Research

Optimal macroprudential policy with preemptive bailouts

• I study the optimal regulation of a banking system in a Gertler and Kiyotaki economy. Bankers issue deposits to households and use their own net worth to invest in productive firms subject to an enforcement constraint: the forward-looking bank value cannot be less than the value of default. I show that a benevolent policymaker has two distinct objectives. First, the optimal policy induces private bankers internalize the pecuniary externalities inherent in the enforcement constraint. An optimal linear deposit tax financed with a net worth subsidy is effective for that matter, while regulatory capital requirements are generally not. Second, the optimal policy rewards survival of banks by tilting the bank value distribution from entrants to survivors, which mitigates the enforcement friction in the first place. A way to achieve the latter is to introduce variation in net worth subsidies between the two groups of banks. The future subsidies to survivors---``preemptive bailouts''---relax the enforcement constraint of the banking system as whole, decreasing the probability of financial crises. Quantitatively, unregulated banks underborrow and underlend compared to the optimal allocation under commitment, and similar conclusions arise in the context of Markov perfect equilibria without commitment.

On optimal time-consistent macroprudential policy (with Gianluca Benigno and Alessandro Rebucci)

• Bianchi and Mendoza (2018) characterize the optimal time-consistent debt tax that implements the constrained efficient allocation and suggest that the key element of the optimal policy is its ex-ante (tax) component. We show that the ex-post (subsidy) component of the optimal policy---active when the collateral constraint binds akin to classic lending of last resort interventions---is critical for its effectiveness and welfare gains. When we restrict the optimal time-consistent policy problem to ex-ante interventions only, we find that the resulting policy entails welfare losses. The (time-inconsistent) ex-ante component of the unrestricted policy generates significantly smaller welfare gains than the optimal time-consistent policy.

Financial constraints, risk sharing, and optimal monetary policy (SSRN, RePEc)

• 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.

Financial dollarization, exchange rate, and macroprudential policy (with Cheng Ding and Vivian Yue)

• Financial dollarization is widespread in emerging economies. On the one hand, liability dollarization makes borrowers more vulnerable to currency crises. On the other hand, credit dollarization serves as an insurance device for domestic savers. We consider a small open economy, in which domestic households and experts trade in home-currency assets, foreign investors trade with domestic agents in foreign-currency assets, and the price-setting for nontradable goods is subject to a nominal rigidity. The optimal exchange rate policy must account for both the price distortions and the costs and benefits of financial dollarization.

Informality and macroprudential policy (with Carla Moreno)

• 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.

Labor migration and offshoring in markets with self-selection (with Federico Mandelman)

• 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.