Business cycles in emerging economies: the role of interest rates
We find that in a sample of emerging economies business cycles are more volatile than in developed ones, real interest rates are countercyclical and lead the cycle, consumption is more volatile than output and net exports are strongly countercyclical. We present a model of a small open economy, where the real interest rate is decomposed in an international rate and a country risk component. Country risk is affected by fundamental shocks but, through the presence of working capital, also amplifies the effects of those shocks. The model generates business cycles consistent with Argentine data. ...
International business cycles with endogenous incomplete markets
Backus, Kehoe and Kydland (1992), Baxter and Crucini (1995) and Stockman and Tesar (1995) find two major discrepancies between standard international business cycle models with complete markets and the data: In the models, cross-country correlations are much higher for consumption than for output, while in the data the opposite is true; and cross-country correlations of employment and investment are negative, while in the data they are positive. This paper introduces a friction into a standard model that helps resolve these anomalies. The friction is that international loans are imperfectly ...
Capital Requirements and Bailouts
We use balance sheet data and stock market data for the major U.S. banking institutions during and after the 2007-8 financial crisis to estimate the magnitude of the losses experienced by these institutions because of the crisis. We then use these estimates to assess the impact of the crisis under alternative, and higher, capital requirements. We find that substantially higher capital requirements (in the 20% to 30% range) would have substantially reduced the vulnerability of these financial institutions, and consequently they would have significantly reduced the need of a public bailout.
The paper studies a fiscal policy instrument that can reduce fiscal distortions, without affecting revenues, in a politically viable way. The instrument is a private contract (tax buyout), offered by the government to each individual citizen, whereby the citizen can choose to pay a fixed price up front in exchange for a given reduction in her tax rate for a prespecified period of time. We consider a dynamic overlapping-generations economy, calibrated to match several features of the U.S. income and wealth distribution, and show that, under simple pricing, the introduction of the buyout is ...
Inflation, Debt, and Default
We study how the co-movement of inflation and economic activity affects real interest rates and the likelihood of debt crises. First, we show that for advanced economies, periods with procyclical inflation are associated with lower real interest rates. Procyclical inflation implies that nominal bonds pay out more in bad times, making them a good hedge against aggregate risk. However, such procyclicality also increases sovereign default risk when the economy deteriorates, since the government needs to make larger (real) payments. In order to evaluate both effects, we develop a model of ...
Competitive equilibria with limited enforcement
Previous literature has shown that the study and characterization of constrained efficient allocations in economies with limited enforcement is useful to understand the limited risk sharing observed in many contexts, in particular between sovereign countries. In this paper we show that these constrained efficient allocations arise as equilibria in an economy in which private agents behave competitively, taking as given a set of taxes. We then show that these taxes, which end up limiting risk sharing, arise as an equilibrium of a dynamic game between governments. Our decentralization is ...
Does income inequality lead to consumption equality? evidence and theory
Using data from the Consumer Expenditure Survey, we first document that the recent increase in income inequality in the United States has not been accompanied by a corresponding rise in consumption inequality. Much of this divergence is due to different trends in within-group inequality, which has increased significantly for income but little for consumption. We then develop a simple framework that allows us to analytically characterize how within-group income inequality affects consumption inequality in a world in which agents can trade a full set of contingent consumption claims, subject to ...
Exchange Rate Policies at the Zero Lower Bound
We study how a monetary authority pursues an exchange rate objective in an environment that features a zero lower bound (ZLB) constraint on nominal interest rates and limits to international arbitrage. If the nominal interest rate that is consistent with interest rate parity is positive, the central bank can achieve its exchange rate objective by choosing that interest rate, a well-known result in international ?nance. However, if the rate consistent with parity is negative, pursuing an exchange rate objective necessarily results in zero nominal interest rates, deviations from parity, capital ...
Exchange rate overshooting and the costs of floating
Currency crises are usually associated with large nominal and real depreciations. In some countries depreciations are perceived to be very costly (?fear of floating?). In this paper we try to understand the reasons behind this fear. We first look at episodes of currency crises in the 1990s and establish that countries entering a crisis with high levels of foreign debt tend to experience large real exchange rate overshooting (devaluation in excess of the long run equilibrium level) and large output contractions. We the develop an model of an open economy with monopolistic competition and ...