Abstract:

This dissertation presents three essays in macroeconometrics. Their common denominator is the use of Bayesian techniques and the emphasis put on the role of expectations.

The first chapter of this dissertation is focused on the evolution of inflation and output dynamics over the last 50 years, the changes in the behavior of the Federal Reserve, and the role of agents' beliefs. I consider a new Keynesian dynamic stochastic general equilibrium model with Markov-switching structural parameters and heteroskedastic shocks. Agents are aware of the possibility of regime changes and they form expectations accordingly. The results support the view that there were regime switches in the conduct of monetary policy. However, the idea that US monetary policy can be described in terms of pre - and post -Volcker proves to be misleading. The behavior of the Federal Reserve has instead repeatedly fluctuated between a Hawk - and a Dove -regime. Counterfactual simulations show that if agents had anticipated the appointment of an extremely conservative Chairman, inflation would not have reached the peaks of the late '70s and the inflation-output trade-off would have been less severe. The estimation of a Markov-switching DSGE model poses specific challenges that are new in the literature. As a technical contribution, this chapter provides a Bayesian algorithm to deal with them.

The goal of chapter 2 is to show that rare events are useful in explaining the cross section of asset returns because they are important in shaping agents' expectations. I reconsider a popular asset pricing model, the "bad beta, good beta" ICAPM, and I point out that the explanatory power of the model depends on including the stock market crash that opened the Great Depression. Using a Markov-switching VAR, I show that a '30s regime can be identified. This regime receives a large weight when forming expectations consistent with the ICAPM. I then generalize this result showing that financial variables behave in a substantially different way during a crisis. Accordingly, the ICAPM delivers excellent results when investors distinguish between a high- and a low-uncertainty regime. As a technical contribution, I describe how to estimate a Markov-switching VAR in reduced form.

The third chapter, coauthored with Haroon Mumtaz and Paolo Surico, studies the joint evolution of monetary policy, the term structure of interest rates and the U.K. economy across policy regimes. The interaction between the macroeconomy and the term structure is modeled using a time-varying VAR augmented with the factors from the yield curve. We document a great moderation in the dynamics of the yield curve, with the factors being persistent and volatile before the introduction of inflation targeting in 1992 but becoming stable afterwards. The introduction of time-variation in the Factor Augmented VAR improves the fit of the model and makes the expectation hypothesis consistent yields close to actual yields, even at long maturities. Monetary policy shocks had a significant impact on the volatility of inflation, output and the policy rate over the pre-inflation targeting era, but their contribution has been negligible in the current regime. Shocks to the level of the yield curve accounted for a large fraction of inflation variability only before 1992.