Research

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 forward-looking value of all banks today, 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. On the contrary, internalizing pecuniary externalities with macroprudential policy can lead to welfare losses if the policymaker does not have commitment and the enforcement friction is sufficiently strong. 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.

Managing financial crises (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

• 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.