Three Essays on the Macroeconomic Consequences of Prices

Abstract

To understand the workings of the macroeconomy, it is not enough to simply focus on the movements of the aggregate variables of the economy. It is necessary to also understand the behavior of its various components and their interactions. In this thesis, I study three important components of macroeconomic behavior; prices, wages, and the financial system and their connection to the behavior of the aggregate economy.

In the first chapter (joint work with Andrew Usher), we use retail scanner data to show two previously unknown empirical facts about prices. First, the probability of price adjustment increases with product revenue. Second, the absolute size of price adjustment decreases with revenue. These facts are consistent with a menu cost model where the fixed cost of adjustment does not scale with product revenue. Taken together, these facts suggest that prices of products with higher revenues respond more to monetary policy than prices of products with lower revenues. Over the business cycle, both the mean and variance of the (log) revenue distribution across goods decrease with the unemployment rate. These empirical facts imply that monetary policy should have stronger effects on the economy in recessions than in expansions. We verify this property using a quantitative menu cost model, and we provide additional evidence of the state-dependence of monetary policy using aggregate data.

In the second chapter (joint work with Miles S. Kimball), we study the optimal wage structure of a firm with imperfect monitoring of worker effort. We find that when firms can commit to (implicit) long-term contracts, imperfect monitoring leads to optimal wage profiles that reflect worker seniority. We provide a precise definition of seniority as a measure of worker value to the firm rather than the length of service by a worker. The paper illustrates how worker seniority will evolve over the worker's tenure with the firm and how wage, effort, and separation evolve with seniority. We also show that monitoring and amenities reflect seniority as well. To solve the optimal contract problem, we present a solution technique, the ``retrograde approach," of solving complex optimization problems with endogenous discounting and forward-looking state variables in a simple and intuitive way.

In chapter three, I find that system wide runs can be triggered by small shocks to fundamental asset values. Informational frictions amplify small shocks causing large contractions in the amount of credit provided to financial institutions. Asset fire sales exacerbate these effects and force a complete collapse of lending to these institutions; a system wide run. The paper identifies the incentive of healthy institutions to differentiate themselves from distressed ones as the key channel driving the contraction in credit. This contrasts with traditional bank runs that stem from the coordination failures of lenders. The findings lead to direct policy implications; including a government clearing house for loans and quantitative easing.