Research

Publications

Optimal Monetary Policy with the Risk-taking Channel with Angela Abbate, European Economic Review, Volume 152, 2023.

Empirical research suggests that lower interest rates induce banks to take higher risks. We assess analytically what this risk-taking channel implies for optimal monetary policy in a tractable New Keynesian model. We show that this channel creates a motive for the planner to stabilize the real rate. This objective conflicts with the standard inflation stabilization objective. Optimal policy thus tolerates more inflation volatility. An inertial Taylor-type reaction function becomes optimal. We then quantify the significance of the risk-taking channel for monetary policy in an estimated medium-scale extension of the model. Ignoring the channel when designing policy entails non-negligible welfare costs (0.7% lifetime consumption equivalent).

Presented at Bank of Spain (Madrid), the 2020 Annual Workshop of the ESCB Research Cluster I (London/online) , the  Norges Bank 2020 Central Bank Macro Modelling Workshop (Oslo/online)  and the 27th International Conference of the Society for Computational Economics (online).

Sovereign Default, Domestic Banks and Exclusion from International Capital Markets  -   Slides

The Economic Journal, Volume 131(635), 2021.

Why do governments borrow internationally? Why do they temporarily remain out of international financial markets after default? This paper develops a quantitative model of sovereign default to propose a unified answer to these questions. In the model, the government has an incentive to borrow internationally since the domestic return on capital exceeds the world interest rate, due to a friction in the banking sector. Since banks are exposed to sovereign debt, sovereign default causes a financial crisis. After default, the government chooses to reaccess international capital markets only once banks have recovered and efficiently allocate investment again. Exclusion hence arises endogenously.

Presented at the European University Institute (Florence), the Universidad Carlos III (Madrid), the Bank of Spain (Madrid), the University of Zurich, the Econometric Society's 2016 European Winter Meeting (Edinburgh), the 21st T2M Conference (Lisbon), the 2nd BdE-CEMFI workshop (Madrid), the 1st Catalan Economic Society Conference (Barcelona), the Econometric Society's 2017 North American Summer Meeting (St. Louis), the ADEMU fiscal risk conference 2017 (Bonn), the BGSE Summer Forum 2018 (Barcelona) , the ECB (Frankfurt) and the IMF (online).

A large Central Bank Balance Sheet? Floor vs Corridor Systems in a New Keynesian Environment (with Óscar Arce, Galo Nuño and Carlos Thomas)   -   Slides

Journal of Monetary Economics, Vol. 114, 2020.

The quantitative easing (QE) policies implemented in recent years by central banks have had a profound impact on the working of money markets, giving rise to large excess reserves and pushing down key interbank rates against their floor – the interest rate on reserves. With macroeconomic fundamentals improving, central banks now face the dilemma as to whether to maintain this large balance sheet/floor system, or else to reduce their balance sheet size towards pre-crisis trends and operate traditional corridor systems. We address this issue using a New Keynesian model featuring heterogeneous banks that trade funds in an interbank market characterized by matching frictions. In this environment, balance sheet expansions push market rates towards their floor by slackening the interbank market. A large balance sheet regime is found to deliver ampler ‘policy space’ by widening the steady-state distance between the interest on reserves and its effective lower bound (ELB). Nonetheless, a lean-balance-sheet regime that resorts to temporary but prompt QE in response to recessions severe enough for the ELB to bind achieves similar stabilization and welfare outcomes as a large-balance-sheet regime in which interest-rate policy is the primary adjustment margin thanks to the larger policy space.

Presented at a ECB MPC Task force meeting 2017 (Paris), the 3rd European University Institute Alumni conference (Florence) and the 2017 annual research conference of the DNB (Amsterdam), the 2017 European Winter Meeting of the Econometric Society (Barcelona), the Bank of England (London), the Bank of Spain (Madrid), the 2018 meeting of the Verein für Socialpolitik (Freiburg), the 2018 EUI-Banque de France Conference (Florence), an MPC seminar at the ECB (Frankfurt), the European Summer Symposium in International Macroeconomics ESSIM 2019 (Tarragona), the CEBRA 2019 Annual Meeting (New York), the Fed Board (Washington DC) and the 2019 ESCB Research Cluster I Workshop (London).

When Fiscal Consolidation Meets Private Deleveraging (with Javier Andres, Óscar Arce and Carlos Thomas)

Review of Economic Dynamics, Vol 37, 2020

Inspired by the recent experience in some euro area countries, we analyze the interaction between fiscal consolidation and private deleveraging in a model of a small open economy in a monetary union. The coexistence of long-term private debt and collateral constraints on new loans implies that, following an adverse financial shock, the economy enters a slow private deleveraging process, the duration of which is endogenous to collateral and debt dynamics. In this context, long-term debt reduces the short-run relative output costs of large and/or fast consolidations by buffering their impact on private debtors' spending capacity. However, such aggressive consolidations increase the length and depth of private deleveraging, causing higher relative output losses over the medium run. The latter effect dominates in terms of present-value multipliers and relative welfare losses, such that the above intertemporal trade-off is resolved in favor of smaller/more gradual consolidations.

Presented at the 2019 ASSET Conference (Athens) and the 2019 ESCB Research Cluster II Workshop (Frankfurt).

Monetary Policy and the Asset Risk Taking Channel (with Angela Abbate)   -   Appendix

Journal of Money, Credit and Banking, Vol. 51(8), 2019 

How important is the risk‐taking channel for monetary policy? To answer this question, we develop and estimate a quantitative monetary DSGE model where banks choose excessively risky investments, due to an agency problem that distorts banks' incentives. As the real interest rate declines, these distortions become more important and excessive risk taking increases, lowering the efficiency of investment. We show theoretically that this novel transmission channel generates a new monetary policy trade‐off between inflation and real interest rate stabilization, whereby the central bank may prefer to tolerate greater inflation volatility in order to lower excessive risk taking.

Presented at the European University Institute, the 6th Bundesbank-CFS-ECB Workshop on Macro and Finance (Frankfurt), the XX Workshop on Dynamic Macroeconomics (Vigo), the 30th Annual Congress of the European Economic Association (Mannheim), the 40th Symposium of the Spanish Economic Association (Girona) and the 4th Bordeaux Workshop in International Economics and Finance.

Working Papers

Firm Heterogeneity, Capital Misallocation and Optimal Monetary Policy (with Beatriz Gonzalez, Galo Nuño and Silvia Albrizio).

We analyze monetary policy in a New Keynesian model with heterogeneous firms and financial frictions. Firms differ in their productivity and net worth and face collateral constraints that cause capital misallocation. TFP endogenously depends on the time-varying distribution of firms. Although a reduction in real rates increases misallocation in partial equilibrium, general-equilibrium effects overturn this result: a monetary expansion increases the investment of high-productivity firms relatively more than that of low-productivity ones, crowding out the latter and increasing TFP. We provide empirical evidence based on Spanish granular data supporting this mechanism. This has important implications for optimal monetary policy. We show how a central bank without pre-commitments engineers an unexpected monetary expansion to increase TFP in the medium run. In the event of a cost-push shock, the central bank leans with the wind to increase demand and reduce misallocation.

Presented at the Bank of Spain (Madrid), the 28th CEPR European Summer Symposium in International Macroeconomics (ESSIM) (online), the Danmarks Nationalbank (Kopenhagen), the ECB (Frankfurt), the Banque de France (Paris), the 2022 EUI Alumni conference (Florence), the 2022 NBER Summer Institute (Cambridge, MA), the 2022 CEBRA conference (Barcelona), the 2022 ITAM-PIER workshop (Mexico City), the ASSA 2023 Annual Meeting (New Orleans) and the 2023 T2M conference (Paris).

The Bright Side of the Doom Loop: Bank's Exposure and Default Incentives with Luis Rojas, BGSE Working Paper 1143.

The feedback loop between sovereign and financial sector solvency has been identified as a key driver of the European debt crisis and has motivated an array of policy proposals. We revisit this “doom-loop” focusing on the government's incentives to default. To this end we present a simple 3-period model with strategic sovereign default where debt is held by domestic banks and foreign investors. The government maximizes domestic welfare, and thus the temptation to default increases in foreign debt. Importantly, the costs of default arise endogenously from the damage default causes to domestic banks' balance sheets. Domestically held debt thus serves a commitment device for the government. We show that two policy prescriptions that have emerged in this literature – lower exposure of banks to domestic sovereign debt or a commitment not to bailout banks – can backfire, as default incentives depend not just on the quantity of debt but also on who holds the debt. By contrast, allowing banks to buy additional sovereign debt in times of sovereign distress can rule out the doom loop. 

Presented at CEMFI (Madrid), UAB (Barcelona), Banco de España (Madrid), the 4th Interdisciplinary Sovereign Debt Research and Management Conference (Florence/online) and the 2020 Annual Workshop of the ESCB Research Cluster III (Frankfurt/online).

Reducing the Computationally Necessary State Space by Anticipating Future Choices

This short technical note outlines a method to reduce the computationally necessary state space for solving dynamic models with global methods. The idea is to replace several state variables by a summary state variable and to anticipate future choices that depend on the replaced variables. I show how this method can be applied to a portfolio choice problem.

Other work

Monetary Policy at the Zero Lower Bound in an Overlapping Generations DSGE Model (with Leopold von Thadden). Mimeo

High frequency evidence on information discovery in Russian stock prices cross-listed with German exchanges (with Marco Woelfle) 23rd Freiburg Nagoya Joint Seminar Reports, 2009

Some recent discussions

A macroeconomic model with financial panics. By Mark Gertler, Nobuhiro Kiyotaki and Andrea Prestipino  (Macro Finance Workshop Bank of England 2018)

Secular stagnation, R&D, public investment and monetary policy: A Global Model Perspective. By Pietro Cova, Patrizio Pagano, Alessandro Notarpietro, Massimiliano Pisani (World Bank - Banco de Espana Conference 2018)

Are negative nominal interest rates expansionary? By Gauti Eggertsson, Ragnar Juelsud and Ella Getz Wold (Banco de Espana Annual Research Conference 2017)