Research
Publications
The Origins of Aggregate Fluctuations in a Credit Network Economy, Journal of Monetary Economics, vol. 117, pp. 316-334, January 2021.
FEDS working paper, Technical Appendix
I show that inter-firm lending plays an important role in business cycle fluctuations. I first build a network model of the economy in which trade in intermediate goods is financed by supplier credit. In the model, a financial shock to one firm affects its ability to make payments to its suppliers. The credit linkages between firms then transmit financial shocks across the economy, amplifying their effects on aggregate output. To calibrate the model, I construct a proxy of inter-industry credit flows from firm- and industry-level data. Counterfactual exercises suggest these credit network effects can be a powerful amplification mechanism. I estimate aggregate and idiosyncratic shocks to industries in the US and find that financial shocks are a prominent driver of observed cyclical fluctuations: more than two-thirds of the drop in industrial production during the Great Recession is accounted for by financial shocks. Furthermore, idiosyncratic financial shocks to a few key industries can explain a considerable portion of these effects. In contrast, while productivity shocks played a meaningful role before 2007, they had a negligible impact during the Great Recession.
Collective Moral Hazard and the Interbank Market (with Joseph E. Stiglitz), American Economic Journal: Macroeconomics, vol. 15, no. 2, pp. 35-64, April 2023.
NBER working paper, FEDS working paper, VoxEU column, LSE Business Review
The concentration of risk within financial system is considered to be a source of systemic instability. We propose a theory to explain the structure of the financial system and show how it alters the risk taking incentives of financial institutions. We build a model of portfolio choice and endogenous contracts in which the government optimally intervenes during crises. By issuing financial claims to other institutions, relatively risky institutions endogenously become large and interconnected. This structure enables institutions to share the risk of systemic crisis in a privately optimal way, but channels funds to relatively risky investments and creates incentives even for smaller institutions to take excessive risks. Constrained efficiency can be implemented with macroprudential regulation designed to limit the interconnectedness of risky institutions.
Working Papers
A Theory of Safe Asset Creation, Systemic Risk, and Aggregate Demand, March 2024
This paper presents a theory in which the creation of safe assets leads to demand-driven fluctuations in output. The model features a two-way feedback between high systemic risk and depressed aggregate demand: The creation of safe assets by financial intermediaries generates a risk of future crisis (systemic risk), which in turn creates a precautionary demand for safe assets ex ante. The natural rate of interest is therefore determined by the level of systemic risk. If systemic risk is sufficiently high, the natural rate falls below the effective lower bound on monetary policy, leading to a demand-driven recession. The economy can enter a risk-driven stagnation trap in which persistently low output growth arises due to excessive systemic risk. Government purchases of risky assets can stimulate aggregate demand by transferring risk from bank balance sheets to that of the government. By contrast, purchases of safe assets may be ineffective. Optimal macroprudential policy prescribes active use of bank capital requirements to stimulate aggregate demand when monetary policy is constrained.
Information Externalities, Funding Liquidity, and Fire Sales (with Jin-Wook Chang), August 2022
We develop a theory of learning in a model of fire sales and collateralized debt to study how beliefs about fundamentals are shaped by market conditions. Agents exchange short-term debt contracts to invest in a long-term risky asset, and receive shocks to the opportunity cost of funds (cost shocks) and news about the fundamental of the asset, both of which are private information. Asset prices play a dual role of clearing markets and conveying agents’ private information, but markets are informationally inefficient: Agents can partially, but never fully, infer their counterparties’ private information from asset prices. The informational inefficiency of markets is more acute when liquidity conditions are especially tight or loose, as this impairs ability of prices to reveal private information about fundamentals. As a result, beliefs about fundamentals are shaped endogenously by cost shocks which are orthogonal to fundamentals, leading to socially costly booms and busts in asset prices. The equilibrium is constrained inefficient due to an information externality in which agents do not internalize how their choices affect the information set of other agents. Interventions in funding markets can stabilize asset prices by altering perceptions of risk.
Trade Credit and Network Contagion: Evidence from Chile (with Patricio Toro), Draft coming soon
We investigate the role of trade credit and input-output linkages in propagating shocks across a network of firms using supervisory, transaction-level data on the universe of firms in Chile. We use two natural experiments to identify credit supply shocks to firms, and to estimate how these shocks propagate through the network of firms. Using a general model of trade credit with minimal restrictions, we decompose these estimated effects into two channels: a trade credit channel, which captures how firms modify the price and quantity of credit to one another; and an input-output channel, which captures how firms modify the price and quantity of goods and services sold to one another. We use the input-output network of these firms to aggregate these effects across firms and to size the relative importance of each channel. Overall, our results indicate that trade credit lending is an important way that financial shocks propagate across firms and leads to sizable aggregate effects.
Work in Progress
Sovereign Debt Distress and Aggregate Demand Externalities (with Martin Guzman and Joseph E. Stiglitz)