Consumption baskets and currency choice in international borrowing

Most emerging markets do not borrow much internationally in their own currency, although doing that has been argued as an attractive insurance mechanism. This phenomenon, commonly labeled"the original sin", has mostly been interpreted as evidence of the countries'inability to borrow in domestic currency from abroad. This paper provides a novel explanation for that phenomenon: not that countries are unable to borrow abroad in their currency, they might not need to do so. In the model, the small prevalence of external borrowing in domestic currency arises as an equilibrium outcome, despite the absence of exogenous frictions or limits on market participation. The equilibrium outcome is driven by the fact that domestic and foreign lenders have differential consumption baskets. In particular, a large part of domestic lenders'consumption basket is denominated in domestic currency whereas all of foreign lenders'is in dollars. A depreciation of domestic currency, which tends to occur in bad times, is therefore less harmful to domestic savers than to foreign investors. This makes domestic lenders require a lower premium than foreign lenders on domestic currency debt. For plausible calibrations, this consumption basket effect can induce foreign investors to pull out of the domestic currency debt market.Debt Markets,Currencies and Exchange Rates,Economic Theory&Research,Emerging Markets,Labor Policies

Essays on Financial Regulation in Macroeconomics

This dissertation investigates two aspects of how to regulate the financial sector optimally in order to increase macroeconomic stability and mitigate the risk of future financial crises. Chapter 1 analyzes the desirability of international coordination in financial regulation. It develops a two-country model of systemic liquidity risk-taking in which financial market imperfections provide a rationale for macro-prudential regulation. In the model, curbing liquidity risk-taking via regulation lowers the price of liquidity during financial crises and thereby reduces the costs associated with market incompleteness. But regulation also entails costs in the form of distortions to productive investment decisions. The discrepancy between the domestic dimension of the costs and the global dimension of the benefits of regulation generates free-riding incentives among regulators operating in different countries. The theory predicts that absent international coordination, national authorities are tempted to regulate their financial systems in a way that results in excessive illiquidity. It therefore speaks in favor of a stronger global coordination of banking regulation. Chapter 2 analyzes the social optimality of private debt maturity choices. It studies debt maturity decisions in a dynamic macroeconomic model in which financial frictions give rise to systemic risk in the form of amplification effects. Long-term liabilities provide insurance against shocks to the asset side of the balance sheet, but they come at an extra cost. The debt maturity structure therefore maps into an allocation of macroeconomic risk between lenders and leveraged borrowers, and fundamental shocks propagate more powerfully in the economy when the maturity is shorter. The market equilibrium is not constrained efficient as borrowers fail to internalize their contribution to systemic risk and take on too much short-term debt in a decentralized economy. The theory indicates that a tax on short-term debt -- a form of macroprudential policy -- leads to Pareto improvements and results in less volatile allocations and asset prices

Liquidity traps, capital flows

This version: September 7, 2017 (original version December 17, 2015)Cette version: 7 septembre 2017 (version originale : 17 décembre 2015)Motivated by debates surrounding international capital flows during the Great Recession, we conduct a positive and normative analysis of capital flows when a region of the global economy experiences a liquidity trap. Capital flows reduce inefficient output fluctuations in this region by inducing exchange rate movements that reallocate expenditure towards the goods it produces. Restricting capital mobility hampers such an adjustment. From a global perspective, constrained efficiency entails subsidizing capital flows to address an aggregate demand externality associated with exchange rate movements. Absent cooperation, however, dynamic terms-of-trade manipulation motives drive countries to inefficiently restrict capital flows, impeding aggregate demand stabilization

Capital flow management when capital controls leak’, paper presented at

Abstract What are the implications of limited capital controls enforcement for the optimal design of capital flow management policies? We address this question in an environment where pecuniary externalities call for prudential capital controls, but financial regulators lack the ability to enforce them in the "shadow economy." While regulated agents reduce their risk-taking decisions in response to capital controls, unregulated agents respond by taking more risk, thereby undermining the effectiveness of the controls. We characterize the choice of a planner who sets capital controls optimally, taking into account the leakages arising from limited regulation enforcement. Our findings indicate that leakages do not necessarily make macro-prudential policy less desirable, and that stabilization gains remain large despite leakages. Finally, there can be significant redistributive effects across the regulated and unregulated spheres

Stagflation and topsy-turvy capital flows

Are unregulated capital flows excessive during a stagflation episode? We argue that they likely are, owing to a macroeconomic externality operating through the economy's supply side. Inflows raise domestic wages through a wealth effect on labor supply and cause unwelcome upward pressure on marginal costs in countries where monetary policy is trying to drive down costs to stabilize inflation. Yet market forces are likely to generate such inflows. Optimal capital flow management instead requires net outflows, suggesting topsy-turvy capital flows following markup shocks

Asset pledgeability and endogenously leveraged bubbles

We develop a simple model of defaultable debt and rational bubbles in the price of an asset, which can be pledged as collateral in a competitive credit pool. When the asset pledgeability is low, the down payment is high, and bubble investment is unleveraged, as in a standard rational bubble model. When the pledgeability is high, the down payment is low, making it easier for leveraged borrowers to invest in the bubbly asset. As loans are packaged together into a competitive pool, the pricing of individual default risk may facilitate risk-taking. In equilibrium, credit-constrained borrowers may optimally choose a risky leveraged investment strategy – borrow to invest in the bubbly asset and default if the bubble bursts. The model predicts joint boom-bust cycles in asset prices and securitized credit

Liquidity traps, capital flows

This version: September 7, 2017 (original version December 17, 2015)Cette version: 7 septembre 2017 (version originale : 17 décembre 2015)Motivated by debates surrounding international capital flows during the Great Recession, we conduct a positive and normative analysis of capital flows when a region of the global economy experiences a liquidity trap. Capital flows reduce inefficient output fluctuations in this region by inducing exchange rate movements that reallocate expenditure towards the goods it produces. Restricting capital mobility hampers such an adjustment. From a global perspective, constrained efficiency entails subsidizing capital flows to address an aggregate demand externality associated with exchange rate movements. Absent cooperation, however, dynamic terms-of-trade manipulation motives drive countries to inefficiently restrict capital flows, impeding aggregate demand stabilization.Motivated by debates surrounding international capital flows during the Great Recession, we conduct a positive and normative analysis of capital flows when a region of the global economy experiences a liquidity trap. Capital flows reduce inefficient output fluctuations in this region by inducing exchange rate movements that reallocate expenditure towards the goods it produces. Restricting capital mobility hampers such an adjustment. From a global perspective, constrained efficiency entails subsidizing capital flows to address an aggregate demand externality associated with exchange rate movements. Absent cooperation, however, dynamic terms-of-trade manipulation motives drive countries to inefficiently restrict capital flows, impeding aggregate demand stabilization