Job Market Paper
Fiscal Multipliers and Financial Crises
[paper], *Updated regularly*
Featured on Marginal Revolution
What is the impact of an extra dollar of government spending during a financial crisis? How important was fiscal policy during the Great Recession? I develop a macroeconomic model of fiscal policy with a financial sector that allows me to study the effects of fiscal policy tools such as government purchases and transfers, as well as of financial sector interventions such as bank recapitalizations and credit guarantees. Solving the model with nonlinear methods allows me to show how the linkages between household and bank balance sheets generate new channels through which fiscal policy can stimulate the economy, and study the state dependent effects of fiscal policy. I combine the model with data on the fiscal policy response to assess its role during the financial crisis and Great Recession. My main findings are that: (i) the fall in consumption would have been 50% worse in the absence of fiscal interventions; (ii) transfers to households and bank recapitalizations yielded the largest fiscal multipliers; and (iii) bank recapitalizations were closest to generating a Pareto improvement.
Runs versus Lemons: Information Disclosure and Fiscal Capacity
[with Joseba Martinez and Thomas Philippon], *Updated October 2016*
Accepted at the Review of Economic Studies
We characterize the optimal use of information disclosure and fiscal backstops during financial crises. In our model, financial crises force governments to choose between runs and lemons. Revealing information about banks’ assets reduces adverse selection in credit markets, but it can also create inefficient runs on weak banks. A fiscal backstop mitigates this risk and allows the government to pursue a high disclosure strategy. A government with a strong fiscal position is more likely to run informative stress tests than a government with a weak fiscal position. As a result, such a government is also less likely to rely on outright bailouts.
The (Unintended?) Consequences of the Largest Liquidity Injection Ever
[with Matteo Crosignani and Luís Fonseca], *Updated November 2016, Submitted!*
Winner of the 3rd SUERF/UniCredit & Universities Research Prize
Press Coverage: Wall Street Journal, Frankfurter Allgemeine (Fazit) [in German]
We study the design of lender of last resort interventions and show that the provision of long-term liquidity incentivizes purchases of high-yield short-term securities by banks. Using a unique security-level data set, we find that the European Central Bank’s three-year Long-Term Refinancing Operation incentivized Portuguese banks to purchase short-term domestic government bonds that could be pledged to obtain central bank liquidity. This “collateral trade” effect is large, as banks purchased short-term bonds equivalent to 8.4% of amount outstanding. The resumption of public debt issuance is consistent with a strategic reaction of the debt agency to the observed yield curve steepening.
A Note on Information Disclosure and Adverse Selection
[with Joseba Martinez and Thomas Philippon]
We analyze public disclosure in a financial market with private information as in Myers and Majluf (1984). Firms need outside financing to invest in valuable projects but they are privately informed about the quality of their assets. Adverse selection in credit markets can then lead to suboptimal investment. We characterize a set of policies that robustly increase investment.
Risk Incentives in an Interbank Network
New version coming soon
I develop a model of the interbank market where financial institutions endogenously form a network of bilateral debt contracts as a response to idiosyncratic liquidity shocks. Counterparty risk and regulatory constraints interact with endowment heterogeneity to generate interest rate dispersion and differing roles in the trading process, such as intermediation. The interbank market allows for socially desirable liquidity transfers, but limited liability may generate perverse incentives that increase risk-taking. These interact with the network structure to generate bank herding and endogenously magnifying aggregate risk. The endogenous nature of the network allows for the analysis of passive (regulatory) and active (interventionist) policies. Numerical simulations suggest that regulatory policies have perverse effects that tend to amplify risk, while interventions are more effective at containing the emergence of systemic risk and the propagation of shocks. No commitment problems arise with banking sector bailouts: by committing to bailout, the authority endogenously contains bank herding, and the formation of risk.
The Portuguese banking system during the sovereign debt crisis
Banco de Portugal Economic Studies 1(2), pp.43-80, July 2015
[with Matteo Crosignani and Luís Fonseca]
Mentioned in a speech by the President of the Deutsche Bundesbank
We describe the evolution of balance sheets of monetary financial institutions (MFI) in Portugal before, during, and after the sovereign debt crisis of the late 2000’s. We account for several dimensions of heterogeneity including size, type, and nationality. We find that the Portuguese MFI sector rapidly expanded and increased its leverage before and during the crisis until 2012, after which it started a long deleveraging process. Many of the major aggregates, such as lending and deposits, follow this pattern. We observe a steady rise of non-traditional banking activities on both sides of the balance sheet of domestic institutions. The crisis weakened the international integration of the Portuguese financial sector, as domestic banks became less exposed to international counterparties. Finally, the Eurosystem and the Portuguese government have become relevant sources of funding as a result of the recent unprecedented monetary and fiscal interventions in the domestic financial system.
Work in Progress
The Fiscal Multiplier of Bank Bailouts: Evidence from the US
Draft coming soon
In late 2008, the Department of Treasury spent almost $500 billion in the largest bank bailout in US history. Estimates of the impact of the bailout in macroeconomic outcomes have remained elusive. I take advantage of the differential exposure of US states and regions to the different bailout programs to compute open economy relative multipliers in the spirit of Nakamura and Steinsson (2014). I combine data on US Treasury transactions under the Troubled Asset Relief Program with granular bank regulatory data and geographical lending exposure of US financial institutions to construct a measure of bailout exposure at the state and MSA level. To circumvent the downwards OLS bias caused by endogenous fiscal treatments highlighted by Chodorow-Reich et al. (2012), I adopt an instrumental variables approach. My procedure allows me to compute both impact and long-run yearly multipliers. I find that the TARP had a positive impact on output. Furthermore, states with greater exposure to the TARP experienced both higher delinquency rates and more pronounced debt deleveraging. These results suggest that bank recapitalizations may help to speed up private sector debt deleveraging while mitigating the output losses that are usually associated with this process.
Fiscal Risk Management and Financial Stabilizers
I reinterpret the role of the consolidated fiscal and monetary authorities of an open economy from a risk management perspective. With a risk-averse private sector that faces contracting frictions, open market operations that swap private risky assets for public safe ones are not neutral and can have a stimulating impact. When the authority lacks the commitment to honor its debts, the effectiveness of these interventions is decreasing in their size. I show how this notion can be applied to interventions such as bank recapitalization programs, private credit guarantees and quantitative easing.