Book Description

My dissertation investigates the transmission of monetary and fiscal policy using both empirical and theoretical frameworks. Chapter 1 examines how the number of products sold by a firm affect its decisions regarding price setting and information acquisition. Using a firm-level survey from New Zealand, I show that firms that produce more goods have both better information about aggregate inflation and more frequent but smaller price changes. To characterize the implications of these empirical findings for the ability of monetary policy to stimulate the economy, I develop a new dynamic general equilibrium model with rationally inattentive multi-product firms that pay a menu cost to reset their prices. I show that the interaction of the menu cost and rational inattention frictions leads firms to adopt a wait-and-see policy and gives rise to a new selection effect: firms have time-varying inaction bands widened by their subjective uncertainty about the economy such that price adjusters choose to be better informed than non-adjusters. This selection effect endogenously generates a distribution of desired price changes with a majority near zero and some very far from zero, which acts as a strong force to amplify monetary non-neutrality. I calibrate the model to be consistent with the micro-evidence on both prices and inattention and find two main quantitative results. First, the new selection effect, coupled with imperfect information of price setters, leads to real effects of monetary policy shocks in the one-good version of the model that are nearly as large as those in the Calvo model. Second, in the two-good version of the model, as firms optimally choose to have better information about monetary shocks, the real effects of monetary policy shocks decline by 20%. In Chapter 2, joint with Hassan Afrouzi, we develop a general equilibrium flexible price model with dynamic rational inattention in which the slope of the Phillips curve is endogenous to systematic aspects of monetary policy. This Phillips curve is flatter when the monetary policy is more hawkish: rationally inattentive firms find it optimal to ignore monetary policy shocks when the monetary authority commits to stabilize nominal variables. Moreover, an unexpectedly more dovish monetary policy leads to a completely flat Phillips curve in the short-run and a steeper Phillips curve in the long-run. We also develop a tractable method for solving general dynamic rational inattention models in linear quadratic Gaussian setups. Chapter 3 asks whether the effectiveness of fiscal stimulus policy depends on the degree of economic income inequality. Many previous works about state-dependence of fiscal multiplier have focused on the degree of slack in the economy. In a surge of concerns about rising inequality of the U.S., I use rich historical state-level data on military procurement and inequality to find the relationship between the degree of income inequality and the local government spending multipliers. I show that the effects of government spending shocks on output are larger in low-inequality states than in high-inequality states. In contrast, I find no evidence that employment multipliers differ by the extent of income inequality. These results are robust to various specifications and other sources of inequality data. I also estimate aggregate output multipliers using historical military spending and income inequality data. I find the evidence that aggregate output multipliers are high when the income inequality is low. Thus, both local and aggregate multipliers are significantly affected by the degree of income inequality of an economy. I consider a variety of potential theoretical explanations for the results, including heterogeneous within-sector inequality and distributional effects of government spending shock, but find that none can adequately explain this finding