Research
Publications
Sudden Stops and Reserve Accumulation in the Presence of International Liquidity Risk (2023) with Flora Lutz
Journal of International Economics, Volume 141, March 2023
Awarded the 'Young Economist Award 19' 12th FIW Research Conference International Economics
We propose a small open economy model where agents borrow internationally and invest in liquid foreign assets to insure against liquidity shocks, which temporarily shut out the economy of short-term credit markets. Due to a pecuniary externality individual agents overborrow and hold too little liquid assets relative to a social planner. This inefficiency rationalizes macroprudential policy intervention in the form of reserve accumulation at the central bank to stabilize trade and the real exchange rate. Our model quantitatively matches the depreciation of the real exchange rate and contractions in output, gross trade flows, and foreign reserve holdings during Sudden Stops.
Journal of Economic Dynamics and Control, Volume 151, June 2023
Long-term loan contracts transfer aggregate risk from borrowing firms to lending banks. When aggregate shocks increase the future default probability of firms, banks are not compensated for the rising default risk of existing contracts. The flip side is that firms benefit from not facing higher interest rates in recessions. If banks are highly leveraged, this can lead to financial instability with severe repercussions in the real economy. If banks are well capitalized, the risk transfer stabilizes the economy. To study this mechanism quantitatively, we build a macroeconomic model of financial intermediation with long-term defaultable loan contracts and calibrate it to match aggregate firm and bank exposure to business cycle risks in the US. We find that moving from Basel II to Basel III capital regulation eliminates banking crises, increases output in the long run and improves welfare.
Working Papers
Fear of Hiking? Rising Interest Rates in Times of High Public Debt
(with Martin Wolf, available as CEPR Discussion Paper 16837)
Awarded the 'Young Economist Award' Annual Meeting of the Austrian Economic Association (NOeG), 2022
We build a sovereign default model to understand the implications of rising safe interest rates for countries with high public debt. When debt levels are below a critical threshold, countries respond to higher interest rates by reducing their debt due to a dominant substitution effect. For high debt levels, in contrast, the same rate rise triggers even more debt - and possibly a slow moving debt spiral - due to a dominant income effect. The seeds for a debt spiral are laid by a long phase of low interest rates: they imply that debt levels rise over time, making a future interest rate normalization more difficult. A successful interest rate normalization involves a credible path of rising interest rates, the speed of which must be intermediary: a too fast normalization leads to debt spirals, but a too slow one undermines incentives by the government to repay.
The existence of an environmental limit changes fundamentally the nature of economic growth. When atmospheric greenhouse gases reach a predetermined absolute threshold, further growth requires a permanently expanding, resource-intensive mitigation effort. We incorporate anthropogenic climate change and its mitigation into the Solow-Swan growth model and show that if the rate of technical progress in mitigation fails to exceed a critical value, the economy behaves as described by Baumol (1967). Economic growth in this regime is then driven by technological progress in mitigation and the dynamics of its relative price. Even in the extreme case that long-run growth of produced output converges to zero, the growth rate of GDP measured in terms of produced goods does not.
We propose a two-country framework to study the effects of introducing bilateral central bank currency swap lines. We focus on swap lines from the Federal Reserve to emerging market central banks. We find that the establishment of permanent swap lines provides insurance against liquidity risk to the emerging market and improves its welfare. The emerging market reacts to the insurance by reducing its precautionary dollar reserve holdings and relies on the swap line extensively to resolve liquidity crises. As a result the swap line leads to an increase in financial instability, undoing its original purpose from a US perspective. Making swap lines available permanently does not provide any benefits to the US and causes welfare losses. We also discuss how swap lines can be implemented in a mutually beneficial way.