Research

Refereed Publications

A Preferred-Habitat Model of Term Premia, Exchange Rates and Monetary Spillovers, conditionally accepted, American Economic Review, January 2025

with Walker Ray and Dimitri Vayanos. We develop a two-country model in which currency and bond markets are populated by different investor clienteles, and segmentation is partly overcome by arbitrageurs with limited capital. Risk premia in our model are time-varying, connected across markets, and consistent with the empirical violations of Uncovered Interest Parity and Expectations Hypothesis. Through risk premia, large-scale bond purchases lower domestic and foreign bond yields and depreciate the currency, and short-rate cuts lower foreign yields, with smaller effects than bond purchases. Currency returns are disconnected from long-maturity bond returns, and yet the currency market is instrumental in transmitting bond demand shocks across countries.

The Economics of Sovereign Debt, Bailouts and the Eurozone Crisis, forthcoming Journal of the European Economic Association, August 2024

with Philippe Martin and Todd Messer. Despite a formal ‘no-bailout clause,’ we estimate significant net present value transfers from the European Union to Cyprus, Greece, Ireland, Portugal, and Spain, ranging from roughly 0.5% (Ireland) to a whopping 43% (Greece) of 2010 output during the Eurozone crisis. We propose a model to analyze and understand bailouts in a monetary union, and the large observed differences across countries. We characterize bailout size and likelihood as a function of the economic fundamentals (economic activity, debt-to-gdp ratio, default costs). Our model embeds a ‘Southern view’ of the crisis (transfers did not help) and a ‘Northern view’ (transfers weaken fiscal discipline). While a stronger no-bailout commitment reduces risk-shifting, it may not be optimal from the perspective of the creditor country, even ex-ante, if it increases the risk of immediate insolvency for high debt countries. Hence, the model provides a potential justification for the often decried policy of ‘kicking the can down the road.’ Mapping the model to the estimated transfers, we find that the main purpose of the outsized Greek bailout was to prevent an exit from the eurozone and possible contagion. Bailouts to avoid sovereign default were comparatively modest.

Changing Global Linkages: A new Cold War? Journal of International Economics, 153, January 2025

with Gita Gopinath, Andrea F. Presbitero and Petia Topalova. Global linkages are changing amidst elevated geopolitical tensions and a surge in policies directed at increasing supply chain resilience and national security. Using granular bilateral data, we provide new evidence of trade and investment fragmentation along geopolitical lines and compare it to the early years of the Cold War. Gravity model estimates point to significant declines in trade, FDI, and portfolio flows between countries in geopolitically distant blocs since the onset of the war in Ukraine, relative to flows between countries in the same bloc. While the extent of fragmentation is still relatively small, the decoupling between the rival geopolitical blocs during the Cold War suggests it could worsen considerably should geopolitical tensions persist and trade restrictive policies intensify. Different from the early years of the Cold War, a set of nonaligned ‘connector’ countries are rapidly gaining importance and serving as a bridge between blocs.

Understanding the International Rise and Fall of Inflation since 2020, Journal of Monetary Economics, 148, August 2024

with Mai Chi Dao, Daniel Leigh and Prachi Mishra. This paper analyzes inflation dynamics in 21 advanced and emerging market economies since 2020. We decompose inflation into core inflation as measured by the weighted median inflation rate, and headline shocks—deviations of headline inflation from core. Headline shocks occurred largely on account of energy price changes, although food price changes and indicators of supply chain problems also played a role. We explain the evolution of core inflation with two factors: the strength of macroeconomic conditions—measured by the unemployment gap, the output gap, and the ratio of job vacancies to unemployment—and the pass-through into core inflation from past headline shocks. We conclude that the international rise and fall of inflation since 2020 largely reflected the direct and pass-through effects of headline shocks. Macroeconomic conditions generally played a secondary role. In the United States, estimated price pressures from strong macroeconomic conditions had been greater than in other economies but have eased.

SME Failures under Large Liquidity Shocks: an Application to the COVID-19 Crisis, Journal of the European Economic Association, 23(2), April 2025

also available from Oxford Publishing. © The Author(s) 2024. Published by Oxford University Press on behalf of European Economic Association.

with Sebnem Kalemli-Ozcan, Veronika Penciakova and Nick Sander. We study the effects of financial frictions on firm exit when firms face large liquidity shocks. We develop a simple model of firm cost-minimization, where firms’ borrowing capacity to smooth temporary shocks to liquidity is limited. In this framework, firm exit arises from the interaction between this financial friction and fluctuations in cash flow due to aggregate and sectoral changes in demand conditions, as well as more traditional shocks to productivity. To evaluate the implications of our model, we use firm level data on small and medium sized enterprises (SMEs) in 11 European countries. We confirm that our framework is consistent with official failure rates in 2017–2019, a period characterized by standard business cycle fluctuations. To capture a large liquidity shock, we apply our framework to the COVID-19 crisis. We find that, absent government support, SME failure rates would have increased by 6.01 percentage points, putting 3.1% of employment at risk. Our results also show that in the presence of financial frictions and in the absence of government support, the firms failing due to COVID have similar productivity and growth to firms that survive COVID.

Global Imbalances and Currency Wars at the Zero Lower Bound, Review of Economic Studies, 88(6), November 2021

with Ricardo Caballero and Emmanuel Farhi. This article explores the consequences of extremely low real interest rates in a world with integrated but heterogeneous capital markets, nominal rigidities, and an effective lower bound [a zero lower bound (ZLB) for simplicity]. We establish four main results: (1) At the ZLB, creditor countries export their recession abroad, which we illustrate with a new Metzler diagram in quantities; (2) Beggar-thy-neighbour currency and trade wars provide stimulus to the undertaking country at the expense of other countries; (3) (Safe) public debt issuances and increases in government spending anywhere are expansionary everywhere; and (4) When there is a scarcity of safe assets, net issuers of these assets import the recession from abroad.

[Media coverage: Vox-EU column]

Dominant Currency Paradigm, American Economic Review, 110(3), March 2020

with Gita Gopinath, Emine Boz, Camila Casas, Federico Diez and Mikkel Plagborg-Møller. We propose a "dominant currency paradigm" with three key features: dominant currency pricing, pricing complementarities, and imported inputs in production. We test this paradigm using a new dataset of bilateral price and volume indices for more than 2,500 country pairs that covers 91 percent of world trade, as well as detailed firm-product-country data for Colombian exports and imports. In strong support of the paradigm we find that (i) non-commodities terms-of-trade are uncorrelated with exchange rates; (ii) the dollar exchange rate quantitatively dominates the bilateral exchange rate in price pass-through and trade elasticity regressions, and this effect is increasing in the share of imports invoiced in dollars; (iii) US import volumes are significantly less sensitive to bilateral exchange rates, compared to other countries' imports; (iv) a 1 percent US dollar appreciation against all other currencies predicts a 0.6 percent decline within a year in the volume of total trade between countries in the rest of the world, controlling for the global business cycle. We characterize the transmission of, and spillovers from, monetary policy shocks in this environment.

Also available as NBER WP 22943. The latest version of this paper combines two earlier papers: Casas et al. (2017) and Boz et al. (2017)

The International Monetary and Financial System , August 2019, Annual Review of Economics, Vol. 11, 2019, pp. 859–893

with Hélène Rey and Maxime Sauzet. International currencies fulfill different roles in the world economy, with important synergies across those roles. We explore the implications of currency hegemony for the external balance sheet of the United States, the process of international adjustment, and the predictability of the US dollar exchange rate. We emphasize the importance of international monetary spillovers and of the exorbitant privilege, and we analyze the emergence of a new Triffin dilemma.

The Safe Assets Shortage Conundrum, Journal of Economic Perspectives, Summer 2017

available from AEAWeb .

with Ricardo Caballero and Emmanuel Farhi. A safe asset is a simple debt instrument that is expected to preserve its value during adverse systemic events. The supply of safe assets, private and public, has historically been concentrated in a small number of advanced economies, most prominently the United States. Over the last few decades, with minor cyclical interruptions, the supply of safe assets has not kept up with global demand. The reason is straightforward: the collective growth rate of the advanced economies that produce safe assets has been lower than the world's growth rate, which has been driven disproportionately by the high growth rate of high-saving emerging economies such as China. The signature of this growing shortage is a steady increase in the price of safe assets; equivalently, global safe interest rates must decline, as has been the case since the 1980s. The early literature, brought to light by Ben Bernanke's famous "savings glut" speech of 2005, focused on a general shortage of assets without isolating its safe asset component. The distinction, however, has become increasingly important over time, particularly in the aftermath of the subprime mortgage crisis and its sequels. We begin by describing the main facts and macroeconomic implications of safe asset shortages. Faced with such a structural conundrum, what are the likely short- to medium-term escape valves? We analyze four of them, each with its own macroeconomic and financial trade-offs.

When Bonds Matter: Home Bias in Goods and Assets, Journal of Monetary Economics, September 2016, 82.

with Nicolas Coeurdacier. This paper presents a model of international portfolios with real exchange rate and non-financial risks that account for observed levels of equity home bias. Bonds matter: in equilibrium, investors structure their bond portfolio to hedge real exchange rate risks. Equity home bias arises when non-financial income risk is negatively correlated with equity returns, after controlling for bond returns. Our framework allows us to derive equilibrium bond and equity portfolios in terms of directly measurable hedge ratios. An empirical application to G-7 countries finds strong empirical support for the theory. We are able to account for a significant share of the equity home bias and obtain an aggregate currency exposure of bond portfolios comparable to the data.

Also available as: NBER WP 17560 and CEPR DP 8649.

Capital Flows to Developing Countries: The Allocation Puzzle, Review of Economic Studies, October 2013, 80(4).

with Olivier Jeanne. The textbook neoclassical growth model predicts that countries with faster productivity growth should invest more and attract more foreign capital. We show that the allocation of capital flows across developing countries is the opposite of this prediction: capital does not flow more to countries that invest and grow more. We call this puzzle the "allocation puzzle". Using a wedge analysis, we find that the pattern of capital flows is driven by national saving: the allocation puzzle is a saving puzzle. Further disaggregation of capital flows reveals that the allocation puzzle is also related to the pattern of accumulation of international reserves. The solution to the 'allocation puzzle', thus, lies at the nexus between growth, saving, and international reserve accumulation. We conclude with a discussion of some possible avenues for research.

Also available as: CEPR DP 6561, NBER WP 13602.

[Online Appendix: available here (pdf).]

[Data Appendix: available here (zip file).]

The Financial Crisis and The Geography of Wealth Transfers, Journal of International Economics, November 2012, 88(2)

with Hélène Rey and Kai Truempler. This paper studies the geography of wealth transfers between 2007Q4 and 2008Q4, at the height of the global financial crisis. We construct valuation changes on bilateral external positions in equity, direct investment and portfolio debt to measure who benefited and who lost on their external exposure. We find a very diverse set of fortunes governed by the structure of countries' external portfolios. In particular, we are able to relate the gains and losses on debt portfolios to the country's exposure to ABS, ABCP conduits and the extent of dollar shortage.

Also available as NBER WP17353 and CEPR DP8567.

[Appendix: Online appendix here. The datafile is available here in ".xlsx" format. The heatmaps are also available here: Total, Portfolio Equity, Portfolio Debt, Direct Investment, Currency.]

Stories of the Twentieth Century for the Twenty-First, American Economic Journal: Macroeconomics, January 2012, 4(1)

with Maury Obstfeld. A key precursor of twentieth-century financial crises in emerging and advanced economies alike was the rapid buildup of leverage. Those emerging economies that avoided leverage booms during the 2000s also were most likely to avoid the worst effects of the twenty-first century's first global crisis. A discrete-choice panel analysis using 1973-2010 data suggests that domestic credit expansion and real currency appreciation have been the most robust and significant predictors of financial crises, regardless of whether a country is emerging or advanced. For emerging economies, however, higher foreign exchange reserves predict a sharply reduced probability of a subsequent crisis.

Also available as NBER WP17252 and CEPR DP8518.

[Online Appendix: dataset and online appendix available here.]

[Media coverage: Vox-EU column]

International Prices, Cost and Markup Differences, American Economic Review, 101(6), 2011

with Gita Gopinath, Chang-Tai Hsieh and Nick Li. Relative cross-border retail prices, in a common currency, comoves closely with the nominal exchange rate. Using a data set with product level retail prices and wholesale costs for a large grocery chain operating in the U.S. and Canada, we decompose this variation into relative wholesale costs and relative markup components. We find that the correlation of the nominal exchange rate with the real exchange rate is mainly driven by changes in relative wholesale costs, arguably the most tradable component of a retailer's costs. We then measure the extent to which national borders impose additional costs that segment markets across countries. We show that retail prices respond to changes in wholesale costs in neighboring stores within the same country but not to changes in wholesale costs in a neighboring store located across the border. In addition, we find a median discontinuous change in retail and wholesale prices of 24 percent at the international border. By contrast, the median discontinuity is 0 percent for state and provincial boundaries.

Earlier version circulated under the title "Estimating the Border Effect: Some New Evidence", CEPR DP7281, NBER WP 14938.

[Appendix: Map of our retailer's distribution centers , also available as a google map.]

An Equilibrium Model of `Global Imbalances' and Low Interest Rates, American Economic Review, 98(1), March 2008.

with Ricardo Caballero and Emmanuel Farhi. Three of the most important recent facts in global macroeconomics --- the sustained rise in the US current account deficit, the stubborn decline in long run real rates, and the rise in the share of US assets in global portfolios --- appear as anomalies from the perspective of conventional wisdom and models. Instead, in this paper we provide a model that rationalizes these facts as an equilibrium outcome stemming from the heterogenity in different regions of the world in their capacity to generate financial assets from real investments. In extensions of the basic model, we also generate exchange rate and FDI excess returns which are broadly consistent with the recent trends in these variables. Beyond the specific sequence of events that motivate our analysis, the framework is flexible enough to shed light on a range of scenarios in a global equilibrium environment.

Also available as: CEPR DP5573, NBER WP11996.

[Media coverage: Economic Principals, The Economist]

International Financial Adjustment, Journal of Political Economy, 115(4), August 2007.

with Hélène Rey. We explore the implications of a country's external constraint for the dynamics of net foreign assets, returns and exchange rates. Deteriorations in external accounts imply future trade surpluses (trade channel) or excess returns on the net foreign portfolio (valuation channel). Using a new dataset on US gross external positions, we find that stabilizing valuation effects contribute 27% of the cyclical external adjustment. Our approach has asset pricing implications: external imbalances predict net foreign portfolio returns one-quarter to two-years ahead and net export growth at longer horizons. The exchange rate is forecastable in and out-of-sample at one quarter and beyond.

Also available as: CEPR DP4923, NBER WP11155.

[Online Appendix: available here. Longer and more detailed working paper version available here]

[Media coverage: Financial Times, Il Sole 24 Ore, Handelsblatt, Le Monde, Reuters]

[Data: Gross positions and total nominal returns by asset class, flows, NXA are available here.]

The Elusive Gains from International Financial Integration, Review of Economic Studies, 73(3), July 2006

with Olivier Jeanne. Standard theoretical arguments tell us that countries with relatively little capital benefit from financial integration as foreign capital flows in and speeds up the process of convergence. We show in a calibrated neoclassical model that conventionally measured welfare gains from this type of convergence appear relatively limited for the typical emerging market country. The welfare gain from switching from financial autarky to perfect capital mobility is roughly equivalent to a 1% permanent increase in domestic consumption for the typical non-OECD country. This is negligible relative to the welfare gain from a take-off in domestic productivity of the magnitude observed in some of these countries.

Also available as: CEPR DP3902, NBER WP9684.

Exchange Rate Puzzles and Distorted Beliefs, Journal of International Economics, 64(2), December 2004

with Aaron Tornell. This paper proposes a new explanation for the foreign exchange forward-premium and delayed-overshooting puzzles. It shows that both puzzles arise from a systematic distortion in investors' beliefs about the interest rate process. Accordingly, the forward premium is always a biased predictor of future depreciation; the bias can be so severe as to lead to negative coefficients in the 'Fama' regression. Delayed overshooting may or may not occur depending upon the persistence of interest rate innovations and the degree of misperception. We document empirically the extent of this distortion using survey data for G-7 countries against the U.S. and find that it is strong enough to account for these irregularities.

This is a much revised version of Exchange Rates Dynamics, Learning and Misperception, also available as CEPR DP3725, NBER WP9391.

Consumption over the LifeCycle, Econometrica, 70(1), January 2002

with Jonathan Parker. This paper estimates a structural model of optimal life-cycle consumption expenditures in the presence of realistic labor income uncertainty. We employ synthetic cohort techniques and Consumer Expenditure Survey data to construct average age-profiles of consumption and income over the working lives of typical households across different education and occupation groups. The model fits the profiles quite well. In addition to providing reasonable estimates of the discount rate and risk aversion, we find that consumer behavior changes strikingly over the lifecycle. Young consumers behave as buffer-stock agents. Around age 40, the typical household starts accumulating liquid assets for retirement and its behavior mimics more closely that of a certainty equivalent consumer. Our methodology provides a natural decomposition of saving and wealth into its precautionary and life-cycle components.

Also available as: CEPR DP2345, NBER WP7271.

[Data: Final inputs into the estimation program are here (this includes the income and consumption profiles of figures 2-4).]

[Code: Gauss code available here.]

Lending Booms: Latin America and the World, Economia, 1(2), Spring 2001

with Rodrigo Valdes and Oscar Landerretche. Many theories of external crisis put lending booms at the root of financial collapses. Yet lending booms may be a natural consequence of economic development and fluctuations. So are lending booms dangerous? In this paper, we investigate empirically this question using a broad sample of lending boom episodes over 40 years, with a special eye for Latin America. Our results indicate that lending booms are often associated with a domestic investment boom; an increase in domestic interest rates; a worsening of the current account; a declines in reserves; a real appreciation; a decline in output growth. `Typical' lending booms, however, do not increase substantially the vulnerability of the banking sector or the balance of payments. Comparing Latin America and the rest of the world, we find that Latin America lending booms make the economy considerably more volatile and vulnerable to financial and balance of payment crisis.

Also available as: CEPR DP2811, NBER WP8249.

[Data: data and programs available here. All the data is available in Gauss matrix format (extension *.fmt) and as ASCII file (extension *.ASC). See the Readme.txt file.]

[Media Coverage: NBER Digest, September 2001.]

Exchange Rates Do Matter: French Job Reallocation and Exchange Rate Turbulence, 1984-1992, European Economic Review, 43(7), June 1999

This paper evaluates the impact of exchange rate fluctuations on inter- and intra-sectoral job reallocation. First, a vintage model of factor reallocation in a small open economy facing real exchange rate fluctuations is developed. Movements in the real exchange rates affect the profitability of production units, and the pattern of entry and exit. The model predicts a bunching' of entry and exit around the peak of predictable appreciation episodes, as less productive firms are cleansed and newcomers adopt more efficient technologies. The paper then investigates empirically the pattern of job creation and destruction in response to real exchange rate movements in France between 1984 and 1992, using disaggregated firm level data. Traded-sector industries are very responsive to real exchange rate movements. In the benchmark estimation, a 1% appreciation of the real exchange rate destroys 0.95% of tradable jobs over the next two years. Further, job creation is more volatile than job destruction. The results indicate the importance of large unanticipated changes in the real exchange rate.

Federal Transfers, Decentralization and the Labor Market, Annales d'Economie et de Statistique, 45, April 1997

This paper analyzes the case for fiscal federal transfers in a Monetary Union. Looking at the labor market structure, it emphasizes the incentive effect of any federal transfer scheme insuring workers against bad draws. When the wage negotiation process occurs at the national level and the federal government has incomplete information on the bargaining process, workers have an incentive to ask ex-ante for higher wages. This may negatively affect the macroeconomic performance in the federation. The first best solution consists in shifting the wage bargaining process from the national to the federal level. Looking at the issue of fiscal federalism, however, the paper shows that it is always optimal to keep federal transfers. Moreover, decentralized policies are only effective when access to financial markets are imperfect.

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