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Working Paper
Quantitative Easing and Direct Lending in Response to the COVID-19 Crisis
When the COVID-19 crisis hit the economy in 2020, the Federal Reserve responded with numerous programs designed to prevent a collapse in bank credit and firms’ available funds. I develop a dynamic general equilibrium model to study how these programs work and to evaluate their effectiveness. In the model, quantitative easing works through three channels: the expansion of bank reserves lowers a liquidity premium, the purchase of assets lowers a volatility risk premium, and the economic stimulus lowers a credit risk premium. Since bank reserves are currently larger than in the past, the ...
Journal Article
The Flattening of the Phillips Curve: Policy Implications Depend on the Cause
According to the historical relationship known as the Phillips curve, strengthening of the economy is commonly associated with increasing inflation. With inflation having only modestly picked up in the past few years as the economy has become more robust, many believe the Phillips curve relationship has weakened, with the curve becoming flatter. I show that the flattening can be due to very different types of structural changes and that knowing the type of change that has occurred is crucial for choosing the appropriate monetary policy.
Working Paper
Debt-Overhang Banking Crises
This paper studies how a worsening of the debt overhang distortion on bank lending can explain banking solvency crises that are accompanied by a plunge of bank asset values and by a severe contraction of lending and economic activity. Since the value of bank assets depends on economic prospects, a pessimistic view of the economy can be self-fulfilling and can trigger a financial crisis: If economic prospects are poor, bank asset values decline, the bank risk of default rises, and the associated debt overhang distortion worsens. The worsening of the distortion leads to a contraction in bank ...
Working Paper
Leverage, investment, and optimal monetary policy
We study optimal monetary policy in an economy where firms? debt overhangs lead to under-investment and under-production. The magnitude of this debt-induced distortion varies over the business cycle, rising significantly during recessions. When debt is contracted in nominal terms, this distortion gives rise to a balance sheet channel for monetary policy. In the presence of real and financial shocks, the monetary authority faces a trade-off between inflation and output gap stabilization. The optimal monetary policy rule prescribes that the anticipated component of inflation should be set equal ...
Working Paper
The 2012 Eurozone Crisis and the ECB’s OMT Program: A Debt-Overhang Banking and Sovereign Crisis Interpretation
This paper develops a model to interpret the 2012 eurozone crisis and the ECB?s policy response. In the model, bank lending is distorted by debt overhang, banks hold sovereign bonds, and the government guarantees the bailout of bank creditors. A self-fulfilling pessimistic view of the economy can trigger a banking and sovereign crisis: with pessimistic economic expectations, the value of sovereign bonds declines, the bank risk of default rises, and the debt overhang distortion worsens; this leads to a contraction in bank lending and to a decline in economic activity, which confi rms the ...
Journal Article
Central Bank Lending in a Liquidity Crisis
Solvent banks may appear insolvent in the midst of a liquidity crisis, due to the plunge of their assets? value below their normal value. The responsibility of the central bank is to provide liquidity to the banks that would be solvent under normal economic conditions, at lending terms consistent with normal market conditions.
Journal Article
The Overhang of Structures before and since the Great Recession
Investment in structures is still 29 percent below its pre-recession peak. Using a new indicator of the level of structures that would be warranted by economic conditions, we find evidence that the level of investment was too high in the first half of the 2000s. This overinvestment created an overhang of structures which has held down the growth of investment in structures during the recovery.
Working Paper
The Optimal Response of Bank Capital Requirements to Credit and Risk in a Model with Financial Spillovers
This paper studies optimal bank capital requirements in an economy where bank losses have financial spillovers. The spillovers amplify the effects of shocks, making the banking system and the economy less stable. The spillovers increase with banks? financial distortions, which in turn increase with banks? credit risk. Higher capital requirements dampen the current supply of banks? credit, but mitigate banks? future financial distortions. Capital requirements should be raised in response to both an expansion of banks? credit supply and an increase in the expected future credit risk of banks. ...
Journal Article
Labor's declining share of income and rising inequality
Labor income has been declining as a share of total income earned in the United States for the past three decades. We look at the past effect of the labor share decline on income inequality, and we study the likely future path of the labor share and its implications for inequality.
Journal Article
Is debt overhang causing firms to underinvest?
Many economists have suggested that the weakness of corporate balance sheets is constraining business spending and investment, and that this in turn is impeding growth and the recovery. High levels of debt can depress spending and investment through several channels. This Commentary explains one of them?debt overhang can cause firms to underinvest?and points to ways in which this effect might be inhibiting the recovery.