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.
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.
Short-Time Work and Precautionary Savings (2025) with Thomas Dengler and Britta Gehrke,
The Economic Journal
During the Covid-19 crisis, most OECD countries used short-time work (subsidised reductions in working hours) to preserve employment. This paper documents that short-time work affects the behaviour of firms (supply) and households (demand). First, using household survey data from Germany, we show that the consumption risk of short-time work is lower than that of unemployment. Second, we construct a New Keynesian model with heterogeneous workers and firms, incomplete asset markets, and labour market frictions. Short-time work weakens workers’ precautionary savings motive and lowers labour costs. This reduces the level and volatility of both the separation and unemployment rate at the cost of tying workers to less productive firms. Quantitatively, the positive employment effects dominate the productivity losses.
Financial Dominance and Macroeconomic Expectations
(with Martin Wolf, draft coming soon)
We study monetary policy in a Keynesian growth model with financial frictions. When an inflationary supply shock hits while private leverage is high, the central bank cannot fully stabilize inflation without triggering a financial crisis - an instance of financial dominance. A "backstop policy'', of raising the interest rate by strictly less, avoids the financial crisis but leads to higher inflation. Following a backstop policy, however, may also expose the economy to multiple expectational equilibria. Once beliefs coordinate on low interest rates, private leverage persists. The central bank becomes cornered with financial dominance, and "animal spirits'' determine the duration and magnitude of the spell of inflation.
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.
Saving Solow: Greenhouse Gas Mitigation and Price-Driven Growth with an Environmental Limit
(with Michael Burda, available as CEPR Discussion Paper 17368)
An environmental limit changes the nature of economic growth, but does not preclude it. When atmospheric greenhouse gases reach a predetermined absolute threshold, further growth requires a permanently expanding, resource-intensive mitigation effort. If technical progress in mitigation is too slow, it becomes the effective source of and constraint on economic growth. Yet growth in measured GDP remains a robust feature of this class of economies, and it characterizes the social planner's optimum that anticipates the costs of reaching the environmental limit abruptly.
Capital Adjustment Costs and Stranded Assets in an Optimal Energy Transition
(with Michael Burda and Anna Göth, draft coming soon)
In the context of a green energy transition, capital adjustment costs render effective substitution between clean and dirty energy sources finite and endogenous, despite infinite long-run substitutability. In the presence of a carbon budget, Ramsey optimal paths robustly frontload clean investment before exhaustion, but also imply capital stranding. Of the three channels of emissions reduction, new investment is quantitatively more important than reduced output or labor redeployment. A more ambitious climate goal in our benchmark scenario implies modest levels of stranded capital at 1.3% of GDP, which rises to over 6% if implementation is delayed by a decade.
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.
The Network Effects of Clearing Trade Credit (with Milan Bozic, Toni Whited and Jurica Zrnc)
How to Avoid Double Transitions of Energy Capital in Emerging Markets? (with Carolyn Fisher and Anna Göth)
A climate-macro model with a technological tipping point (with Carolyn Fisher and Christian Schoder)