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Working Paper
Quantitative Easing and Direct Lending in Response to the COVID-19 Crisis
When the COVID-19 crisis hit the economy in 2020, the Federal Reserve responded with numerous programs designed to prevent a collapse in bank credit and firms’ available funds. I develop a dynamic general equilibrium model to study how these programs work and to evaluate their effectiveness. In the model, quantitative easing works through three channels: the expansion of bank reserves lowers a liquidity premium, the purchase of assets lowers a volatility risk premium, and the economic stimulus lowers a credit risk premium. Since bank reserves are currently larger than in the past, the ...
Working Paper
The Macroeconomic Effects of the Tax Cuts and Jobs Act
This paper studies the macroeconomic effects of seven key TCJA provisions, including the tax cuts for individuals and businesses, the bonus depreciation of equipment, the amortization of R&D expenses, and the limits on interest deductibility. I use a dynamic general equilibrium model with interest deductibility and accelerated depreciation. I find that, initially, the tax reform had a small positive impact on output and investment. In the medium term, however, the effect on output will diminish, and the effect on investment will turn negative. The tax reform will depress investment in R&D. ...
Journal Article
Are the New Basel III Capital Buffers Countercyclical? Exploring the Option of a Rule-Based Countercyclical Buffer
Countercyclical capital regulation can reduce the procyclicality of the banking system and dampen aggregate economic fluctuations. I describe two new capital buffers introduced in Basel III and discuss why their countercyclical effects may be small. If over time regulators want to increase the degree of countercyclicality of capital regulation, they might consider adopting a rule-based countercyclical buffer, that is, a buffer that is automatically lowered during recessions according to a rule. I present a conservative example of such a rule and its effects on capital requirements over the ...
Journal Article
Central Bank Lending in a Liquidity Crisis
Solvent banks may appear insolvent in the midst of a liquidity crisis, due to the plunge of their assets? value below their normal value. The responsibility of the central bank is to provide liquidity to the banks that would be solvent under normal economic conditions, at lending terms consistent with normal market conditions.
Working Paper
Debt overhang and credit risk in a business cycle model
We study the macroeconomic implications of the debt overhang distortion. In our model, the distortion arises because investment is non-contractible?when a firm borrows funds, the debt contract cannot specify or depend on the firm?s future level of investment. After the debt contract is signed, the probability that the firm will default on its debt obligation acts like a tax that discourages its new investment, because the marginal benefit of that investment will be reaped by the creditors in the event of default. We show that the distortion moves countercyclically: It increases during ...
Journal Article
The Overhang of Structures before and since the Great Recession
Investment in structures is still 29 percent below its pre-recession peak. Using a new indicator of the level of structures that would be warranted by economic conditions, we find evidence that the level of investment was too high in the first half of the 2000s. This overinvestment created an overhang of structures which has held down the growth of investment in structures during the recovery.
Journal Article
Is debt overhang causing firms to underinvest?
Many economists have suggested that the weakness of corporate balance sheets is constraining business spending and investment, and that this in turn is impeding growth and the recovery. High levels of debt can depress spending and investment through several channels. This Commentary explains one of them?debt overhang can cause firms to underinvest?and points to ways in which this effect might be inhibiting the recovery.
Journal Article
Household balance sheets and the recovery
Falling home and financial asset prices have combined to weaken the average household?s balance sheet, and this has helped to slow down the current recovery. We examine the role that household balance sheets have typically played in postwar business cycles and assess their importance in explaining why some recoveries, including the current one, have been weaker than others.
Working Paper
The Optimal Response of Bank Capital Requirements to Credit and Risk in a Model with Financial Spillovers
This paper studies optimal bank capital requirements in an economy where bank losses have financial spillovers. The spillovers amplify the effects of shocks, making the banking system and the economy less stable. The spillovers increase with banks? financial distortions, which in turn increase with banks? credit risk. Higher capital requirements dampen the current supply of banks? credit, but mitigate banks? future financial distortions. Capital requirements should be raised in response to both an expansion of banks? credit supply and an increase in the expected future credit risk of banks. ...
Journal Article
The Flattening of the Phillips Curve: Policy Implications Depend on the Cause
According to the historical relationship known as the Phillips curve, strengthening of the economy is commonly associated with increasing inflation. With inflation having only modestly picked up in the past few years as the economy has become more robust, many believe the Phillips curve relationship has weakened, with the curve becoming flatter. I show that the flattening can be due to very different types of structural changes and that knowing the type of change that has occurred is crucial for choosing the appropriate monetary policy.