Optimal macroprudential policy with redistribution. (September 2021)
I study the optimal regulation of a banking system in a quantitative general equilibrium environment. Financial intermediaries issue deposits to households under limited liability and with limited enforcement, invest in the real economy with state-contingent returns, and face survival risk. On the one hand, the individual banks tend to overborrow and overinvest due to pecuniary externalities implicit in the enforcement constraint and balance sheet effects, which exacerbates the debt-deflation mechanism when enforcement constraints occasionally bind. On the other hand, the individual institutions cannot internalize the impact of the entry-exit dynamics on the aggregate enforcement constraint of the banking system, leaving room for optimal redistribution. I characterize both the constrained efficient allocation under commitment and the optimal time-consistent allocation and show that they can be implemented with either linear taxes on bank assets and liabilities or state-contingent capital requirements. The redistribution of wealth within the banking system in the form of young/old-specific transfers is welfare-improving.
I characterize optimal government policy in a sticky-price economy with different types of consumers and endogenous financial constraints in the banking and entrepreneurial sectors. The competitive equilibrium allocation is constrained inefficient due to a pecuniary externality implicit in the collateral constraint and other externalities arising from consumer type heterogeneity. These externalities can be corrected with appropriate fiscal instruments. Independently of the availability of such instruments, optimal monetary policy aims to achieve price stability in the long run and approximate price stability in the short run, as in the conventional New Keynesian environment. Compared to the competitive equilibrium, the constrained efficient allocation significantly improves between-agent risk sharing, approaching the unconstrained Pareto optimum and leading to sizable welfare gains. Such an allocation has lower leverage in the banking and entrepreneurial sectors and is less prone to the boom-bust financial crises and zero-lower-bound episodes observed occasionally in the decentralized economy.
On (seemingly) multiple equilibria in macro-banking models. (December 2020)
Quantitative macro-banking models with enforcement constraints can have multiple deterministic steady states with different local stability properties. Yet, the same model might have a unique stochastic steady state. When this situation arises in the context of normative analyses, a researcher choosing to apply a local approximation about a stable deterministic steady state---when the enforcement constraint is either always binding or always not binding---might obtain imprecise welfare implications. It is thus important to use global solution methods to approximate equilibria in such models.
Credit market externalities and optimal monetary policy. (October 2020)
I develop a quantitative macroeconomic model with a banking sector, where banks find optimal to issue equity not because of an ad-hoc capital constraint but to mitigate "financial intermediation costs". Bank lending to entrepreneurs is collateralized. Unlike in the literature on collateralized borrowing in international financial markets, the price of debt is endogenous; therefore, in addition to a standard pecuniary externality stemming from the collateral asset price, there is an externality coming from the loan rate if the expected value of collateral must cover the value of loan repayment. I study the constrained efficient allocation and the role of capital requirements in restoring efficiency. Finally, I explore the implications of pecuniary externalities on optimal monetary policy.
Sovereign risk, banking crises, and macroprudential policy. (December 2019)
I study the transmission of sovereign risk to the banking sector from a normative perspective. Both banks and foreign lenders invest in sovereign debt that is subject to default risk. The sovereign's financial standing is a two-state Markov chain calibrated to match the observed sovereign default and exclusion events. I find that a proportional subsidy to lending to the real sector improves welfare and reduces the probability of banking crises. A bank net worth subsidy in good times combined with a tax in bad times achieves qualitatively similar but quantitatively smaller effects.
Efficient value function iteration. (October 2018) Slides
I develop a computational approach that improves the efficiency of value function iteration with a continuous choice set. The method employs linear interpolation between grid points, does not rely on numerical solvers, and convergence is guaranteed under standard assumptions. The approach can be applied to any model involving an income fluctuations problem, including many real business cycle, heterogeneous-agent, and overlapping generations models. The curse of dimensionality applies, but the method is by an order of magnitude faster than conventional value function iteration.
Updated: September 8, 2021