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Carolin Pflueger

Perceptions about Monetary Policy, with Michael Bauer and Adi Sunderam, 2022


We estimate time-varying perceptions about the Fed's monetary policy rule from cross-sectional survey data and document systematic shifts in the perceived rule that are relevant for monetary policy and asset pricing. First, the perceived reaction coefficient to the output gap varies over the monetary policy cycle, with a pattern of quick and surprising rate cuts but gradual and data-dependent tightening. Second, this variation in the perceived rule explains changes in the sensitivity of interest rates to macroeconomic announcements. Third, high-frequency monetary policy surprises lead to updates in beliefs about the policy rule that depend on the state of the economy in the direction that is consistent with rational learning. Fourth, when monetary policy is perceived to be more responsive to real activity, risk premia on long-term Treasury bonds are low, consistent with standard asset pricing logic. Our findings can help explain certain empirical puzzles, such as systematic forecast errors about short-term interest rates and the decoupling of long-term rates during conundrum episodes.

Why does the Fed Move Markets so Much? A Model of Monetary Policy and Time-Varying Risk Aversion, with Gianluca Rinaldi, 2022

revise and resubmit, Journal of Financial Economics


We build a new model integrating a work-horse New Keynesian model a work-horse New Keynesian model with investor risk aversion that moves with the business cycle. We show that the same habit preferences that explain the equity volatility puzzle in quarterly data also naturally explain the large high-frequency stock response to Federal Funds rate surprises. In the model, a surprise increase in the short-term interest rate lowers output and consumption relative to habit, thereby raising risk aversion and amplifying the fall in stocks. The model explains the positive correlation between changes in breakeven inflation and stock returns around monetary policy announcements with long-term inflation news.

Doubling Down on Debt: Limited Liability as a Financial Friction, with Jesse Perla and Michal Szkup, 2022


We show that limited liability and pre-existing debt lead to heterogeneous investment distortions, where high leverage firms tend to overinvest while low leverage firms tend to underinvest. In our model, limited liability allows equity holders to change default timing and, thus, “double-sell” cash flows already promised to existing bondholders. We characterize this new financial friction and differentiate it from traditional sources of dilution. With repeated investment opportunities, creditors anticipate equity holders’ incentives to change default timing, increasing the cost of funds and reducing investment. Restricting equity payouts exacerbates overinvestment by high leverage firms but mitigates underinvestment by low leverage firms.

A Model of Politics and the Central Bank, with Wioletta Dziuda, 2021


We present a two-period model examining how the central bank and the elected government jointly shape elections and economic outcomes. An apolitical central bank minimizes a quadratic loss function in inflation and unemployment along an expectational Phillips curve, which is shifted by the government's quality. Fully rational voters optimally choose between the incumbent, whose quality they infer from unemployment, and a challenger of unknown quality. We find that governments prefer more inflation-averse central banks than the social planner, rationalizing the political success of inflation-targeting in practice. Inflation-targeting, however, has negative economic consequences by allowing lower quality incumbents to be reelected.