Rational Inattention, Financial Heterogeneity and Effectiveness of Monetary Policy
How do financial constraints affect firms' information acquisition and, thus, the effectiveness of monetary policy over the business cycle? This paper addresses these questions in a rational inattention model in which heterogeneous firms face both (aggregate) monetary shocks and (idiosyncratic) productivity shocks. The model predicts that, due to strategic complementarity in pricing decisions, firms with a binding financial constraint pay more attention to monetary shocks than unconstrained ones. At the aggregate level, heterogeneity in attention allocation implies that prices become more responsive to shocks as the fraction of constrained firms increases. As a result, in the calibrated version of the model, monetary policy is less powerful in recessions, when financial frictions are more severe. The model is consistent with firms' heterogeneous attention to macroeconomic conditions and with the state-dependent effectiveness of monetary policy, two features supported both by the empirical evidence provided in the paper and by the existing literature.
Endogenous Liquidity of Financial Assets and Macroeconomic Implications, joint with Li Li
One decade after the financial crisis of 2007-2008, the cause of this crisis is still in debate. This paper studies the endogenous liquidity of assets in a closed economy and characterizes a general, non-parametric mechanism of economic fluctuations, including severe crises. We endogenize liquidity in the following aspects: (i) new construction of the liquidity property of assets; (ii) liquidity-augmented asset pricing; (iii) liquidity creation and evolution in the financial market. We derive asset pricing with consideration of liquidity and show that asset prices, augmented by liquidity service, inflate with liquidity premium and induce distorted investments in the real economy. Securities, which are widely used to facilitate transactions, induce new issuance and inevitably lower the pecuniary yields of the physical capital that backs them. The consequence is that asset prices and privately created liquidity become fragile, in the sense that small shocks can lead to large drops in asset prices and damage balance sheets of financial intermediaries. According to this theory, asset prices and liquidity play a central role; this points to the importance of stabilizing asset prices, not only commodity prices. We analyze the associated policies in recessions that can be conducted by fiscal and monetary authorities. The present theory is consistent with the classic wisdom before the second world war.
Work in Progress
Firm Information Acquisition and Industry Concentration
Industry concentration has been continuously raising in the last 50 years. Meanwhile, superstar firms are also enriching their arsenal with information analysing technology and human resources regarding big data, artificial intelligence, etc. I provide a model to rationalise the superstar firm phenomenon from rational inattention perspective. In an economy with variable markup and fixed initial information processing capacity, more productive firms pay more attention to idiosyncratic uncertainty due to their smaller counter-cyclical markup elasticity, which is consistent with recent empirical findings. Once all firms have sufficient profits to pay a fixed cost (e.g., building a new department to adopt new data technology) and start improving information processing capacity, more productive firms will have more incentive to invest in tracking both idiosyncratic and aggregate uncertainty, which lead to absolute lower profit loss due to both kinds of uncertainties. Therefore, in the later stage, more productive firms keep adopting new data/information technology and become superstar firms, equipped with higher information processing capacity.
"Rational" Finite Planning Horizon, joint with Dmitriy Sergeyev and Luigi Iovino