Interests:

Macroeconomics

Monetary theory

Juan Pablo Nicolini is a senior research economist with the Federal Reserve Bank of Minneapolis. Prior to joining the Fed in 2009, Juan Pablo taught at the Instituto Tecnológico Autónomo de México, the Universitat Pompeu Fabra in Barcelona, and the Universidad Torcuato Di Tella in Buenos Aires, where he holds a part-time position. In addition, he served as chairman of the Economics Department (1994–99) and president (2001–9) of Universidad Torcuato Di Tella. In 2006–7, he was Tinker Visiting Professor in the Economics Department and the Center for Latin-American Studies at the University of Chicago. He has also been a visiting researcher at the Banco de Portugal and in the Monetary Stance Division of the European Central Bank.

Juan studied economics at the Universidad Nacional de Tucumán in Argentina and earned M.A. and Ph.D. degrees in economics from the University of Chicago. The focus of his research centers on monetary theory and policy and on bounded rationality in macroeconomics. Juan’s work has appeared in several journals, among them the *Journal of Political Economy*, *American Economic Review*, *Journal of Monetary Economics*, *Review of Economic Dynamics*, and *Journal of Economic Dynamics and Control*.

**Stock Market Volatility and Learning**

We show that consumption-based asset pricing models with time-separable preferences generate realistic amounts of stock price volatility if one allows for small deviations from rational expectations. Rational investors with subjective beliefs about price behavior optimally learn from past price observations. This imparts momentum and mean-reversion into stock prices. The model quantitatively accounts for the volatility of returns, the volatility and persistence of the price-dividend ratio, and the predictability of long-horizon returns. It passes a formal statistical test for the overall fit of a set of moments provided one excludes the equity premium.

On the Stability of Money Demand

We show that regulatory changes that occurred in the banking sector in the early eighties, which considerably weakened Regulation Q, can explain the apparent instability of money demand during the same period. We evaluate the effects of the regulatory changes using a model that goes beyond aggregates as M1 and treats currency and different deposit types as alternative means of payments. We use the model to construct a new monetary aggregate that performs remarkably well for the entire period 1915-2012.

We study a model of a small open economy that specializes in the production of commodities and that exhibits frictions in the setting of both prices and wages. We study the optimal response of monetary and exchange rate policy following a positive (negative) shock to the price of the exportable that generates an appreciation (depreciation) of the local currency. According to the calibrated version of the model, deviations from full price stability can generate welfare gains that are equivalent to almost 0.5% of lifetime consumption, as long as there is a significant degree of rigidity in nominal wages. On the other hand, if the rigidity is concentrated in prices, the welfare gains can be at most 0.1% of lifetime consumption. We also show that a rule – formally defined in the paper – that resembles a “dirty floating” regime can approximate the optimal policy remarkably well.

**Unconventional Fiscal Policy at the Zero Bound**

When the zero lower bound on nominal interest rates binds, monetary policy cannot provide appropriate stimulus. We show that, in the standard New Keynesian model, tax policy can deliver such stimulus at no cost and in a time-consistent manner. There is no need to use inefficient policies such as wasteful public spending or future commitments to low interest rates.

The paper analyzes optimal policy in a simple small open economy model with price setting frictions. In particular, the paper studies the optimal response of the nominal exchange rate following a terms-of-trade shock. The paper departs from the New Keynesian (NK) literature in that it explicitly models internationally traded commodities as intermediate inputs in the production of local final goods and assume that the small open economy takes this price as given. This modification is not only in line with the long standing tradition of small open economy models, but also changes the optimal movements in the exchange rate. In contrast with the recent Small Open Economy NK literature, the model in this paper is able to reproduce the comovement between the nominal exchange rate and the price of exports, as it has been documented in the commodity currencies literature. Although the paper shows that there are preferences for which price stability is optimal even without flexible fiscal instruments, the model suggests that more attention should be given to the coordination between monetary and fiscal policy (taxes) in small open economies that are heavily dependent on exports of commodities. The model the paper proposes is a useful framework to study fear of floating.

**Money is an Experience Good: Competition and Trust in the Private Provision of Money**

The interplay between competition and trust as efficiency-enhancing mechanisms in the private provision of money is studied. With commitment, trust is automatically achieved and competition ensures efficiency. Without commitment, competition plays no role. Trust does play a role but requires a bound on efficiency. Stationary inflation must be non-negative and, therefore, the Friedman rule cannot be achieved. The quality of money can be observed only after its purchasing capacity is realized. In this sense, money is an experience good.

**The Argentine Economy After Two Centuries**

We document the behavior of income per capita in Argentina subsequent to independence and the civil wars of the mid-19th century. We first decompose the data to isolate low frequency behavior and show that, with significant departures over some periods of time, income per capita grew, on average, at 1.2% per year. The decomposition shows that the largest departure from this behavior is the period from 1974 to 2010, when there was a large and sustained deviation from the trend, with two subperiods of rapid convergence. Using a simple version of Solow’s growth model as a conceptual framework, we focus our analysis on that particular period. We calibrate and simulate the model from 1950 onwards and use its predictions to provide a quantitative measure of the extremely poor performance of the Argentine economy since 1974. We also use a simple model of the government budget constraint to account for the macroeconomic history of Argentina during that same period. We argue that the systematic mismanagement of government budgets is the principal reason for Argentina’s long departure from the trend. The two subperiods of rapid convergence coincide with the two subperiods of macro fiscal discipline.

**Optimal Unemployment Insurance and Employment History**

In existing unemployment insurance programmes, it is standard to condition eligibility on the previous employment record of unemployed workers. The purpose of this article is to study conditions under which the efficient contract exhibits these properties. In order to do so, we characterize the optimal unemployment insurance contract in asymmetric information environments in which workers experience multiple unemployment spells. We show that if quits cannot be distinguished from layoffs, it is optimal to condition the benefits paid to unemployed workers on their employment history, in particular, the coverage should increase with the length of previous employment spells.

**Optimal Fiscal and Monetary Policy: Equivalence Results**

In this article, we analyze the implications of price‐setting restrictions for the conduct of cyclical fiscal and monetary policy. We consider standard monetary economies that differ in the price‐setting restrictions imposed on the firms. We show that, independently of the degree or type of price stickiness, it is possible to implement the same efficient set of allocations and that each allocation in that set is implemented with policies that are also independent of the price stickiness. In this sense, environments with different price‐setting restrictions are equivalent.

**Money and Prices in Models of Bounded Rationality in High-Inflation Economies**

This paper studies the short run correlation of inflation and money growth. We study whether a model of learning does better or worse than a model of rational expectations, and we focus our study on countries of high inflation. We take the money process as an exogenous variable, estimated from the data through a switching regime process. We find that the rational expectations model and the model of learning both offer very good explanations for the joint behavior of money and prices.

**Optimal Maturity of Government Debt without State Contingent Bonds**

This paper shows that state contingent debt can be synthetically constructed using non-contingent debt of different maturities. A main policy implication of this principle is that the Ramsey allocation with complete markets can be sustained with non-contingent debt only by properly managing its maturity structure. The numerical experiments, however, suggest that this policy implication ought to be taken with care. We find that the debt positions that sustain the Ramsey allocation are very high (on the order of a few hundred times total GDP for a very simple four state economy) and increasing in the number of states. In addition, they are very sensitive to small variations in the parameters of the model.

**Inside-Outside Money Competition**

We study how competition from privately supplied currency substitutes affects monetary equilibria. Whenever currency is inefficiently provided, inside money competition plays a disciplinary role by providing an upper bound on equilibrium inflation rates. Furthermore, if “inside monies” can be produced at a sufficiently low cost, outside money is driven out of circulation. Whenever a “benevolent” government can commit to its fiscal policy, sequential monetary policy is efficient and inside money competition plays no role.

**More on the Time Consistency of Monetary Policy**

The author introduces costs of unexpected inflation in a general equilibrium monetary model by changing the timing of the constraints faced by consumers. We show that in this environment monetary policy is still time inconsistent, but the nature of the inconsistency is very different from the standard result found in the literature. In particular, we find that the government may find optimal to deviate by choosing inflation rates lower than expected. By making a brief review of the monetary literature, we argue that the model of this paper is more attractive than the ones proposed before to study the time consistency of optimal monetary policy.

**Tax Evasion and the Optimal Inflation Tax**

We developed a simple monetary model to study the effects of tax evasion on the optimal inflation tax. The model is constructed so that inflation might be an indirect way of taxing the underground sector of the economy. We show that while there are theoretical reasons for positive optimal inflation rates, the effects are quantitatively small, even in countries with large underground sectors. We calculate the optimal nominal interest rate for Peru to be between 7% and 19%, despite the fact that its underground sector is close to 40% of measured GNP. According to our calculations, the welfare gain of using inflation to tax the underground sector is also very small.

**Los Spreads de tasas de interes en la Argentina**

[English summary] The aim of this paper is to understand the high differential between the interest rate spreads in Argentina relative to developed countries. We document the evolution of the lending interest rates for the post convertibility plan period together with the different characteristics of loans, focusing the analysis on the wide heterogeneity of the interest rates charged for different types of loans. The theoretical framework is a simple competitive model with constant returns to scale technologies to each credit line. We test the model using a panel data set constructed by the Central Bank of Argentine Republic.

**Optimal Unemployment Insurance**

This paper considers the design of an optimal unemployment insurance system. The problem is modeled as a repeated principal-agent problem involving a risk‐averse agent‐the unemployed worker‐and a risk‐neutral principal, which cannot monitor the agent’s search effort. The optimal long‐term contract subject to the associated incentive constraints is characterized. This contract involves a replacement ratio that decreases throughout the unemployment spell and a wage tax after reemployment that, under some mild regularity conditions, increases with the length of the unemployment spell. Some numerical results are presented that suggest that the gains from switching to this optimal unemployment insurance scheme could be quite large. The performance of this optimal contract is also compared to alternative liquidity provision mechanisms.

**La reforma del seguro de desempleo en Espana: Hay algo que aprender de la teoria?**

[English summary] In this paper we discuss the main theoretical results regarding efficient unemployment insurance programs and explain the basic intuition behind them. We then provide a quantitative benchmark analysis to examine the current unemployment insurance in Spain and to provide estimates of the budget savings involved in the adoption of the optimal discussed in the paper. We also analyze on how relevant heterogeneity may be for the results. Our quantitative exploration suggests both that there is a large scope for improvement and that heterogeneity may be important.

**Ruling Out Speculative Hyperinflations: The Role of the Government**

In this paper we show that if the government can levy taxes to back the currency, speculative hyperinflations are ruled out as equilibrium outcomes. This is so even though convertibility is never observed in equilibrium. The only observational difference between a pure fiat money economy and a convertible economy as the one described in this paper is the potential of the former to exhibit speculative hyperinflations. The lack of empirical support for those speculative paths can be taken as evidence against interpreting modern economies as pure fiat money systems.

Monitoring Money for Price Stability

In this paper, we use a simple model of money demand to characterize the behavior of monetary aggregates in the United States from 1960 to 2016. We argue that the demand for the currency component of the monetary base has been remarkably stable during this period. We use the model to make projections of the nominal quantity of cash in circulation under alternative future paths for the federal funds rate. Our calculations suggest that if the federal funds rate is lifted up as suggested by the survey of economic projections made by the members of the Federal Open Market Committee (FOMC), the fall in total currency demanded in the next two years ranges between 50 and 200 billion. Our discussion suggests that specific measures by the Federal Reserve to absorb that cash could be worth considering to make the future path of the price level consistent with the price stability mandate.

DOI: https://doi.org/10.21034/wp.744

Real Exchange Rates and Primary Commodity Prices

In this paper, we show that a substantial fraction of the volatility of real exchange rates between developed economies such as Germany, Japan, and the United Kingdom against the US dollar can be accounted for by shocks that affect the prices of primary commodities such as oil, aluminum, maize, or copper. Our analysis implies that existing models used to analyze real exchange rates between large economies that mostly focus on trade between differentiated ﬁnal goods could benefit, in terms of matching the behavior of real exchange rates, by also considering trade in primary commodities.

DOI: https://doi.org/10.21034/wp.743

**International Evidence on Long-Run Money Demand**

We explore the long-run demand for M1 based on a data set that has comprised 32 countries since 1851. In many cases, cointegration tests identify a long-run equilibrium relationship between either velocity and the short rate or M1, GDP, and the short rate. Evidence is especially strong for the United States and the United Kingdom over the entire period since World War I and for moderate and high-inflation countries.

With the exception of high-inflation countries–for which a “log-log” specification is preferred–the data often prefer the specification in the levels of velocity and the short rate originally estimated by Selden (1956) and Latané (1960). This is especially clear for the United States and other low-inflation countries.

**Liquidity Traps and Monetary Policy: Managing a Credit Crunch**

We study a model with heterogeneous producers that face collateral and cash-in-advance constraints. A tightening of the collateral constraint results in a credit-crunch-generated recession that reproduces several features of the ﬁnancial crisis that unraveled in 2007 in the United States. The model can be used to study the eﬀects of the credit-crunch on the main macroeconomic variables and the impact of alternative policies. The policy implications regarding forward guidance are in contrast with the prevalent view in most central banks, based on the New Keynesian explanation of the liquidity trap.

**Self-fulfilling Prophecies in Sovereign Debt Markets**

In this paper, we discuss conditions under which adverse expectations can trigger abrupt and large changes in the interest rate at which a sovereign country can borrow in international financial markets. We argue that such changes are caused by self-fulfilling expectations outcomes, in which interest rates are high because the perceptions of future defaults are high, but those perceptions are high precisely because the interest rates are high. A model based on these elements successfully simulates the near-default experience of Greece, Italy, Spain and Portugal, among other countries. We show that self-fulfilling traps can occur when two conditions are met: First, the existing level of government debt must be relatively high; second, the probability that the country faces a long period of economic stagnation must be substantial. We also show that if a sufficiently large institution is willing to lend to the country, these self-fulfilling traps can be eliminated. Our model thus suggests that the Outright Monetary Transactions (OMT) program adopted by the European Central Bank in the summer of 2012 saved southern European countries from a massive sovereign debt crisis.

**Monetary Policy and Dutch Disease: The Case of Price and Wage Rigidity**

We study a model of a small open economy that specializes in the production of commodities and that exhibits frictions in the setting of both prices and wages. We study the optimal response of monetary and exchange rate policy following a positive (negative) shock to the price of the exportable that generates an appreciation (depreciation) of the local currency. According to the calibrated version of the model, deviations from full price stability can generate welfare gains that are equivalent to almost 0.5% of lifetime consumption, as long as there is a significant degree of rigidity in nominal wages. On the other hand, if the rigidity is concentrated in prices, the welfare gains can be at most 0.1% of lifetime consumption. We also show that a rule – formally defined in the paper – that resembles a “dirty floating” regime can approximate the optimal policy remarkably well.

**Sovereign Default: The Role of Expectations**

We study a variation of the standard model of sovereign default, as in Aguiar and Gopinath (2006) or Arellano (2008), and show that this variation is consistent with multiple interest rate equilibria. Some of those equilibria correspond to the ones identified by Calvo (1988), where default is likely because rates are high, and rates are high because default is likely. The model is used to simulate equilibrium movements in sovereign bond spreads that resemble sovereign debt crises. It is also used to discuss lending policies similar to the ones announced by the European Central Bank in 2012.

**Macroeconomic Policy during a Credit Crunch**

Most economic models used by central banks prior to the recent financial crisis omitted two fundamental elements: financial markets and liquidity measures. Those models therefore failed to foresee the crisis or understand the policy reaction that followed.

In contrast to more orthodox models, we develop a theory in which credit markets and measures of liquidity are central. Our model emphasizes the role of collateral constraints on credit lines and the role of money in transactions, and it can be used to study the effects of alternative monetary policies during and after a financial crisis.

A key insight from our approach is that a credit crisis characterized by tightened collateral constraints can cause a bout of deflation that exacerbates the constraints and reduces investment, productivity, employment and economic output. Policymakers can curb deflation and soften the recession by issuing more bonds and money, exactly as U.S. fiscal and monetary officials did in 2008.

But our model also reveals an important trade-off in the aftermath of the crisis. Additional liquidity injections necessary to maintain low inflation will partially crowd out private investment and thereby slow economic recovery. The cost of curbing the recession’s depth is thus to extend its duration.

**Stock Market Volatility and Learning**

Consumption-based asset pricing models with time-separable preferences can generate realistic amounts of stock price volatility if one allows for small deviations from rational expectations. We consider rational investors who entertain subjective prior beliefs about price behavior that are not equal but close to rational expectations. Optimal behavior then dictates that investors learn about price behavior from past price observations. We show that this imparts momentum and mean reversion into the equilibrium behavior of the price-dividend ratio, similar to what can be observed in the data. When estimating the model on U.S. stock price data using the method of simulated moments, we find that it can quantitatively account for the observed volatility of returns, the volatility and persistence of the price-dividend ratio, and the predictability of long-horizon returns. For reasonable degrees of risk aversion, the model generates up to one-half of the equity premium observed in the data. It also passes a formal statistical test for the overall goodness of fit, provided one excludes the equity premium from the set of moments to be matched.

On the Stability of Money Demand

We show that regulatory changes that occurred in the banking sector in the early eighties, which considerably weakened Regulation Q, can explain the apparent instability of money demand during the same period. We evaluate the effects of the regulatory changes using a model that goes beyond aggregates as M1 and treats currency and different deposit types as alternative means of payments. We use the model to construct a new monetary aggregate that performs remarkably well for the entire period 1915-2012.

**Liquidity Traps and Monetary Policy: Managing a Credit Crunch**

We study a model with heterogeneous producers that face collateral and cash-in-advance constraints. These two frictions give rise to a nontrivial financial market in a monetary economy. A tightening of the collateral constraint results in a recession generated by a credit crunch. The model can be used to study the effects on the main macroeconomic variables, and on the welfare of each individual of alternative monetary and fiscal policies following the credit crunch. The model reproduces several features of the recent financial crisis, such as the persistent negative real interest rates, the prolonged period at the zero bound for the nominal interest rate, and the collapse in investment and low inflation in spite of the very large increases in liquidity adopted by the government. The policy implications are in sharp contrast to the prevalent view in most central banks, which is based on the New Keynesian explanation of the liquidity trap.

**Is There a Stable Relationship between Unemployment and Future Inflation? Evidence from U.S. Cities**

This paper makes two straightforward points that we argue are central to understanding the literature and debate surrounding the stability of the Phillips curve. First, the endogeneity of monetary policy implies that aggregate data are largely uninformative as to the existence of a stable relationship between unemployment and future inflation. Second, if the NAIRU model is assumed to be true, regional data can be used to identify the structural relationship between unemployment and future inflation. We find that a 1 percentage point increase in the unemployment rate is associated with a roughly 0.3 percentage point decline in inflation over the next year.

**Is There a Stable Phillips Curve After All?**

The Phillips curve refers to a negative (or inverse) relationship between unemployment and inflation in an economy—when unemployment is high, inflation tends to be low, and vice versa. This inflation-unemployment link has been observed in many countries during many times, most famously by William Phillips in 1958 looking at historical data for the United Kingdom. If this relationship is stable (or “structural”)—meaning that it holds regardless of changes in the economic environment, including policy adjustment—then policymakers might be able to trade off increases in inflation to achieve lower unemployment, or the inverse.

However, research over the past 40 years has thrown a great deal of doubt onto whether a stable Phillips curve relationship exists. Economists have documented large changes over time in the relationship between unemployment and inflation. In addition, theoretical work has shown that the existence of an empirical association does not necessarily mean that policymakers can exploit that relationship; there may be a statistical correlation—but not a causal link—between inflation and unemployment.

In this essay, we revisit the stability of the Phillips curve. Our key insight is that if the analysis incorporates a central bank seeking to stabilize inflation, national data are likely to provide little information about the existence (or absence) of a stable relationship. We show that regional data can overcome this obstacle. While estimates of Phillips curves using national U.S. data are highly unstable over the past 40 years, we find that estimates based on regional data are remarkably stable. Our results suggest that a 1-percentage-point-lower unemployment rate is associated with higher inflation of 0.3 percentage points over the next year, and the stability of the relationship suggests that it might provide a viable tool for policymakers.

We analyze optimal policy in a simple small open economy model with price setting frictions. In particular, we study the optimal response of the nominal exchange rate following a terms of trade shock. We depart from the New Keynesian literature in that we explicitly model internationally traded commodities as intermediate inputs in the production of local final goods and assume that the small open economy takes this price as given. This modification not only is in line with the long-standing tradition of small open economy models, but also changes the optimal movements in the exchange rate. In contrast with the recent small open economy New Keynesian literature, our model is able to reproduce the comovement between the nominal exchange rate and the price of exports, as it has been documented in the commodity currencies literature. Although we show there are preferences for which price stability is optimal even without flexible fiscal instruments, our model suggests that more attention should be given to the coordination between monetary and fiscal policy (taxes) in small open economies that are heavily dependent on exports of commodities. The model we propose is a useful framework in which to study fear of floating.

**Unconventional Fiscal Policy at the Zero Bound**

When the zero lower bound on nominal interest rates binds, monetary policy cannot provide appropriate stimulus. We show that, in the standard New Keynesian model, tax policy can deliver such stimulus at no cost and in a time-consistent manner. There is no need to use inefficient policies such as wasteful public spending or future commitments to low interest rates.

**Money Is an Experience Good: Competition and Trust in the Private Provision of Money**

The interplay between competition and trust as efficiency-enhancing mechanisms in the private provision of money is studied. With commitment, trust is automatically achieved and competition ensures efficiency. Without commitment, competition plays no role. Trust does play a role but requires a bound on efficiency. Stationary inflation must be non-negative and, therefore, the Friedman rule cannot be achieved. The quality of money can be observed only after its purchasing capacity is realized. In this sense, money is an experience good.

**Optimal Fiscal and Monetary Policy: Equivalence Results**

In this article, we analyze the implications of price-setting restrictions for the conduct of cyclical fiscal and monetary policy. We consider standard monetary economies that differ in the price-setting restrictions imposed on the firms. We show that, independently of the degree or type of price stickiness, it is possible to implement the same efficient set of allocations and that each allocation in that set is implemented with policies that are also independent of the price stickiness. In this sense, environments with different price-setting restrictions are equivalent.

**Inside-Outside Money Competition**

We study how competition from privately supplied currency substitutes affects monetary equilibria. Whenever currency is inefficiently provided, inside money competition plays a disciplinary role by providing an upper bound on equilibrium inflation rates. Furthermore, if “inside monies” can be produced at a sufficiently low cost, outside money is driven out of circulation. Whenever a ’benevolent’ government can commit to its fiscal policy, sequential monetary policy is efficient and inside money competition plays no role.

**Electronic Money: The End of Inflation?**

We study economies where government currency and electronic money, drawn from interest bearing deposits in private financial intermediary institutions, are full substitutes. We analyze the impact of competition on policy outcomes under different assumptions regarding: the objectives of the central bank, the ability of the monetary authorities to commit to future policies, and the legal restrictions—in the form of reserve requirements—on financial intermediaries. Electronic money competition can discipline a revenue maximizing government and result in lower equilibrium inflation rates, even when there is imperfect commitment. The efficient Friedman rule policy, of zero nominal interest rates, is only implemented if the government maximizes households preferences, in which case, electronic money competition may either have no role, or weaken the incentive effects of the “reputational mechanism.” We also show how an independent choice of the reserve requirements can be an effective policy rule to enhance the disciplinary role of electronic money competition.