Optimal macroprudential policy with preemptive bailouts. (Job market paper) Slides
I study the optimal regulation of a banking system in a quantitative general equilibrium environment with endogenously incomplete markets. 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. Pecuniary externalities affect the forward-looking bank value and the value of default through asset prices and asset returns, justifying system-wide regulation, e.g., in the form of balance sheet taxation or minimum capital requirements. An alternative way to improve welfare is through "preemptive bailouts": expected future transfers relax today's financial constraints, mitigating the enforcement friction and decreasing the probability of financial crises. Quantitatively, unregulated banks overborrow and overlend compared to the Markov perfect equilibrium outcome but underborrow and underlend compared to the Ramsey outcome.
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.
Collateral constraints and the informal economy (with Carla Moreno). (November 2021)
We study how occasionally binding endogenous collateral constraints affect entrepreneurs' decisions to hire workers on an informal basis. By increasing the share of informal but less productive workers, entrepreneurs require less working capital and can borrow more in the financial market. On the other hand, lower average labor productivity decreases output, the demand for capital, and the collateral asset price, tightening the financial constraint. Nonlinear trade-offs arise when the optimal quantity of borrowing approaches the net value of collateral.
We study optimal government policy in small open economies with stock collateral constraints dependent on asset prices. We show that under fairly general conditions, a benevolent policymaker can use the tax on debt to implement the unconstrained first-best allocation. The optimal policy is not Markovian but time consistent. Compared to the optimal allocation, the unregulated competitive equilibrium features underborrowing, contrary to the conventional view.
Labor migration and offshoring in markets with self-selection (with Federico Mandelman). (January 2021)
We study the general equilibrium effects of unskilled labor migration and skilled labor offshoring. Unskilled workers are employed in the domestic and foreign nontradable sectors. Skilled workers self-select into a nontradable or tradable sector based on the realization of a stochastic productivity. As unskilled immigration increases, the equilibrium wage in the domestic nontradable sector falls, and domestic skilled workers reallocate from the nontradable to the tradable sector. The aggregate domestic labor supply falls, and the aggregate consumption increases; consequently, welfare increases.
Sovereign risk, banking crises, and macroprudential policy. (September 2020)
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. The environment is then extended to that with a strategic sovereign government making endogenous default decisions under lack of commitment. The constrained efficient allocation is studied, and the optimal time-consistent government policy is characterized.
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: November 28, 2021