RECENTLY ACCEPTED

"Sudden Stops and Optimal Policy in a Two-agent Economy", with Nina Biljanovska

Journal of International Economics      

We introduce heterogeneity between workers and entrepreneurs in a standard Fisherian model to study Sudden Stop dynamics and optimal policy. The distinction between workers and entrepreneurs introduces a redistributive motive that meaningfully interacts with Fisherian deflation. While in tranquil times redistribution is driven by the relative marginal utilities of consumption, the planner additionally favors entrepreneurs during Sudden Stops to mitigate Fisherian deflation. We show how heterogeneity adds to the understanding of how ex ante and ex post policies can be best designed to alleviate the negative effects of Sudden Stops.

"Optimal Bank Regulation in the Presence of Credit and Run Risk", with Anil Kashyap and Dimitri Tsomocos. 

Journal of Political Economy

We modify the Diamond and Dybvig (1983) model so that, besides offering liquidity services to depositors, banks also raise equity funding, make loans that are risky, and can invest in safe, liquid assets. The bank and its borrowers are subject to limited liability. When profitable, banks monitor borrowers to ensure that they repay loans. Depositors may choose to run based on conjectures about the resources that are available for people withdrawing early and beliefs about banks' monitoring.  We use a new type of global game to solve for the run decision.  We find that banks opt for a more deposit-intensive capital structure than a social planner would choose.  The privately chosen asset portfolio can be more or less lending-intensive, while the scale of intermediation can also be higher or lower depending on a  planner's preferences between liquidity provision and credit extension. To correct these three distortions, a package of three regulations is warranted. 

 "Financial Stability Implications of Digital Assets", with Azar, Baughman, Carapella, Gerszten, Lubis, Perez-Sangimino, Rappoport, Scotti, Swem, Werman, 

Economic Policy Review 

The value of assets in the digital ecosystem has grown rapidly, amid periods of high volatility. Does the digital financial system create new potential challenges to financial stability? This paper explores this question using the Federal Reserve’s framework for analyzing vulnerabilities in the traditional financial system. The digital asset ecosystem has recently proven itself highly fragile. However adverse digital asset markets shocks have had limited spillovers to the traditional financial system. Currently, the digital asset ecosystem does not provide significant financial services outside the ecosystem, and it exhibits limited interconnections with the traditional financial system. The paper describes emerging vulnerabilities that could present risks to financial stability in the future if the digital asset ecosystem becomes more systemic, including: run risks among large stablecoins, valuation pressures in crypto-assets, fragilities of DeFi platforms, growing interconnectedness, and a general lack of regulation.

WORKING PAPERS

"Leverage and Stablecoin Pegs", with Gary Gorton, Chase Ross, Sharon Ross, and Elizabeth Klee

Money is debt that circulates with no questions asked. Stablecoins are a new form of private money which circulate with many questions asked. We show how stablecoins can maintain a constant price even though they face run risk and pay no interest. Stablecoin holders are indirectly compensated for stablecoin run risk because they can lend the coins to levered traders. When speculative demand is strong, levered traders are willing to pay a premium to borrow stablecoins. Therefore, the stablecoin can support a $1 peg even with higher levels of run risk.

"Optimal Macroprudential Policy and Asset Price Bubbles", with Nina Biljanovska and Lucyna Gornicka 

We study the interplay between indebtedness and asset price bubbles. A bubble relaxes borrowing constraints and increases borrowing capacity. Yet a deflating bubble amplifies downturns when constraints start binding. We show analytically and quantitatively that optimal macroprudential policy should respond to bubbles in a non-monotonic way, which depends on the underlying level of indebtedness. If the level of debt is moderate, policy should accommodate the bubble to reduce the incidence of a binding borrowing constraint. If debt is elevated, policy should lean against the bubble more aggressively to mitigate the externalities when constraints bind. 

"Financial Stability Implications of CBDC", with Francesca Carapella, Jin-Wook Chang, Sebastian Infante, Melissa Leistra, and Arazi Lubis

A Central Bank Digital Currency (CBDC) is a form of digital money that is denominated in the national unit of account and constitutes a direct liability of the central bank. We examine the financial stability risks and benefits of issuing a CBDC under different design options. Our analysis is based on lessons derived from historical case studies as well as on an analytical framework that allows us to characterize the mechanisms through which a CBDC can affect financial stability. We further discuss various policy tools that can be employed to mitigate financial stability risks. 

"Banks, Non-banks, and Lending Standards", with Matt Darst and Ehraz Refayet

We study how competition between banks and non-banks affects lending standards. Banks have private information about some borrowers and are subject to capital requirements to mitigate risk-taking incentives from deposit insurance. Non-banks are uninformed and market forces determine their capital structure. We show that lending standards monotonically increase in bank capital requirements. Intuitively, higher capital requirements raise banks' skin in the game and screening out bad projects assures positive expected lending returns. Non-banks enter the market when capital requirements are sufficiently high, but do not cause a deterioration in lending standards. Optimal capital requirements trade-off inefficient lending to bad projects under loose standards with inefficient collateral liquidation under tight standards.

"Designing a Main Street Lending Facility" 

Banks add value by monitoring borrowers. High funding costs make banks reluctant to lend. A central bank can ease funding by purchasing loans, but cannot distinguish which loans require more or less monitoring, exposing it to adverse selection. Multi-tier pricing arises as the optimal design setting differential purchases terms given loan characteristics. The relative welfare gain compared to uniform pricing depends on three sufficient statistics: the share of loans requiring monitoring, the risk-retention ratio, and the liquidity premium. For plausible values in the data, the gain ranges from 0.02% to 0.31% of the size of central bank's loan purchases.

WORK IN PROGRESS

"Fragility of Payment Stablecoins", with Elizabeth Klee, Arazi Lubis, Chase Ross, Sharon Ross

"Optimal Mortgage Regulation and Income Inequality", with Nina Biljanovska