Risk Sharers of the World, Unite!

I have a new working paper titled “Better Risk Sharing Through Monetary Policy? The Financial Stability Case for a Nominal GDP Target“. I presented this paper at the recent Cato Monetary Policy Conference.

Here is the abstract:

A series of papers have shown that a monetary regime targeting nominal GDP (NGDP)

can reproduce the distribution of risk that would exist if there were widespread use of state contingentdebt securities (Koenig, 2013; Sheedy, 2014; Azariadis et al., 2016, Bullard and DiCecia, 2018). This paper empirically evaluates this view by exploiting an implication of the theory: those countries whose NGDP stayed closest to its expected pre-crisis growth path during the crisis should have experienced the least financial instability. This paper constructs an NGDP gap measure for 21 advanced economies that is used to test this implication. The results strongly suggest that there is a meaningful role for NGDP in promoting financial and economic stability.

And an excerpt:

The key insight of Koenig (2013), Sheedy (2014), Azariadis et al. (2016), and Bullard and DiCecia (2018) is that in a world of incomplete markets where there is non-state contingent nominal contracting, an NGDP target can reproduce the risk distribution that would occur if there were complete markets and state contingent nominal debt contracting.  An NGDP target, in other words, can make up for the lack of insurance against future risks that could affect debtors’ ability to repay their debt. Conversely, an NGDP target can also make up for the lack of insurance against potential returns a creditor might miss out on because their funds are locked up in a fixed-price nominal loan. Bullard and Dicecia (2018) show that this result holds even when the heterogeneity among debtors and creditors modeled approximates that of the actual income, financial wealth, and consumption inequality in the United States. They note this makes NGDP targeting “monetary policy for the masses.” 

Please check out the paper.