Alisdair McKay

Senior Research Economist

alisdair.mckay@gmail.com
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Alisdair McKay joined the Federal Reserve Bank of Minneapolis as a research consultant in 2017 and became a senior research economist in 2018. Prior to joining the Research Division, he was an associate professor in the Department of Economics at Boston University. He received his Ph.D. and M.A. in economics from Princeton University and his B.A. in economics from Columbia. His work has been published in the Journal of Monetary Economics, American Economic Review, Econometrica, and other top-tier journals. Alisdair’s primary area of research focuses on the macroeconomic implications of economic inequality.

The Discounted Euler Equation: A Note

We present a simple model with income risk and borrowing constraints that yields a ‘discounted Euler equation’. This feature of the model mutes the extent to which news about far future real interest rates (i.e. forward guidance) affects current outcomes. We show that this simple model approximates the outcomes of a rich model with uninsurable income risk and borrowing constraints in response to a forward guidance shock. The model is simple enough to be easily incorporated into simple New Keynesian models. We illustrate this with an application to the zero lower bound.

Time-Varying Idiosyncratic Risk and Aggregate Consumption Dynamics

Long-term earnings losses for displaced workers are large and counter-cyclical. Similarly, the skewness of earnings growth rates is strongly pro-cyclical. This paper presents an incomplete markets business cycle model in which idiosyncratic risk varies over time in accordance with these empirical findings. These dynamics of idiosyncratic risk give rise to a cyclical precautionary savings motive that substantially raises the volatility of aggregate consumption growth. According to the model, idiosyncratic risk spiked during the Great Recession, leading to a substantial decline in aggregate consumption.

The Power of Forward Guidance Revisited

In recent years, central banks have increasingly turned to forward guidance as a central tool of monetary policy. Standard monetary models imply that far future forward guidance has huge effects on current outcomes, and these effects grow with the horizon of the forward guidance. We present a model in which the power of forward guidance is highly sensitive to the assumption of complete markets. When agents face uninsurable income risk and borrowing constraints, a precautionary savings effect tempers their responses to changes in future interest rates. As a consequence, forward guidance has substantially less power to stimulate the economy.

The Role of Automatic Stabilizers in the U.S. Business Cycle

Most countries have automatic rules in their tax‐and‐transfer systems that are partly intended to stabilize economic fluctuations. This paper measures their effect on the dynamics of the business cycle. We put forward a model that merges the standard incomplete‐markets model of consumption and inequality with the new Keynesian model of nominal rigidities and business cycles, and that includes most of the main potential stabilizers in the U.S. data and the theoretical channels by which they may work. We find that the conventional argument that stabilizing disposable income will stabilize aggregate demand plays a negligible role in the dynamics of the business cycle, whereas tax‐and‐transfer programs that affect inequality and social insurance can have a larger effect on aggregate volatility. However, as currently designed, the set of stabilizers in place in the United States has had little effect on the volatility of aggregate output fluctuations or on their welfare costs despite stabilizing aggregate consumption. The stabilizers have a more important role when monetary policy is constrained by the zero lower bound, and they affect welfare significantly through the provision of social insurance.

Rational Inattention to Discrete Choices: A New Foundation for the Multinomial Logit Model

Individuals must often choose among discrete actions with imperfect information about their payoffs. Before choosing, they have an opportunity to study the payoffs, but doing so is costly. This creates new choices such as the number of and types of questions to ask. We model these situations using the rational inattention approach to information frictions. We find that the decision maker’s optimal strategy results in choosing probabilistically in line with a generalized multinomial logit model, which depends both on the actions’ true payoffs as well as on prior beliefs.

Search for Financial Returns and Social Security Privatization

I develop a general equilibrium model in which the quality of household financial decisions is endogenously determined by the incentives to exert effort in learning about financial opportunities. The model generates predictions for asset market participation and returns across households. Moreover, search for financial returns enables the model to generate a more skewed equilibrium wealth distribution. In this context, social security privatization affects household search effort, asset market participation and the competitiveness of the asset market. Privatization reduces average welfare and this reduction is somewhat magnified by the search friction. While some have suggested that household decision making could be important for the consequences of privatization, my analysis does not bear this out.

Simple Market Equilibria with Rationally Inattentive Consumers

We study a market with rationally inattentive consumers who are unsure of the terms of the offers made by firms, but can acquire information about the terms at a cost. In a symmetric equilibrium, the price set by firms is continuously increasing in the cost of information for consumers and decreasing in the number of firms operating. In addition, favorable a priori information about a firm leads it to set a higher price, and a new entrant can increase demand for incumbents. When consumers have heterogeneous costs of information, firms selling low-quality products may choose to set the highest prices.

News Shocks and Business Cycle

This article considers the question, raised by Beaudry and Portier in their recent articles, of whether “news shocks” can lead to expansions and contractions that look like business cycle movements. News shocks are to be thought of solely as affecting expectations (regarding future events) and thus do not influence current resource restrictions at all. So the question is, for example, whether news about lower future productivity could lead our key aggregate variables—consumption, investment, and employment—to co-move down now. Beaudry and Portier make the point that standard neoclassical models clearly will not allow this outcome, and they, along with other researchers in follow-up work, suggest elaborations on the standard model that would. In the present research, we review this literature and propose a very simple model that does quite well in predicting co-movements in response to news shocks. The model is based on a departure from competitive labor markets: It uses a standard Diamond-Mortensen-Pissarides view that unemployment is determined as a function of search/matching frictions.

The Brevity and Violence of Contractions and Expansions

Early studies of business cycles argued that contractions in economic activity were briefer (shorter) and more violent (rapid) than expansions. This paper systematically investigates this claim and in the process discovers a robust new business cycle fact: contractions in employment are briefer and more violent than expansions but we cannot reject the null of equal brevity and violence for expansions and contractions in output. The difference arises because employment typically lags output around peaks but they coincide in their troughs. We discuss the performance of existing business cycle models in accounting for this fact, and conclude that none can fully account for it. We then show that a business cycle model with asymmetric adjustment costs on employment and a choice of when to scrap old technologies can account for the business cycle fact both qualitatively and quantitatively.