Working Papers

The Risk Channel of Unconventional Monetary Policy 
Abstract: This paper examines how unconventional monetary policy affects asset prices and macroeco- nomic conditions by reallocating risk in the economy. I consider an environment with two main ingredients: heterogeneity in risk tolerance and frictions in portfolio adjustment. Risk-tolerant investors take leveraged positions, exposing the economy to balance sheet recessions. The presence of passive investors implies the balance sheet of the central bank is non-neutral. Unconventional monetary policy reduces the risk premium and endogenous volatility. During balance sheet recessions, asset purchases boost investment and growth. In contrast, during normal times, the expectation of future interventions reduces growth by its impact on savings. Asset purchases also have implications for the concentration of risk. Leveraged institutions respond to the policy by reducing risk-taking relatively more than risk-averse investors. As risk concentration falls, the probability of negative tail-events is reduced, enhancing financial stability. Under the optimal policy, the central bank should increase its exposure to risk, which is inconsistent with increase in holdings of long- term government bonds.

(joint with Robert M. Townsend)
Abstract: We study the risk-taking behavior of entrepreneurs over the life cycle in the presence of limited idiosyncratic insurance. Imperfect insurance leads to an idiosyncratic risk premium and this premium accounts for a large fraction of entrepreneurial returns in the data. The fraction of wealth invested in the business depends on the idiosyncratic risk premium and it declines substantially with age. The consumption-wealth ratio is U-shaped over the life cycle. We solve for the wealth distribution both across and within age groups and show that it has an inverted-U shape. The model is able to quantitatively account for the levels of aggregate and idiosyncratic risk premium, the patterns of inequality, and the life cycle profiles observed in the data. We also consider the aggregate and distributive impact of financial development. A relaxation of risk constraints leads to a reduction in the idiosyncratic risk premium and an investment boom. Consistent with a Kuznets curve, inequality increases in the short-run, but it declines in the long-run. While the initial generation of entrepreneurs benefits from better insurance, future generations of entrepreneurs are worse-off due to the reduction in returns.

(joint with Nicolas Caramp)
Abstract: We revisit the monetary paradoxes of standard monetary models in a liquidity trap and study the channels through which they occur. We focus on two paradoxes: the Forward Guidance Puzzle and the Paradox of Flexibility. First, we propose a decomposition of consumption into substitution and wealth effects, both of which take into account the general equilibrium effects on output and inflation, and we show that the substitution effect cannot account for the puzzles. Instead, monetary paradoxes are the result of strong wealth effects which, generically, are solely determined by the expected fiscal response to the monetary shocks. We estimate the fiscal response to monetary policy shocks and find responses with the opposite sign to the ones implied by the standard equilibrium. Finally, we introduce the estimated fiscal responses into a medium-size DSGE model. We find that the impulse-response of consumption and inflation do not match the data, suggesting that wealth effects induced by fiscal policy are important even outside of the liquidity trap.

Abstract: This paper studies, in the context of a New Keynesian open-economy model, the optimal response of fiscal policy to a risk premium shock for a country in a currency union. First, I show that the planner should not use government spending to stimulate the economy. Instead of distorting the provision of public goods, it is optimal to use simple tax instruments, as consumption, sales, and payroll tax, to achieve stabilization goals. Second, it is optimal to front-load taxes, i.e., the overall level of taxes increase in response to a positive risk premium shock, and it declines over time. The composition of taxes is also time-varying. Consumption tax is increasing, while either VAT or payroll taxes decline over time after an initial increase. Under downward nominal wage rigidities, it is optimal to implement a form of fiscal appreciation, a decline in the VAT accompained by an increase in the payroll tax. Government debt is smaller under the optimal policy than under a passive fiscal policy where the government does not react to the shock. Under some circumstances, it may be optimal to stabilize the government debt at its pre-shock level. Therefore, under the optimal policy, there is no necessary trade off between stabilization policy and fiscal consolidation.

Work in progress

Risk externalities
(joint with Felipe Iachan)

Heterogeneity, Trading Frictions, and Asset Prices
(joint with Juan Passadore and Wei Cui)