Research

Publications 

Coessentiality  of Money and Credit: A Mechanism Design View

With Stanislav Rabinovich (University of North-Carolina at Chapel Hill). Journal of Economic Theory (213), 2023.

Under what conditions are money and credit both essential for trade? We answer this question by applying a mechanism-design approach to a standard monetary search model, augmented with two types of credit technologies. First, payment can be enforced up to some exogenous amount (enforcement-based credit). Second, default on past promises can be partially monitored by future trading partners (monitoring-based credit). Consistent with prior literature, we find that money and monitoring-based credit cannot be jointly essential. However, we show that money and enforcement-based credit are jointly essential as long as neither payment instrument by itself is sufficient to implement the first-best. In fact, coexistence of money and credit arises naturally in the very basic environment in which, according to conventional wisdom, it would not arise. Money is memory, but it is not enforcement.


Coexistence of Money and Interest-Bearing Bonds

 Journal of Economic Dynamics and Control (153), 2023.

This paper revisits how coexistence of money and bonds can make a society better off. For this purpose, a model is constructed in which payment instruments matter for settling real transactions and savings instruments matter because agents differ in how they discount future utility. Because bonds and money differ in their characteristics as payment and savings instruments, the model is able to explain the coexistence puzzle for an optimally chosen monetary policy. Such a policy trades-off efficiency in financial markets, in which money is traded for bonds, with efficiency in goods markets, in which money is traded for a real good. Financial markets can achieve a better distribution of savings when agents are constrained by their money holdings, but this is bad for efficiency in goods markets. The former effect can dominate the latter so that optimal policy deviates from the Friedman rule.


Preference Heterogeneity and Optimal Monetary Policy

With Burak Uras (Tilburg University). Journal of Economics Dynamics and Control (134), 2022.


We study optimal policy design in a monetary model with heterogeneous preferences. In the model, financial markets are incomplete and households are heterogeneous with respect to their current consumption preferences and discount factors. The government controls the supply of money (liquid) and nominal bonds (illiquid), and households make optimal portfolio choices. We uncover that the two types of preference heterogeneity have distinct distributional consequences and different implications for the optimal monetary policy. While the heterogeneity in current consumption preferences pushes the economy towards a zero lower bound (ZLB) associated with nominal interest rates, the heterogeneity in discount factors moves the economy away from the ZLB. We characterize the optimal policy design and quantify the welfare losses associated with a binding ZLB - and thus also the potential welfare benefits of being able to implement negative interest rates. 


Nonlinear Unemployment Effects of the Inflation Tax

With Mohammed Ait Lahcen (University of Qatar), Garth Baughman (Federal Reserve Board of Governors), and Stanislav Rabinovich (University of North-Carolina at Chapel Hill). European Economic Review (148), 2022. 


Long-run inflation has nonlinear and state-dependent effects on unemployment, output, and welfare. We show this using a standard monetary search model with two shocks – productivity and monetary – and frictions in both labor and goods markets. Inflation lowers the surplus from a worker–firm match, in turn making it more sensitive to both productivity shocks and further increases in inflation. We calibrate the model to match key aspects of the US labor market and monetary data. The calibrated model is consistent with a number of empirical correlations, which we document using panel data from the OECD: (1) there is a positive long-run relationship between anticipated inflation and unemployment; (2) there is also a positive correlation between anticipated inflation and unemployment volatility; (3) the long-run inflation-unemployment relationship is stronger when unemployment is higher. The key mechanism through which the model generates these results is the negative effect of inflation on measured output per worker, which is likewise consistent with cross-country data. Finally, we show that the welfare cost of inflation is nonlinear in the level of inflation and is amplified by the presence of aggregate uncertainty.

Working Papers

Contagious Stablecoins?

With Hans Gersbach (ETH Zurich) and Sebastian Zelzner (ETH Zurich)

We study competition between stablecoins  pegged to a stable currency. Stablecoins are issued by coalescing investors and backed by long-term assets. They can either be redeemed with the issuer or traded in a secondary market. When an issuer limits redemption and sticks to an investment rule, its stablecoin is stable in an idiosyncratic sense---it is invulnerable to runs and always trades at the pegged price. Competition between issuers, however, entails a coordination problem in which an issuer must pay interest on its stablecoin if other issuers pay interest as well. As a consequence, the economy can be inefficient and unstable. The efficient allocation can be implemented uniquely when regulation prevents the issuance of interest-bearing stablecoins, as these can be contagious.


Credit Enforcement and Monetary-Policy Transmission in a Search Economy

With Markus Althanns (ETH Zurich) and Hans Gersbach (ETH Zurich)

We study a model in which fiat money and private money facilitate real transactions in directed and competitive search markets. Money is held by the buyers and private money is created by financial intermediaries that extend credit to the sellers. The sellers use credit to prepone consumption and credit is backed by the income processes that sellers earn in the search markets. We study how sellers' ability to commit to actions in these markets affects the long-run transmission of monetary policy. We find that inflation increases credit extension as it drives down the real interest rate. Without sellers' ability to commit to search-market actions, the usual negative effect of inflation then gets aggravated due to a moral-hazard problem---once indebted, sellers take decisions which reduce the arrival rate of matches. With sellers' ability to commit, we find the opposite---to borrow more, sellers commit to actions which increase the arrival rate of matches.  When this effect is strong enough, the economy overheats and welfare declines.


Liquid Equity and Boom-Bust Dynamics

I develop and analyze a monetary model with liquid equity. Equity is a claim on the profits of firms acting as sellers in the search-and-matching market. Buyers in that market devote search to obtain matches with firms, and use the equity to relax a liquidity constraint. The dual nature of equity in the search-and-matching market entails a strategic  complementary in search operating through buyers' liquidity constraint, and it gives rise to endogenous booms and busts. The economy is stable in an inflation-targeting regime if combined with asset purchases, meaning the government effectively puts a floor below the value of equity.


Money, Asset Markets, and Efficiency of Capital Formation

With Burak Uras (Tilburg University)

Holdings of money and illiquid assets are likely to be determined jointly. Therefore, frictions that give rise to a need for money may affect capital formation, resulting in either too much or too little investment. Existing models of money and capital however tend to overlook that both types of investment inefficiencies can be equilibrium outcomes. Building upon insights from the New-Monetarist literature, we construct a model in which preference heterogeneity between agents implies that both over- and under-investment can arise. We use our framework to study whether monetary policy can effectively resolve both types of investment inefficiencies, and find that increasing inflation could resolve under-investment inefficiencies while reducing inflation could curb over-investment inefficiencies. 


Money Creation in a Neoclassical Economy: Equilibrium Multiplicity and the Liquidity Trap

With Lukas Altermatt (University of Essex) and Lukas Voellmy (Swiss National Bank).

We introduce banks that issue liquid deposits backed by bonds and capital into an otherwise standard cash-in-advance economy. Liquidity transformation by banks increases aggregate consumption and investment relative to a cash-only economy but can also lead to inefficient overinvestment. Furthermore, liquidity transformation can lead to multiple steady-state equilibria with different interest rates and real outcomes. Whenever multiple equilibria exist, one of them constitutes a ‘liquidity trap’, in which nominal bond rates equal zero and banks are indifferent between holding bonds and reserves. Whether economic activity is higher in a liquidity trap or in a (coexisting) equilibrium with positive interest rates is ambiguous, but the liquidity trap equilibrium is more likely to go in hand with overinvestment.


On the Negatives of Negative Interest Rates

With Aleksander Berentsen (Universit of Basel and FRB St. Louis) and Romina Ruprecht (University of Basel). Revise and Resubmit at the European Economic Review.

Major central banks remunerate reserves at negative rates (NIR). To study the long-run effects of NIR, we construct a dynamic general equilibrium model with commercial banks holding reserves and funding investments with retail deposits. In the long run, NIR distorts investment decisions, lowers welfare, depresses output, and reduces bank profitability. The type of distortion depends on the transmission of NIR to retail deposits. The availability of cash explains the asymmetric effects of policy-rate changes in negative vs positive territory. Finally, lowering the policy rate into NIR territory can initially have positive short-run effects on welfare and aggregate output.


Racial Unemployment Gaps and the Disparate Impact of the Inflation Tax

With Mohammed Ait Lahcen (University of Qatar) and Garth Baughman (Federal Reserve Board of Governors).

We study the nonlinearities present in a standard monetary labor search model modified to have two groups of workers facing exogenous differences in the job finding and separation rates. We use our setting to study the racial unemployment gap between Black and white workers in the United States. A calibrated version of the model is able to replicate the difference between the two groups both in the level and volatility of unemployment. We show that the racial unemployment gap rises during downturns, and that its reaction to shocks is state-dependent. In particular, following a negative productivity shock, when aggregate unemployment is above average the gap increases by 0.6pp more than when aggregate unemployment is below average. In terms of policy, we study the implications of different inflation regimes on the racial unemployment gap. Higher trend inflation increases both the level of the racial unemployment gap and the magnitude of its response to shocks. 


Risk, Inside Money, and the Real Economy

In modern economies, most money takes the form of inside money; deposits created by commercial banks to fund credit extension. Because inside money is used as a payment instrument, doubts about the risks associated with credit extension can affect aggregate outcomes. This paper constructs and analyzes a model of risky credit extension, inside money creation, and monetary exchange. When credit extension is sufficiently risky, a positive probability of bank default arises and this affects the return characteristics of inside money. Depositors then demand a risk premium for holding inside money, which drives a wedge between bankers’ funding costs and the social benefits of money creation. This wedge negatively affects credit extension, output, and welfare. A government can restore efficiency by swapping risky inside money for risk-free forms of government debt. 


Systemic Bank Runs without Aggregate Risk: How a Misallocation of Liquidity May Trigger a Solvency Crisis

With Lukas Altermatt (University of Essex) and Lukas Voellmy (Swiss National Bank). Revise and resubmit at the Journal of Financial Economics.

We develop a general equilibrium model of self-fulfilling bank runs in a setting without aggregate risk. The key novelty is the way in which the banking system’s assets and liabilities are connected. Banks issue loans to entrepreneurs who sell goods to (impatient) households, which in turn pay for the goods by redeeming bank deposits. The return on bank assets is thus contingent on impatient households being able to withdraw their deposits. In a run, not all impatient households manage to withdraw since part of banks’ cash reserves end up in the hands of running patient households. This lowers revenues of entrepreneurs, which causes some of them to default on their loans and thereby rationalises the run in the first place. Importantly, interventions that restrict redemptions in a run – such as deposit freezes – can be self-defeating due to their negative effect on demand in goods markets. We show how runs may be prevented with combinations of deposit freezes and redemption penalties as well as with the provision of emergency liquidity by central banks.

Work in Progress

Asset Pricing, Liquidity, and Monetary Policy

With Mohammed Ait Lahcen (University of Qatar), Stanislav Rabinovich (University of North-Carolina at Chapel Hill), and Pedro Gomis-Porqueras (Queensland University of Technology)

We propose an asset pricing model with direct and indirect utility to study the equity premium when agents trade in competitive frictional and frictionless markets. Other than money, risk-free nominal bonds and equity can expand the consumption possibilities of goods traded in frictional markets. In particular, these assets can be used as collateral when agents trade in frictional markets, while any financial arrangement can be used when trading in frictionless markets. Within this environment, we analyze how the relative indirect liquidity of risky and safe nominal assets affect spreads. We also explore how monetary policy affects the pricing of various assets and the equity premium.


Financial Markets, Banks, Liquidity Traps, and Panics

This paper studies how economies endowed with institutions that provide liquidity insurance, can be subject to self-fulfilling liquidity traps and financial panics. The novelty is that private assets in the model are claims on profits earned by firms operating in frictional markets. These frictional markets are plagued by search and information frictions: agents devote effort to get matched to trading partners and need money to settle transactions. Due to these frictions, when banks hold private assets or agents can trade private assets at short notice on a financial market, a coordination problem regarding search effort arises. Contrary to conventional wisdom, both financial market economies and banking economies are subject to self-fulfilling prophecies.


Food Waste

With Frans Cruijssen (Tilburg University), Patrico Dalton (Tilburg University), and Burak Uras (Williams College and Tilburg University).


Monetary Hierarchy

With Hans Gersbach (ETH Zurich)

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