Unique Equilibrium in the Eaton-Gersovitz Model of Sovereign Debt

We provide a proof that Markov Perfect equilibrium is unique in the standard infinitehorizon incomplete-market model with a default option which, following Eaton and Gersovitz (1981), has become a benchmark for quantitative analyses of sovereign debt (Arellano (2008), Aguiar and Gopinath (2006), Aguiar and Amador (2014)).Macro-Financial Modeling grou

Unique equilibrium in the Eaton-Gersovitz model of sovereign debt.

Thesis: Ph. D., Massachusetts Institute of Technology, Department of Economics, 2015.2nd and 3rd chapter co-authored with Matthew Rognlie. Cataloged from PDF version of thesis.Includes bibliographical references.This thesis consists of three chapters on monetary and fiscal policy. The first chapter explores the importance of redistribution in explaining why monetary policy has aggregate effects on household consumption. I argue that traditional representative agent models focusing on substitution effects ignore a key component of the monetary policy transmission mechanism, which exists because those who gain from accommodative monetary policy have higher marginal propensities to consume (MPCs) than those who lose. I use a sufficient statistic approach to show that, provided households' elasticities of intertemporal substitution are reasonably small, redistributive effects can be as important as substitution effects in explaining the response of aggregate consumption to real interest rate changes in the U.S. My calibrated general equilibrium model predicts that, if U.S. mortgages all had adjustable rates, the effect of interest-rate changes on consumer spending would more than double and would be asymmetric, with rate increases reducing spending by more than cuts would increase it. The second chapter, joint with Matthew Rognlie, explains why a monetary union between countries (such as the Eurozone today) may lead to a stronger fiscal union. Since exchange rates can no longer adjust to offset shocks, the presence of nominal rigidities implies that fiscal risk-sharing becomes more valuable in a monetary union. As a result, countries in such a union are capable of overcoming their lack of commitment to fiscal transfers. However, inefficient equilibria without fiscal transfers remain possible. We derive implications for the optimal policy of the central bank when the fiscal union is under stress. The third chapter, also joint with Matthew Rognlie, studies the possibility that feedbacks between sovereign bond spreads and governments' desire to default may lead to multiple equilibria in sovereign debt markets. We show that such multiplicity does not exist in the infinite-horizon model of Eaton and Gersovitz (1981), a widely adopted benchmark for quantitative analyses of these markets. Our proof may be important to understand Euro government bond markets, and calls for renewed attention on the theoretical conditions that are needed for sovereign debt models to generate multiple equilibria.by Adrien Auclert.Chapter 1. Monetary policy and the redistribution channel -- Chapter 2. Monetary union begets fiscal union -- Chapter 3.Unique equilibrium in the Eaton-Gersovitz model of sovereign debt.Ph. D

Income and Wealth Distribution in Macroeconomics: A Continuous-Time Approach * Pierre-Louis Lions

Abstract We recast the Aiyagari-Bewley-Huggett model of income and wealth distribution in continuous time. This workhorse model -as well as heterogeneous agent models more generally -then boils down to a system of partial differential equations, a fact we take advantage of to make two types of contributions. First, a number of new theoretical results: (i) an analytic characterization of the consumption and saving behavior of the poor, particularly their marginal propensities to consume; (ii) a closed-form solution for the wealth distribution in a special case with two income types; (iii) a proof that there is a unique stationary equilibrium if the intertemporal elasticity of substitution is weakly greater than one; (iv) a characterization of "soft" borrowing constraints. Second, we develop a simple, efficient and portable algorithm for numerically solving for equilibria in a wide class of heterogeneous agent models, including -but not limited to -the Aiyagari-Bewley-Huggett model. * This version supersedes an earlier version of the paper entitled "Heterogeneous Agent Models in Continuous Time." We are grateful to Fernando Alvarez, Adrien Auclert, Dave Backus, Roland Bénabou, Jess Benhabib, Jocelyn Boussard, Paco Buera, Lorenzo Caliendo, Dan Cao, Wouter Den Haan, Xavier Gabaix, Mark Huggett, Mariacristina De Nardi, Greg Kaplan, Nobu Kiyotaki, Ellen McGrattan, Giuseppe Moscarini, Galo Nuño, Ezra Oberfield, Alan Olivi, Jesse Perla, Matt Rognlie, Tony Smith, Ivan Werning, Wei Xiong, Stan Zin and seminar participants at various institutions for useful comments. We also thank Déborah Sanchez for stimulating discussions in early stages of this project and SeHyoun Ahn, Riccardo Cioffi, Xiaochen Feng and Max Vogler for outstanding research assistance

Watering a Lemon Tree: Heterogeneous Risk Taking and Monetary Policy Transmission Watering a Lemon Tree: Heterogeneous Risk Taking and Monetary Policy Transmission

Abstract We build a general equilibrium model with maturity transformation that impedes monetary policy transmission. In equilibrium, productive agents choose higher leverage, exposing themselves to greater liquidity risk, which limits their responsiveness to interest rate changes. A reduction in the interest rate then leads to a deterioration in aggregate investment quality, which blunts the monetary stimulus and decreases liquidation values. This, in turn, reduces loan demand, decreasing the interest rate further and generating a negative spiral. Overall, the allocation of credit is distorted and monetary stimulus can become ineffective even with significant interest rate drops