Fernando Alvarez joined the Federal Reserve Bank of Minneapolis as a consultant in 2013. He is a professor of economics at the University of Chicago. He received his B.A. degree in economics from Universidad Nacional de La Plata and his Ph.D. from the University of Minnesota in 1994. He has taught at The Wharton School, University of Pennsylvania, and has been a visitor at Universidad de San Andres and the Universidad Torcuato Di Tella (both in Argentina), as well as the Enaudi Institute of Economics and Finance. He is a Wim Duisenberg Fellow at the European Central Bank. Fernando has been a Fellow of the Sloan Foundation and is a Fellow of the Econometric Society. He was as editor of the *Journal of Political Economy* and associate editor of the *Review of Economic Dynamics* and Quality Rated *Journal of Macroeconomics*. His work on endogenously incomplete markets shows that the limited commitment model of Kehoe, Levine, and Kocherlakota can be decentralized with certain borrowing constraints, as well as explain some features of asset prices. He has also presented a new estimate of the welfare cost of business cycles based on observed asset prices. His other work includes models of monetary economies with segmented markets and menu cost, and search models with incomplete markets.

**Sluggish Responses of Prices and Inflation to Monetary Shocks in an Inventory Model of Money Demand **

We examine the responses of prices and inflation to monetary shocks in an inventory-theoretic model of money demand. We show that the price level responds sluggishly to an exogenous increase in the money stock because the dynamics of households’ money inventories leads to a partially offsetting endogenous reduction in velocity. We also show that inflation responds sluggishly to an exogenous increase in the nominal interest rate because changes in monetary policy affect the real interest rate. In a quantitative example, we show that this nominal sluggishness is substantial and persistent if inventories in the model are calibrated to match U.S. households’ holdings of M2.

**If Exchange Rates Are Random Walks, Then Almost Everything We Say About Monetary Policy Is Wrong **

The key question asked by standard monetary models used for policy analysis is, How do changes in short-term interest rates affect the economy? All of the standard models imply that such changes in interest rates affect the economy by altering the conditional means of the macroeconomic aggregates and have no effect on the conditional variances of these aggregates. We argue that the data on exchange rates imply nearly the opposite: the observation that exchange rates are approximately random walks implies that fluctuations in interest rates are associated with nearly one-for-one changes in conditional variances and nearly no changes in conditional means. In this sense, standard monetary models capture essentially none of what is going on in the data. We thus argue that almost everything we say about monetary policy using these models is wrong.

**Time-Varying Risk, Interest Rates, and Exchange Rates in General Equilibrium **

Under mild assumptions, the data indicate that fluctuations in nominal interest rate differentials across currencies are primarily fluctuations in time-varying risk. This finding is an immediate implication of the fact that exchange rates are roughly random walks. If most fluctuations in interest differentials are thought to be driven by monetary policy, then the data call for a theory which explains how changes in monetary policy change risk. Here we propose such a theory based on a general equilibrium monetary model with an endogenous source of risk variation—a variable degree of asset market segmentation.

**The Time Consistency of Monetary and Fiscal Policies **

We show that optimal monetary and fiscal policies are time consistent for a class of economies often used in applied work, economies appealing because they are consistent with the growth facts. We establish our results in two steps. We first show that for this class of economies, the Friedman rule of setting nominal interest rates to zero is optimal under commitment. We then show that optimal policies are time consistent if the Friedman rule is optimal. For our benchmark economy in which the time consistency problem is most severe, the converse also holds: if optimal policies are time consistent, then the Friedman rule is optimal.

**Money, Interest Rates, and Exchange Rates With Endogenously Segmented Asset Markets **

This paper analyzes the effects of money injections on interest rates and exchange rates in a model in which agents must pay a Baumol-Tobin style fixed cost to exchange bonds and money. Asset markets are endogenously segmented because this fixed cost leads agents to trade bonds and money only infrequently. When the government injects money through an open market operation, only those agents that are currently trading absorb these injections. Through their impact on these agents’ consumption, these money injections affect real interest rates and real exchange rates. We show that the model generates the observed negative relation between expected inflation and real interest rates. With moderate amounts of segmentation, the model also generates other observed features of the data: persistent liquidity effects in interest rates and volatile and persistent exchange rates. A standard model with no fixed costs can produce none of these features.

**Money and Interest Rates With Endogenously Segmented Markets **

This paper analyses the effects of open market operations on interest rates in a model in which agents must pay a fixed cost to exchange assets and cash. Asset markets are endogenously segmented in that some agents choose to pay the fixed cost and some do not. When the fixed cost is zero, the model reduces to the standard one in which persistent money injections increase nominal interest rates, flatten the yield curve, and lead to a downward-sloping yield curve on average. In contrast, if markets are sufficiently segmented, then persistent money injections decrease interest rates, steepen or even twist the yield curve, and lead to an upward-sloping yield curve on average.

**Banking in Computable General Equilibrium Economies **

In this paper we develop a computable general equilibrium economy that models the banking sector explicitly. Banks intermediate between households and between the household sector and the government sector. Households borrow from banks to finance their purchases of houses and they lend to banks to save for retirement. Banks pool households’ savings and they purchase interest-bearing government debt and non-interest bearing reserves. We use this structure to answer two sets of questions: one normative in nature that evaluates the welfare costs of alternative monetary and tax policies, and one positive in nature that studies the real effects of following a procyclical interest-rate policy rule.