Research
Working Papers
The Fiscal Theory of the Price Level with a Bubble
with Markus Brunnermeier and Yuliy Sannikov. May 2023 - Revise & Resubmit, Review of Economic Studies
Abstract: This paper extends the unique price level determination of the Fiscal Theory of the Price Level (FTPL) to environments with a bubble. The expanded FTPL equation incorporates a bubble term to explain why countries with persistently negative primary surpluses can have a positively valued government debt and currency. Appropriate off-equilibrium taxation and "fiscal space" can ensure a unique equilibrium in which the bubble stays on government debt rather than on other assets, like crypto assets. In this case, the government enjoys an exorbitant privilege and is able to continuously roll over its debt.
Previous Version (July 2022), NBER Working Paper (July 2022), CESifo Working Paper (July 2022), CEPR Working Paper (April 2020)
Global Solutions to Master Equations for Continuous Time Heterogeneous Agent Macroeconomic Models
with Zhouzhou Gu, Mathieu Lauriere and Jonathan Payne. May 2024
Abstract: We propose and compare new global solution algorithms for continuous time heterogeneous agent economies with aggregate shocks. First, we approximate the agent distribution so that equilibrium in the economy can be characterized by a high, but finite, dimensional non-linear partial differential equation. We consider different approximations: discretizing the number of agents, discretizing the agent state variables, and projecting the distribution onto a finite set of basis functions. Second, we represent the value function using a neural network and train it to solve the differential equation using deep learning tools. We refer to the solution as an Economic Model Informed Neural Network (EMINN). The main advantage of this technique is that it allows us to find global solutions to high dimensional, non-linear problems. We demonstrate our algorithm by solving important models in the macroeconomics and spatial literatures (e.g. Krusell and Smith (1998), Khan and Thomas (2007), Bilal (2023)).
Flight to Safety in a New Keynesian Model
with Ziang Li. February 2022
Abstract: Recent economic recessions feature dramatic rises in uncertainty. Empirical studies have found large-scale portfolio rebalancing towards nominally safe assets in times of high uncertainty. This paper builds a New Keynesian model with idiosyncratic risk and incomplete markets to study the transmission of uncertainty shocks through investors’ portfolio decisions and how monetary-fiscal policy can stabilize fluctuations in demand for safe assets. In response to a sudden increase in uncertainty, investors reallocate their resources from productive assets to safe assets for precautionary motives. When prices are sticky, the heightened demand for safe assets leads to overshooting in capital price, which gives rise to aggregate demand recessions. Conventional monetary policy that operates through interest rate changes alone has limited power in influencing household portfolios. Instead, fiscal policy plays a crucial role in price stabilization and optimal policy.
The Macro Implications of Narrow Banking: Financial Stability versus Growth
November 2020
Abstract: This paper builds a model of the inherent instability of a banking system based on money-creating fractional reserve banks and studies the macroeconomic implications of narrow banking, a reform proposal to overcome this instability by prohibiting bank money creation. In an economy without fractional reserve banks, the interaction between the roles of money as a store of value and a medium of exchange is inherently stabilizing: when risk premia rise and induce agents to demand more money for safety reasons, the resulting deflationary pressure makes real transaction media less scarce, lowers the money premium and thereby mitigates the overall price reaction. The presence of fractional reserve banks undermines this mechanism, as simultaneous bank losses lead banks to delever, thereby shrinking the supply of deposit money. This makes transaction media scarcer, which generates additional deflationary pressures, a Fisherian deflationary spiral emerges. Introducing narrow banking restores the stabilizing force that would prevail in a world without banks. However, narrow banking also lowers economic growth by increasing the need for government-provided outside money, which crowds out real productive investment.
COVID-19: Inflation and Deflation Pressures
with Markus Brunnermeier, Jonathan Payne, and Yuliy Sannikov. September 2020
Abstract: Pandemics can lead to rich inflation dynamics with strong inflationary as well as deflationary forces. Initially, deflationary pressures play a dominating role because idiosyncratic risk is elevated until recovery arrives. The inflation dynamics are highly dependent on government policies. Government lending programs allow the contact-intensive, distressed sector to become more indebted, which prevents deflation if the pandemic is short-lived but amplifies deflation if the pandemic lasts longer. Redistribution moderates the deflationary forces and can lead to excessive inflation in the long-run.
Stock Price Cycles and Business Cycles
with Klaus Adam. July 2019
Abstract: We present a simple model that quantitatively replicates the behavior of stock prices and business cycles in the United States. The business cycle model is standard, except that it features extrapolative belief formation in the stock market, in line with the available survey evidence. Extrapolation amplifies the price effects oftechnology shocks and - in response to a series of positive technology surprises - gives rise to a large and persistent boom and bust cycle in stock prices. Boom-bust dynamics are more likely when the risk-free interest rate is low because low rates strengthen belief-based amplification. Stock price cycles transmit into the real economy by generating inefficient price signals for the desirability of new investment.The model thus features a `financial accelerator', despite the absence of financial frictions. The financial accelerator causes the economy to experience persistent periods of over- and under-accumulation of capital.
Publications
Journal Articles
Safe Assets
(previous titles: "Debt as Safe Asset"; "Safe Assets: A Dynamic Retrading Perspective")
with Markus Brunnermeier and Yuliy Sannikov. December 2023 - forthcoming, Journal of Political Economy
Abstract: The price of a safe asset reflects not only the expected discounted future cash flows but also future service flows, since retrading allows partial insurance of idiosyncratic risk in an incomplete markets setting. This lowers the issuers' interest burden. As idiosyncratic risk rises during recessions, so does the value of the service flows bestowing the safe asset with a negative β. The resulting exorbitant privilege resolves government debt valuation puzzles and allows the government to run a permanent (primary) deficit without ever paying back its debt, but the government faces a "Debt Laffer Curve".
Working Paper Version (December 2023), NBER Working Paper (January 2022), CESifo Working Paper (December 2021)
Can a Financial Transaction Tax Prevent Stock Price Booms
with Klaus Adam, Johannes Beutel, and Albert Marcet. Journal of Monetary Economics, 2015, 76, S90-S109.
Abstract: We present a stock market model that quantitatively replicates the joint behavior of stock prices, trading volume and investor expectations. Stock prices in the model occasionally display belief-driven boom and bust cycles that delink asset prices from fundamentals and redistribute considerable amounts of wealth from less to more experienced investors. Although gains from trade arise only from subjective belief differences, introducing financial transactions taxes (FTTs) remains undesirable. While FTTs reduce the size and length of boom–bust cycles, they increase the likelihood of such cycles, thereby overall return volatility and wealth redistribution. Contingent FTTs, which are levied only above a certain price threshold, give rise to problems of equilibrium multiplicity and non-existence.
Book Chapters
A Safe-Asset Perspective for an Integrated Policy Framework
with Markus Brunnermeier and Yuliy Sannikov. In: The Asian Monetary Policy Forum: Insights for Central Banking, World Scientific Publishing Co Pte Ltd, 2021
Abstract: Borrowing from Brunnermeier and Sannikov (2016, 2019) this policy paper sketches a policy framework for emerging market economies by mapping out the roles and interactions of monetary policy, macroprudential policies, foreign exchange interventions, and capital controls. Safe assets are central in a world in which financial frictions, distribution of risk, and risk premia are important elements. The paper also proposes a global safe asset for a more self-stabilizing global financial architecture.
Other
Lecturs on Money, Macro, and Finance - A Heterogeneous-Agent Continuous-Time Approach
with Markus Brunnermeier and Yuliy Sannikov. Lecture Notes (preliminary and evolving).