Essays in monetary economics

In chapter 1, I generate priors for a VAR from a standard RBC model, an RBC model with capital adjustment costs and habit formation, and a sticky price model with an unaccommodating monetary authority. The response of hours worked to a TFP shock differs sharply across these models. I compare the accuracy of the forecasts made with each of the resulting VARs. The economic models generate similar forecast errors to one another. However, the models generally yield forecasts that are quite competitive both with those made using an unrestricted VAR and with those made using a VAR with shrinkage from a Minnesota prior. In chapter 2, I look at the reaction of stock markets to macroeconomic news. It is well known that U.S. monetary policy is well-approximated by a Taylor rule. This suggests a reason why good macroeconomic news sometimes depresses equity returns: good news about the real side of the economy implies tighter future monetary policy. I test this hypothesis by assessing the effect of news on equity returns after controlling for changes in expectations of future monetary policy using Fed Funds Futures data. The results do not support the theory. Furthermore, the negative response of stock markets to unanticipated inflation is unchanged by controlling for changes in monetary policy expectations. In chapter 3, I ask why monetary contractions have strong effects on the housing market. The chapter presents a model with staggered housing adjustment in which monetary policy has real effects in the absence of any rigidity in producer pricing or wages. Limited participation in financial markets leads to a rise in the real mortgage rate following an increase in the nominal short rate. Since households must take on a mortgage to consume housing, the rise in the real interest rate reduces the share of residential investment in outpu