynamic equilibria by imposing a structure on the formation of beliefs. Beliefs are self-fulfilling, and shocks to these beliefs generate a large and volatile risk premium that is correlated with the interest rate differential. Changes in uncertainty about beliefs cause a reversal of expected excess returns associated with the current interest differential, similar to the reversal found in the data. I provide empirical evidence in favor of my mechanism and show that persistence of past expectations can account for most of the observed deviation from uncovered interest parity. The third chapter extends the methodology developed in the first chapter to the open economy framework. I build a model of the eurozone crisis. I study a two-country model in which agents form self-fulfilling beliefs about asset prices. Using the labor market search and matching frictions and abandoning Nash bar- gaining over wage, I create multiple equilibria on the labor market where any unemployment rate can be sustained as a steady state. Self-fulfilling beliefs about the future value of assets select the equilibrium. I show that sudden downward revisions of beliefs ('animal spirits') cause stagnation in real economic activity, international financial contagion, and, in the absence of recovery in confidence, permanently high rates of unemployment. High unemployment is viewed as a new steady state, not a temporary deviation from the natural rate of unemployment. Policy aimed at recovering the eurozone needs to trigger optimistic beliefs about the value of assets.