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This paper discusses some of the important insights from behavioral finance for international monetary and financial analysis. A broad approach to behavioral finance is advo- cated which includes analysis of the effects of uncertainty, perverse incentives, and complexity economics as well as the cognitive biases focused on in the initial contributions to behavioral finance. It offers reasons why capital mobility is often not perfect and expectations are sometimes not ra- tional. Correctly interpreted it is not a wholesale attack on efficient market theory but rather argues that markets can behave differently at different times, being efficient some- times and subject to destabilize or insufficiently stabilizing speculation at others and focuses on the conditions that make different types of behavior more likely. It helps pro- vide insights into issues such as currency crisis, the effects of official intervention in foreign exchange markets, the international monetary trilemma, capital flow surges and reversals, the discipline effects of fixed exchange rates and international financial markets and why uncovered interest rate parity often does not hold.

We quantify government spending multipliers in US data using Bayesian prior and posterior analysis of a monetary model with fiscal details and two distinct monetary-fiscal policy regimes. The combination of model specification, observable data, and relatively diffuse priors for some parameters lands posterior estimates in regions of the parameter space that yield fresh perspectives on the transmission mechanisms that underlie government spending multipliers. Short-run output multipliers are comparable across regimes—posterior means around 1.3 on impact—but much larger after 10 years under passive money/active fiscal than under active money/passive fiscal—90 percent credible sets of [1.5, 1.9] versus [0.1, 0.4] in present value, when estimated from 1955 to 2016.

In November 2008, the Federal Reserve faced a deteriorating economy and a financial crisis. The federal funds rate had already been reduced to virtually zero. Thus, the Federal Reserve turned to unconventional monetary policies. Through “quantitative easing,” the Fed announced plans to buy mortgage-backed securities and debt issued by government-sponsored enterprises. Subsequent purchases would eventually lead to a five-fold expansion in the Fed’s balance sheet, from$900 billion to $ 4.5 trillion, and leave the Fed holding over 20 percent of all mortgage-backed securities and marketable Treasury debt. In addition, Fed policy statements in December 2008 began to include explicit references to the likely path of the federal funds interest rate, a policy that came to be known as “forward guidance.” The Fed ceased its direct asset purchases in late 2014. Starting in October 2017, it has allowed the balance sheet to shrink gradually as existing assets mature. From December 2015 through June 2018, the Fed has raised the federal funds interest rate seven times. Thus, the time is ripe to step back and ask whether the Fed’s unconventional policies had the intended expansionary effects—and by extension, whether the Fed should use them in the future.

We study the gains from increased wage flexibility using a small open economy model with staggered price and wage setting. Two results stand out: (i) the effectiveness of labor cost reductions as a means to stimulate employment is much smaller in a currency union, and (ii) an increase in wage flexibility often reduces welfare, more likely so in an economy that is part of a currency union or with an exchange-rate-focused monetary policy. Our findings call into question the common view that wage flexibility is particularly desirable in a currency union.

This article analyses the effects of the Federal Reserve's quantitative easing (QE) on global portfolio flows, differentiating across recipient region of the flows, type of flow and QE rounds. Furthermore, the analysis differentiates between the impact of QE expansionary announcements and the actual market operations. The analysis shows that QE1 resulted in (slight) rebalancing towards the US, while QE2 and QE3 resulted in rebalancing towards non-US assets. This suggests that QE increased the procyclicality of flows outside the US, in particular into emerging market equities. The results also suggest a link between US macro-financial conditions and the transmission of QE to portfolio flows.

We study optimal monetary and fiscal policies in a New Keynesian model with heterogeneous agents, incomplete markets, and nominal rigidities. Our approach uses small-noise expansions and Fréchet derivatives to approximate equilibria quickly and efficiently. Responses of optimal policies to aggregate shocks differ qualitatively from what they would be in a corresponding representative agent economy and are an order of magnitude larger. A motive to provide insurance that arises from heterogeneity and incomplete markets outweighs price stabilization motives.

We propose a theory of monetary policy and macroprudential interventions in financial markets. We focus on economies with nominal rigidities in goods and labor markets and subject to constraints on monetary policy, such as the zero lower bound or fixed exchange rates. We identify an aggregate demand externality that can be corrected by macroprudential interventions in financial markets. Ex post, the distribution of wealth across agents affects aggregate demand and output. Ex ante, however, these effects are not internalized in private financial decisions. We provide a simple formula for the required financial interventions that depends on a small number of measurable sufficient statistics. We also characterize optimal monetary policy. We extend our framework to incorporate pecuniary externalities, providing a unified approach to both externalities. Finally, we provide a number of applications which illustrate the relevance of our theory.