Search Results
Working Paper
Efficient bailouts?
This paper develops a non-linear DSGE model to assess the interaction between ex-post interventions in credit markets and the build-up of risk ex ante. During a systemic crisis, bailouts relax balance sheet constraints and mitigate the severity of the recession. Ex ante, the anticipation of such bailouts leads to an increase in risk-taking, making the economy more vulnerable to a financial crisis. The optimal policy requires, in general, a mix of ex-post intervention and ex-ante prudential policy. We also analyze the effects of bailouts on financial stability and welfare in the absence of ...
Conference Paper
Overborrowing, financial crises and ‘macro-prudential’ taxes
We study overborrowing and financial crises in an equilibrium model of business cycles and asset prices with collateral constraints. Private agents in a decentralized competitive equilibrium do not internalize the effects of their individual borrowing plans on the market price of assets at which collateral is valued and on the wage costs relevant for working capital financing. Compared with a constrained social planner who internalizes these effects, they undervalue the benefits of an increase in net worth when the constraint binds and hence they borrow "too much" ex ante. Quantitatively, ...
Working Paper
The Prudential Use of Capital Controls and Foreign Currency Reserves
We provide a simple framework to study the prudential use of capital controls and currency reserves that have been explored in the recent literature. We cover the role of both pecuniary externalities and aggregate demand externalities. The model features a central policy dilemma for emerging economies facing large capital outflows: the choice between increasing the policy rate to stabilize the exchange rate and decreasing the policy rate to stabilize employment. Ex ante capital controls and reserve accumulation can help mitigate this dilemma. We use our framework to survey the recent ...
Working Paper
Overborrowing, Underborrowing, and Macroprudential Policy
In this paper, we revisit the scope for macroprudential policy in production economies with pecuniary externalities and collateral constraints. We study competitive equilibria and constrained-efficient equilibria and examine the extent to which the gap between the two depends on the production structure and the policy instruments available to the planner. We argue that macroprudential policy is desirable regardless of whether the competitive equilibrium features more or less borrowing than the constrained-efficient equilibrium. In our quantitative analysis, macroprudential taxes on borrowing ...
Working Paper
A Theory of Fear of Floating
Many central banks whose exchange rate regimes are classified as flexible are reluctant to let the exchange rate fluctuate. This phenomenon is known as “fear of floating”. We present a simple theory in which fear of floating emerges as an optimal policy outcome. The key feature of the model is an occasionally binding borrowing constraint linked to the exchange rate that introduces a feedback loop between aggregate demand and credit conditions. Contrary to the Mundellian paradigm, we show that a depreciation can be contractionary, and letting the exchange rate float can expose the economy ...
Working Paper
Helicopter Drops and Liquidity Traps
We show that if the central bank operates without commitment and faces constraints on its balance sheet, helicopter drops can be a useful stabilization tool during a liquidity trap. With commitment, even with balance sheet constraints, helicopter drops are, at best, irrelevant.
Working Paper
A Macroprudential Theory of Foreign Reserve Accumulation
This paper proposes a theory of foreign reserves as macroprudential policy. We study an open economy model of financial crises, in which pecuniary externalities lead to over-borrowing, and show that by accumulating international reserves, the government can achieve the constrained-efficient allocation. The optimal reserve accumulation policy leans against the wind and significantly reduces the exposure to financial crises. The theory is consistent with the joint dynamics of private and official capital flows, both over time and in the cross section, and can quantitatively account for the ...
Working Paper
Exchange Rate Policies at the Zero Lower Bound
We study how a monetary authority pursues an exchange rate objective in an environment that features a zero lower bound (ZLB) constraint on nominal interest rates and limits to international arbitrage. If the nominal interest rate that is consistent with interest rate parity is positive, the central bank can achieve its exchange rate objective by choosing that interest rate, a well-known result in international ?nance. However, if the rate consistent with parity is negative, pursuing an exchange rate objective necessarily results in zero nominal interest rates, deviations from parity, capital ...
Working Paper
Overborrowing and systemic externalities in the business cycle
Credit constraints that link a private agent?s debt to market-determined prices embody a credit externality that drives a wedge between competitive and constrained socially optimal equilibria, inducing private agents to overborrow. The externality arises because agents fail to internalize the debt-deflation effects of additional borrowing when negative income shocks trigger the credit constraint. We quantify the effects of this inefficiency in a two-sector dynamic stochastic general equilibrium model of a small open economy calibrated to emerging markets. The credit externality increases the ...
Working Paper
Bank Runs, Fragility, and Credit Easing
We present a tractable dynamic macroeconomic model of self-fulfilling bank runs. A bank is vulnerable to a run when a loss of investors’ confidence triggers deposit withdrawals and leads the bank to default on its obligations. We analytically characterize how the vulnerability of an individual bank depends on macroeconomic aggregates and how the number of banks facing a run affects macroeconomic aggregates in turn. In general equilibrium, runs can be partial or complete, depending on aggregate leverage and the dynamics of asset prices. Our normative analysis shows that the effectiveness of ...