Research

Managing Financial Crises (with Gianluca Benigno and Alessandro Rebucci)

• In this paper, we revisit the question of how to manage financial crises in the workhorse framework proposed by Bianchi and Mendoza (2018). We show that in this model economy, there is a multiplicity of constrained-efficient equilibria that arises because the shadow value of collateral affects the forward-looking asset price. Under certain conditions, the welfare-dominant equilibrium entails the ``unconstrained allocation'' chosen by a benevolent planner subject to the country budget constraint. We show that a tax/subsidy on debt and intermediate inputs, jointly, can implement the whole set of constrained-efficient equilibria. Any such tax on debt has an ``ex ante'' component (active when the collateral constraint is slack) and an ``ex post'' component (active when the constraint binds). The tax on inputs is required only if there is a working capital constraint and only when the constraint binds. Furthermore, there is one specific equilibrium---the one studied by Bianchi and Mendoza (2018)---that can be implemented with the tax/subsidy on debt only. In the latter case, quantitatively, both ex ante (nonnegative tax) and ex post (debt subsidy) components are essential for welfare gains from the optimal time-consistent policy. Restricting either component can lead to welfare losses.

Optimal macroprudential policy with preemptive bailouts

• I study the optimal regulation of a financial sector where individual banks face self-enforcing constraints countering their default incentives. The constrained-efficient social planner can improve over the unregulated equilibrium in two dimensions. First, by internalizing the impact of banks' portfolio decisions on the prices of assets and liabilities that affect the enforcement constraints. Second, by redistributing future net worth from new entrants to surviving banks, which increases the current forward-looking value of all banks, relaxing their enforcement constraints and decreasing the probability of banking crises. The latter can be accomplished with systemic preemptive bailouts that are time consistent and unambiguously welfare improving. Unregulated banks can be both overleveraged and underleveraged depending on the state of the economy, thus macroprudential policy requires both taxes and subsidies, while minimum bank capital requirements are generally ineffective.

Financial constraints, risk sharing, and optimal monetary policy

• 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)

Informality and macroprudential policy (with Carla Moreno)