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Report
The Prudential Toolkit with Shadow Banking
Several countries now require banks or money market funds to impose state-contingent costs on short-term creditors to absorb financial stress. We study these requirements as part of the broader prudential toolkit in a model with five key ingredients: banks may face an aggregate stress state with high withdrawals; a fire-sale externality motivates a mix of non-contingent and state-contingent regulation; banks may use shadow technologies to circumvent regulation; parameters of the shadow technologies may be private information; and bailouts may occur. We characterize the optimal policy for ...
Working Paper
Mixed Signals: Investment Distortions with Adverse Selection
We study how adverse selection distorts equilibrium investment allocations in a Walrasian credit market with two-sided heterogeneity. Representative investor and partial equilibrium economies are special cases where investment allocations are distorted above perfect information allocations. By contrast, the general setting features a pecuniary externality that leads to trade and investment allocations below perfect information levels. The degree of heterogeneity between informed agents' type governs the direction of the distortion. Moreover, contracts that complete markets dampen the impact ...
Working Paper
International Capital Flows: Private Versus Public Flows in Developing and Developed Countries
Empirically, net capital inflows are pro-cyclical in developed countries and counter-cyclical in developing countries. That said, private inflows are pro-cyclical and public in flows are counter-cyclical in both groups of countries. The dominance of private (public) in flows in developed (developing) countries drives the difference in total net inflows. We rationalize these patterns using a dynamic stochastic two-sector model of a small open economy facing borrowing constraints. Private agents over-borrow because of the pecuniary externality arising from constraints. The government saves ...
Discussion Paper
How Shadow Banking Reshapes the Optimal Mix of Regulation
Decisions that are privately optimal often impose externalities on other agents, giving rise to regulations aimed at implementing socially optimal outcomes. In the banking industry, regulations are particularly heavy, plausibly reflecting a view by regulators that the relevant externalities could culminate in financial crises and destabilize the broader economy. Over time, the toolkit for regulating banks and bank-like institutions has expanded, as has banks’ restructuring of activities into shadow banking to lessen the regulatory burden. This post, based on our recent Staff Report, ...