Abstract:
In this paper, we revisit the scope for macroprudential policy in production economies with pecuniary externalities and collateral constraints. We study competitive equilibria and constrained-efficient equilibria and examine the extent to which the gap between the two depends on the production structure and the policy instruments available to the planner. We argue that macroprudential policy is desirable regardless of whether the competitive equilibrium features more or less borrowing than the constrained-efficient equilibrium. In our quantitative analysis, macroprudential taxes on borrowing turn out to be larger when the government has access to ex-post stabilization policies.
Federal Reserve Bank of Chicago working paper version
Abstract:
This paper proposes a quantitative theory of the interaction between private and public debt in an open economy. Excessive private debt increases the frequency of financial crises. During such crises, the government provides fiscal bailouts financed with risky public debt. This response may cause a sovereign debt crisis, which is characterized by a higher probability of a sovereign default. The model is quantitatively consistent with the evolution of private debt, public debt, and sovereign spreads in Spain from 1999 to 2015, and provides an estimate of the degree of overborrowing, its effect on sovereign risk, and optimal macroprudential policy.
Federal Reserve Bank of Chicago working paper version
Abstract:
Emerging markets with greater inequality tend to have fewer capital controls. We propose a novel dynamic real-exchange-rate distributional externality as a potential explanation. Our model features nonhomothetic preferences, collateral-constrained high-income borrowers, and low-income hand-to-mouth households. Borrowing generates intertemporal redistribution through the real exchange rate. A planner can improve redistribution by manipulating the terms of trade in favor of the poor. We decompose the optimal borrowing tax into Fisherian and distributional components. Incorporating inequality can substantially lower the average optimal macroprudential tax, even generating a subsidy. Our mechanism remains quantitatively significant in a production economy as long as wages are flexible.
Abstract:
We propose a macroprudential theory of foreign reserve accumulation that can rationalize the secular trends in public and private international capital flows. In middle-income countries, the increase in international reserves has been associated with elevated private capital inflows, both in the aggregate and in the cross-section, and economies with a more open capital account have accumulated more reserves. We present an open economy model of financial crises that is consistent with these features. We show that the optimal reserve management policy leans against the wind, raising gross private borrowing while improving the net foreign asset position and reducing the exposure to crises.
Federal Reserve Bank of Chicago working paper version
Abstract:
Do sovereign debt ceilings matter if countries keep breaching or raising them? This paper proposes a new sovereign default model with long-term debt in which each government inherits a previously announced ceiling that it can breach by paying a cost and announces a new ceiling for the following period. This friction generates a state-dependent form of intermediate commitment. The ceiling mitigates debt dilution at the expense of fiscal flexibility. We show that ceilings that are backed by high breach costs lead to welfare gains. Conversely, when costs are low, impatient governments are tempted to gamble by promising tight ceilings that they then frequently breach. This can lead to welfare losses even relative to having no rule. Our contribution is to provide a positive theory of debt ceilings as endogenous, costly-to-breach commitment devices in sovereign debt markets.
Federal Reserve Bank of Chicago working paper version
Abstract:
Political crises often coincide with fiscal crises, with complex causal dynamics at play. We examine the interaction between tax revolts and sovereign risk using a quantitative structural model calibrated to Argentina. In the model, the government can be controlled by political parties with different preferences for redistribution. Households may opt to revolt in response to the fiscal decisions of the ruler. While revolts entail economic costs, they also increase the likelihood of political turnover. Our model mirrors the data by generating political crises concurrent with fiscal turmoil. Specifically, we find that our model aligns closely with the conditions observed during the Macri administration (2015-2019). We find that left-leaning parties are more prone to default upon entering office, while right-leaning parties issue more debt. Our framework explains the high deficits observed during the Macri administration as well as the sovereign default that occurred immediately after the left regained power.
Federal Reserve Bank of Chicago working paper version
Abstract:
This paper develops a variance decomposition framework to study how sovereign credit risk responds to different sources of information and noise. Using dealer’s data from sovereign credit default swap (CDS) markets, we decompose sovereign CDS spread movements into four components: global-market information, country-specific public information, country-specific private information revealed through trading, and noise. We find that variation in sovereign CDS spreads is driven primarily by country-specific information, although noise remains a quantitatively important component. We further examine how country’s macroeconomic fundamentals shape the relative importance of these informational and noise components and how information driven volatility is priced in sovereign credit markets.