This proposal contains four closely related projects. (1) The Zero-Lower Bound and Optimal Policy. The goal of this project is to characterize the properties of optimal monetary policy in the presence of a zero lower bound on nominal interest rates. As in Aruoba and Schorfheide (2010 AEJ Macro) the analysis will account for both the New Keynesian as well as Friedman welfare cost channel. While the latter has been largely ignored in the existing literature, the previous results document its quantitative importance. Unlike in AS, the welfare cost calculation will account for aggregate uncertainty. The PI's will consider optimized simple monetary policy rules as well as the fully optimal policy. (2) Credit Frictions and Liquidity. The goal is to develop an estimable monetary DSGE model in which financial shocks can disrupt the exchange of goods in decentralized markets that require money or some form of credit as a medium of exchange. The model is then estimated based on U.S. data and its fit is compared to a more flexible benchmark. The estimated model is used to assess monetary policy in crisis periods. (3) Nonlinear DSGE-Based Hierarchical Models. The goal of this project is to obtain a novel toolkit for the estimation and inference in potentially misspecified nonlinear DSGE models. These tools will be applied to the estimation and evaluation of the models described in Projects 1 and 2. Starting point is the DSGE-VAR framework developed by Del Negro and Schorfheide (2004 IER, 2009 AER). (4) Model Perturbations. The goal of this project is to develop and apply Bayesian econometric and computational techniques to account for uncertainty caused by auxiliary aspects of the specification of a DSGE model. Intellectual Merit of the Proposed Projects The intellectual merit of the work is high, as the problems address developing models that capture important trade-offs and constraints faced by monetary policy makers and creating econometric tools that enable plausible characterizations of uncertainty - are widely acknowledged to be both highly challenging and crucially important for compelling empirical application of modern macroeconomic models to monetary policy analysis. The projects are timely, since the U.S. is experiencing a period of near-zero nominal interest rates and policy makers are debating the most effective monetary and fiscal policy instruments. Broader Impact of the Proposed Projects The broader impacts of the projects are substantial and several-fold. First, it will contribute directly to teaching and learning via mentoring and collaborating with graduate students. Second, we will reach out to underrepresented groups via broad web-based dissemination of all research results. Third, the projects will enhance infrastructure for research and education by establishing a variety of collaborations: between disciplines (by deepening our understanding of the econometrics / macroeconomics interface), between researchers and nations (by utilizing national and international co-authorships and joint projects), and between academia and other communities including government and policy organizations (by facilitating and accelerating knowledge transfer from academia). This knowledge transfer is crucially important, because the problems on which the proposed research focuses are precisely those that have hindered widespread application of modern macroeconomic models in government and policy organizations. Hence if the intellectual merit of the research is high, its value is nevertheless much greater than that associated purely with its intellectual merit. Indeed, the research will significantly push modern macroeconomic modeling, policy analysis, and forecasting toward routine application, producing improved policy, and ultimately improved general performance of the macroeconomy
