Essays on the micro foundations of monetary policy

The first essay explores the connection between technological breakthroughs and the subsequent moderation of real and nominal economic activity. By developing a New Keynesian DSGE model that incorporates vintage technology adoption and learning, the impact of learning on the volatility of economic variables is examined. The process of learning and reorganization during the adoption of new technology moderates economic fluctuations, especially in economies closer to the technological frontier. If the central bank does not account for this learning process when measuring potential output and the output gap, it will respond more aggressively to shocks, further attenuating economic fluctuations. This leads to a flattening of the measured Phillips curve. The empirical analysis, which uses cross-country data, supports the main implications of the model. A significant portion of the observed moderation in the sample countries can be explained by an index that proxies a country's proximity to the technological frontier. As the model suggests, countries nearer to the technological frontier, which require more intensive learning processes, exhibit greater moderation in real and nominal economic activity. Other factors, such as openness to trade, central bank independence etc. turn out to be less important. The second essay studies the role of central bank credibility in affecting agents' inflation expectations and, hence, inflation trends and it contributes to the micro foundation of central bank credibility. A measure of central bank credibility is derived in the context of a New Keynesian framework with agents' imperfect knowledge about the central bank targets. Agents do not know the central bank's actual inflation target and the effective weight on price stability relative to the output gap. This way, central bank credibility is shown to be the product of agents' beliefs about the central bank's effective focus on price stability and the conduct of monetary policy, and this definition can explain inflation and agents' forecasts in both developed and emerging countries. The model is then estimated through Bayesian techniques, employing surveys about professionals' inflation expectations, as well as official data on CPI, for the case of the US and Turkey. Results indicate that recent long-term inflation forecast trends can be explained by the central bank's credibility level in both countries. In particular, during the recent energy price shock, US inflation expectations remained stable thanks to increased central bank credibility. At the same time, Turkey experienced a deterioration in central bank credibility, with consequent unanchored and highly volatile inflation forecasts. Finally, the model shows that improving central bank credibility leads to anchored expectations and stabilizes the inflation rate. The third essay estimates the marginal cost curves of heterogeneous firms to provide evidence on the slope of the Phillips curve. The New Keynesian framework is extended to incorporate heterogeneous firms in terms of production technology, thereby delivering an explicit role for resource reallocation. This way, the study estimates firms' pricing equations, utilizing prices and quantities of outputs and factor inputs of French and Dutch manufacturing firms along with exogenous downstream demand instruments from global input-output and trade data to identify the parameters. Firm-level data are from the micro-data infrastructure (MDI) database, newly built under the EU Technical Support Instrument project. Model heterogeneity is addressed using a clustering method to classify firms according to their production technology and observed cost shock pass-through. It is, hence, found that more productive firms have flatter marginal cost curves and exhibit a lower price response to changes in output. The aggregate Phillips curve is flatter when the more productive firms absorb a larger portion of demand shocks, which is generally the case. Finally, CompNet micro-based data from several European countries support these findings for the non-farm business sector.