James Hebden and Fabian Winkler | We propose an efficient procedure to solve for policy counterfactuals in linear models with occasionally binding constraints. The procedure does not require knowledge of the structural or reduced-form equations of the model, its state variables, or its shock processes. Forecasts of the variables entering the policy problem, and impulse response functions of these variables to anticipated policy shocks under an arbitrary policy, constitute sufficient information to construct valid counterfactuals. We show how to compute solutions for instrument rules and optimal discretionary and commitment policies with multiple policy instruments, and discuss various extensions, including imperfect information, asymmetric objectives, and limited commitment. Our procedure facilitates the comparison of the effects of policy regimes across models. As an application, we compute counterfactual paths of the U.S. economy around 2015 for several monetary policy regimes.

Shaghil Ahmed, Ozge Akinci, Albert Queralto | Using a macroeconomic model, we explore how sources of shocks and vulnerabilities matter for the transmission of U.S. monetary changes to emerging market economies (EMEs). We utilize a calibrated two-country New Keynesian model with financial frictions, partly-dollarized balance sheets, and imperfectly anchored inflation expectations. Contrary to other recent studies that also emphasize the sources of shocks, our approach allows the quantification of effects on real macroeconomic variables as well, in addition to financial spillovers. Moreover, we model the most relevant vulnerabilities structurally. We show that higher U.S. interest rates arising from stronger U.S. aggregate demand generate modestly positive spillovers to economic activity in EMEs with stronger fundamentals, but can be adverse for vulnerable EMEs. In contrast, U.S. monetary tightenings driven by a more-hawkish policy stance cause a substantial slowdown in activity in all EMEs. Our model also captures the challenging policy tradeos that EME central banks face. We show that these tradeoffs are more favorable when inflation expectations are well anchored.

Giuseppe Fiori and Filippo Scoccianti | This paper uses over two decades of Italian survey data on business managers' expectations to measure subjective firm-level uncertainty and quantify its economic effects. We document that firm-level uncertainty persists for a few years and varies across firms' demographic characteristics. Uncertainty induces long-lasting economic effects over a broad array of real and financial variables. The source of uncertainty matters with firms responding only to downside uncertainty, that is, uncertainty about future adverse outcomes. Economy-wide uncertainty, constructed aggregating firm-level uncertainty, is countercyclical but uncorrelated with typical proxies in the literature, and accounts for a sizable amount of GDP variation during crises.

Mathias S. Kruttli, Phillip J. Monin, Lubomir Petrasek, Sumudu W. Watugala | Hedge fund gross U.S. Treasury (UST) exposures doubled from 2018 to February 2020 to $2.4 trillion, primarily driven by relative value arbitrage trading and supported by corresponding increases in repo borrowing. In March 2020, amid unprecedented UST market turmoil, the average UST trading hedge fund had a return of -7% and reduced its UST exposure by close to 20%, despite relatively unchanged bilateral repo volumes and haircuts. Analyzing hedge fund-creditor borrowing data, we find the large, more regulated dealers provided disproportionately more funding during the crisis than other creditors. Overall, the step back in hedge fund UST activity was primarily driven by fund-specific liquidity management rather than dealer regulatory constraints. Hedge funds exited the turmoil with 20% higher cash holdings and smaller, more liquid portfolios, despite low contemporaneous outflows. This precautionary flight to cash was more pronounced among funds exposed to greater redemption risk through shorter share restrictions. Hedge funds predominantly trading the cash-futures basis faced greater margin pressure and reduced UST exposures and repo borrowing the most. After the market turmoil subsided following Fed intervention, hedge fund returns recovered quickly, but UST exposures did not revert to pre-shock levels over the subsequent months.