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Working Paper
Bank Risk-Taking and Monetary Policy Transmission: Evidence from China
We present evidence that monetary policy easing reduces bank risk-taking but exacerbates capital misallocation in China after implementing the Basel III capital regulationsin2013. Thenewregulationstightenedbankcapitalrequirementsandintroduced a new risk-weighting approach to calculating the capital adequacy ratio (CAR). To meet tightened capital requirements, a bank can boost its effective CAR by raising capital or by increasing the share of lending to low-risk borrowers. Using confidential loan-level data from a large Chinese commercial bank, merged with firm-level data on a large set of ...
Working Paper
When do inventories destabilize the economy? an analytical approach to (S,s) policies
Conventional wisdom has it that inventory investment destabilizes the economy because it is procyclical to sales. Khan and Thomas (2007) show that the conventional wisdom is wrong in a general equilibrium (S,s) model with capital. We argue that their finding is not robust?the conventional wisdom can still hold in general equilibrium if firms can adjust output by varying the capacity utilization rate. Our result also holds true if there exist investment adjustment costs. Unlike the existing (S,s) inventory literature that relies on the Krusell-Smith (1998) numerical solution methods, we ...
Working Paper
Two-way capital flows and global imbalances: a neoclassical approach
Financial capital and fixed capital tend to flow in opposite directions between poor and rich countries. Why? What are the implications of such two-way capital flows for global trade imbalances and welfare in the long run? This paper introduces frictions into a standard two- country neoclassical growth model to explain the pattern of two-way capital flows between emerging economies (such as China) and the developed world (such as the United States). We show how underdeveloped credit markets in China can lead to abnormally high rate of returns to fixed capital but excessively low rate of ...
Working Paper
What inventories tell us about aggregate fluctuations -- a tractable approach to (S,s) policies
We estimate a DSGE model with (S,s) inventory policies. We find that (i) taking inventories into account can significantly improve the empirical fit of DSGE models in matching the standard business-cycle moments (in addition to explaining inventory fluctuations); (ii) (S,s) inventory policies can significantly amplify aggregate output fluctuations, in contrast to the findings of the recent general-equilibrium inventory literature; and (iii) aggregate demand shocks become more important than technol- ogy shocks in explaining the business cycle once inventories are incorporated into the model. ...
Working Paper
Financial development and long-run volatility trends
Countries with more developed financial markets tend to have significantly lower aggregate volatility. This relationship is also highly non-linear starting from a low level of financial development the reduction in aggregate volatility is far more significant with respect to financial deepening than when the financial market is more developed. We build a fully-edged heterogeneous-agent model with an endogenous financial market of private credit and debt to rationalize these stylized facts. We show how financial development that promotes better credit allocations under more relaxed borrowing ...
Working Paper
Interest-Rate Liberalization and Capital Misallocations
We study the consequences of interest-rate liberalization in a two-sector general equilibrium model of China. The model captures a key feature of China's distorted financial system: state-owned enterprises (SOEs) have greater incentive to expand production and easier access to credit than private firms. In this second-best environment, interest-rate liberalization can improve capital allocations within each sector, but can also exacerbate misallocations across sectors. Under calibrated parameters, the liberalization policy can reduce aggregate productivity and welfare unless other policy ...