469 research outputs found
A crash course on crises: macroeconomic concepts for run-ups, collapses , and recoveries
No full textWith alarming frequency, modern economies go through macro-financial crashes that arise from the financial sector and spread to the broader economy, inflicting deep and prolonged recessions. A Crash Course on Crises brings together the latest cutting-edge economic research to identify the seeds of these crashes, reveal their triggers and consequences, and explain what policymakers can do about them. Each of the book’s ten self-contained chapters introduces readers to a key economic force and provides case studies that illustrate how that force was dominant. Markus Brunnermeier and Ricardo Reis show how the run-up phase of a crisis often occurs in ways that are preventable but that may go unnoticed and discuss how debt contracts, banks, and a search for safety can act as triggers and amplifiers that drive the economy to crash. Brunnermeier and Reis then explain how monetary, fiscal, and exchange-rate policies can respond to crises and prevent them from becoming persistent. With case studies ranging from Chile in the 1970s to the COVID-19 pandemic, A Crash Course on Crises synthesizes a vast literature into ten simple, accessible ideas and illuminates these concepts using novel diagrams and a clear analytical framework
The pass-through of monetary rates to bank interest rates: implications for monetary policy
No full textI study the pass-through of monetary rates into bank interest rates using both empirical and theoretical methods. I use the results of my study to derive implications for the conduct of monetary policy. Chapter 1, co-authored with Cynthia Balloch, provides theory and evidence that banks’ profitability and credit supply fundamentally depend on the level of nominal interest rates. I use a forty-year panel of Japanese banks to show that their profitability and lending terms depend on the level of nominal interest rates. These facts hold in the aggregate and in the cross-section, where I exploit bank heterogeneity. I build a macroeconomic model that rationalizes these facts and use it to study the implications for the aggregate supply of credit and the choice of an optimal inflation target.
Chapter 2 , co-authored with Markus Brunnermeier, studies how bank lending reacts to monetary policy shocks in very-low or negative interest rate environments. In such environments, further decrease in rates can lead to lower bank profitability if banks are not sufficiently hedged, generating lower credit supply when their credit constraints bind. When these effects dominate the stimulatory effects of monetary shocks coming from presence of sticky prices, monetary policy reaches a “reversal rate” below which interest rate cuts are contractionary for lending.
Chapter 3 studies how banks pass-through changes in monetary rates into their bank product. I study both bank assets, such as loans, and bank liabilities, such as various forms of deposits. I show that there is significant heterogeneity across products, and that the pass-through is highly non-linear, with dependence on the direction of the change as well as the economy’s state. The heterogeneity in bank product pass-through delivers heterogeneous pass-through to households that positively correlate with their liquid wealth. I show in a heterogenous-agents New Keynesian model that this reduces monetary policy propagation, affects the Taylor principle, and makes any effective lower bound – such as the reversal rate – bind more often
The Euro area's macroeconomic balancing act
No full textThe European Systemic Risk Board (ESRB) and the proposed prevention and correction of macroeconomic imbalances regulation (EIP) are designed to avoid imbalances. However, these instruments overlap, and need clarification.
Both the ESRB and the Commission, which is given certain powers by the EIP, must identify and act early on risks. Acting in the face of strong economic and political pressure is difficult. Complementing the current approach with transparent and rules-based mechanisms will reduce this problem.
The EIP and ESRB can complement each other in terms of analysis and policy, and close collaboration will be vital. The EIP regulation can be used to ensure that ESRB recommendations are followed up. In the area of financial recommendations relevent to macroeconomic imbalances, the Commission should have a more formal requirement to act on ESRB recommendations. The EIP regulation would benefit from a clause allowing recommendations to be addressed not only to member states.
Conflicts between the ESRB and Commission could arise. In this case, the Treaty requires the Commission to issue a recommendation even if the ESRB issues a negative finding.
Legally, it might not be possible to exclude the use by the Commission of confidential information obtained in the ESRB.
Essays on Interest Rates, Exchange Rates and Flight to Safety
No full textThis dissertation consists of three independent chapters on interest rate dynamics and international macroeconomic policies. The first chapter presents new empirical evidence connecting the banking sector and the dynamics of the federal funds rate, and the rest two chapters study topics in international macroeconomic policies.
In the first chapter, I document that the income gap, a measure of banks’ interest-rate risk exposure, strongly forecasts future changes in the federal funds rate at the one-year horizon before the 2008 financial crisis. The forecasting power comes from predicting the unexpected component of the federal funds rate relative to market expectations. I show that the income gap’s predictability of the unexpected component in the short rate leads to bond excess return predictability. I present additional evidence to support the view that the bond excess return predictability of the income gap does not result from a risk-premium-based explanation.
The second chapter presents a model to study a signaling channel of policies aiming to stabilize the nominal exchange rate. For small open economics, nominal exchange rate devaluation is an important tool for aggregate demand management. Ex-ante commitment to stabilize exchange rate reduces ex-post flexibility of deploying exchange rate devaluation in the face of shortfall of aggregate demand. As a result, such commitment can serve as a costly signal for informing foreign investors about the country’s fundamentals. The model presents a new rationale for stabilizing exchange rates absent concerns for financial stability.
The third chapter, co-authored with Markus Brunnermeier, studies fickle international capital flows induced by flight-to-safety. We provide a model of the flight-to-safety crisis. Domestic investors have to co-invest in a safe asset and physical capital. In times of crisis, investors replace the initially safe domestic government bonds with safe US Treasuries and fire-sell part of their capital. The reduction in physical capital lowers GDP and tax revenue, leading to increased default risk justifying the loss of the government bond’s safe-asset status. We compare different ways to mitigate this self-fulfilling scenario
Deciphering the Liquidity and Credit Crunch 2007-08
No full textThis paper summarizes and explains the main events of the liquidity and credit crunch in 2007-08. Starting with the trends leading up to the crisis, I explain how these events unfolded and how four different amplification mechanisms magnified losses in the mortgage market into large dislocations and turmoil in financial markets.
Essays on Liquidity, Information, and Macroeconomics
No full textChapter 1 proposes a theory of credit cycles driven by the private production of opaque, liquid assets (e.g., ABS or CLOs). Opacity enhances assets' liquidity, permitting greater issuance volumes, but prevents investors from determining whether the underlying projects are of low quality. Strong macroeconomic fundamentals give rise to credit booms characterized by opaque asset origination and pervasive credit misallocation. As bad projects build up in the economy, investors begin to question the value of opaque assets and eventually refuse to finance them altogether, precipitating a collapse in investment. The bust has a cleansing effect: opaque origination is abandoned, and investors no longer finance projects whose quality they cannot evaluate. I show that a policymaker would limit opaque intermediation during booms in order to moderate the subsequent bust.
Chapter 2 presents a model in which agents with heterogeneous beliefs borrow by using a physical asset and the liabilities of other agents as collateral. In equilibrium, a chain of lending emerges: each agent lends to the next-most optimistic agent and borrows from the next-most pessimistic agent. Intermediation allows optimists to lever up while pessimists invest in safe assets. In extensions of the benchmark model, I examine the implications of this arrangement for financial stability and relate the model's predictions to stylized facts.
Chapter 3, which was co-authored with Markus Brunnermeier, develops a model of digital record-keeping. Traditional centralized record-keeping systems establish a consensus based on trust in the record-keeper. Trust arises from the ability to incentivize honest reporting. Rents extracted by the record-keeper create an internal source of trust, allowing the system to be self-sufficient. Blockchains decentralize record-keeping, dispensing with the need for trust in a single entity. Some build a consensus based on externally verifiable resource costs (proof-of-work), whereas others do not (proof-of-stake). We prove a Blockchain Trilemma: it is impossible for any digital record-keeping system to simultaneously be (i) self-sufficient, (ii) rent-free, and (iii) resource-efficient. Record-keeping systems without rents or resource costs must ultimately rely on some external source of trust
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