Essays in Macroeconomics

Abstract

This thesis contains three chapters in macroeconomics. In the first chapter, co-authored with Robert Minton, we study how firms forecast their own future costs, and the implications of this for inflation. Firms’ forecasts of their own future costs are central to the propagation of shocks into inflation. Using survey data on US firms, we establish five novel facts about these forecasts: they (1) are driven by idiosyncratic cost movements, (2) are overly sensitive to a firm’s own costs (a failure of rational expectations), (3) over-react consistently across time, sectors, and firm size, (4) incorporate cost movements slowly over time, and (5) under-react to aggregate shocks until costs move. We estimate a model of firms’ beliefs that is able to match these facts, and embed this in a New Keynesian model. The New Keynesian Phillips curve becomes less forward-looking and steeper, and we confirm this in external pricing data. Supply shocks are made more inflationary, because they hit costs quickly, leading firms’ beliefs to over-react, while demand shocks are made less inflationary, as firms fail to anticipate future wage pressure. We show that optimal monetary policy is less reliant on forward guidance and commitment, since it is difficult to move firms’ beliefs without first moving their costs. In contrast, current interest rates remain powerful, and may have lasting effects, suggesting a sharp optimal reaction to inflationary shocks. In the second chapter, I study the role of inventories in propagating demand fluctuations. Inventory investment accounts for a significant share of the business-cycle variation in GDP. I develop a tractable New Keynesian model with inventories to analytically explore their role in propagating demand fluctuations. Persistent increases in demand are amplified upstream, while transitory ones are smoothed out. The slope of the supply curve is increasing in the persistence of demand fluctuations, as markups respond more to more persistent shocks. And inventories amplify convexity in the supply curve, making larger positive demand shocks even more inflationary. In a quantitative model, I show that this demand channel of inventory investment amplifies the peak effect of monetary policy on GDP and inflation, but only when the shock is sufficiently persistent. Likewise inventories boost the peak GDP response to very persistent demand shocks, but dampen the response to transitory shocks. Finally, I show that the supply curve is more convex when shocks are more persistent, suggesting that the key to a nonlinear Phillips curve is that the demand shocks be both large and persistent. In the third chapter, co-authored with Gert Bijnens, Helene Hall, and Laura Nicolae, we use quasi-randomly assigned wage indexation events in Belgium to study the effects of wages on employment. In Belgium, nearly all employees’ wages are indexed to inflation. Firms are grouped into long-standing labor agreements that determine the exact timing and frequency at which wages are indexed, e.g. every year versus every month. Using firm-level administrative data, we leverage the resulting variation in real wages across firms to estimate the employment response. We find that firms that are forced to increase wages by 1% react by cutting employment by 0.4% over four quarters. This result is robust to including NACE sector-date fixed effects and to using only variation in firms’ indexation timing, controlling for their chosen indexation frequency. About one-third of the response comes via anticipation of future wage increases. The elasticity is more than twice as large in magnitude in the post-pandemic period than before it, suggesting strong nonlinearities. Overall, these results show that, by preventing inflation from reducing real wages, inflation indexation reduces employment.