Andrew Foerster’s research while affiliated with Federal Reserve Bank of San Francisco and other places

We develop a new model of cycles and crises in emerging markets, featuring an occasionally binding borrowing constraint and stochastic volatility, and estimate it with quarterly data for Mexico since 1981. We propose an endogenous regime‐switching formulation of the occasionally binding borrowing constraint, develop a general perturbation method to solve the model, and estimate it using Bayesian methods. We find that the model fits the Mexican data well without systematically relying on large shocks, matching the typical stylized facts of emerging market business cycles and Mexico's history of sudden stops in capital flows. We also find that interest rate shocks play a smaller role in driving both cycles and crises than previously found in the literature.

Total factor productivity (TFP) and investment specific technology (IST) growth both exhibit regime‐switching behavior, but the regime at any given time is difficult to infer. We build a rational expectations real business cycle model where the underlying TFP and IST regimes are unobserved. We develop a general perturbation solution algorithm for a wide class of models with unobserved regime‐switching. Using our method, we show learning about regime‐switching fits the data, affects the responses to regime shifts and intra‐regime shocks, increases asymmetries in the responses, generates forecast error bias even with rational agents, and raises the welfare cost of fluctuations. This article is protected by copyright. All rights reserved

This paper examines the implications of interacting pricing frictions, labor market frictions, and consumption risk by comparing variants of a New Keynesian model. The model variants make alternative assumptions about whether hiring and pricing decisions occur within the same firm or across different firms, and whether workers pool income. Each model implies the same contract is offered to workers, making model comparisons transparent. The economy's response to changes in unemployment benefits or persistently below-target inflation depends on whether hiring and pricing decisions are integrated. The dynamics following technology or monetary shocks are shaped both by firm- and worker-level assumptions.

Despite the ubiquity of inflation targeting, central banks communicate their frameworks in a variety of ways. No central bank explicitly expresses their conduct via a policy rule, which contrasts with models of policy. Central banks often connect theory with their practice by publishing inflation forecasts that can, in principle, implicitly convey their reaction function. We return to this central idea to show how a central bank can achieve the gains of a rule-based policy without publicly stating a specific rule. The approach requires central banks to specify an inflation target, inflation tolerance bands, and provide economic projections. When inflation moves outside the band, inflation forecasts provide a time frame over which inflation will return to within the band. We show how this communication replicates and provides the same information as a rule-based policy. In addition, the communication strategy produces a natural benchmark for assessing central bank performance.

An economy that switches between high and low growth regimes creates incentives for the monetary authority to change the parameters in its simple rule. As lower growth tends to produce lower real interest rates, the monetary authority has an incentive to increase the inflation target and increase the degree of inertia in setting rates in an attempt to keep the nominal rate away from the zero lower bound. An optimal simple rule therefore responds to permanently lower growth by slightly increasing both the inflation target and inertia; focusing solely on the inflation target ignores a key margin of adjustment. With repeated growth rate regime switches, an optimal simple rule that switches at the same time internalizes both the direct effects of growth regime change and the indirect expectation effects generated by switching in policy. The switching rule improves economic outcomes relative to a constant rule. A constant rule may be preferred if the monetary authority attempts a switching rule but implements the wrong rule with high enough frequency.

We estimate a workhorse DSGE model with an occasionally binding borrowing constraint. First, we propose a new specification of the occasionally binding constraint, where the transition between the unconstrained and constrained states is a stochastic function of the leverage level and the constraint multiplier. This specification maps into an endogenous regime-switching model. Second, we develop a general perturbation method for the solution of such a model. Third, we estimate the model with Bayesian methods to fit Mexico's business cycle and financial crisis history since 1981. The estimated model fits the data well, identifying three crisis episodes of varying duration and intensity: the Debt Crisis in the early-1980s, the Peso Crisis in the mid-1990s, and the Global Financial Crisis in the late-2000s. The crisis episodes generated by the estimated model display sluggish and long-lasting build-up and stagnation phases driven by plausible combinations of shocks. Different sets of shocks explain different variables over the business cycle and the three historical episodes of sudden stops identified.