Research Interests:
Macroeconomics, Monetary and Fiscal Policy, Heterogeneity, Sovereign Default

Curriculum Vitae

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Publications:

Discretionary Monetary and Fiscal Policy with Endogenous Sovereign Risk
Journal of Economic Dynamics and Control, Vol. 105, 2019, pp. 44-66.

[Abstract] [Link]

How does the presence of sovereign risk affect the conduct of public policy? To answer this question, this paper studies optimal monetary and fiscal policy without commitment for a model economy with nominal public debt and strategic sovereign default. Compared to an economy without the possibility of default, economies with sovereign risk experience more volatile interest rates, which impedes the government’s ability to smooth tax rates across states. Risk of default also limits public debt accumulation, reducing the government’s incentive to use surprise inflation on average. When calibrated to the United States, the model predicts that a counterfactual increase in the average annual default probability from 0 to 1% lowers average inflation by 33%, raises the standard deviation of inflation by 18% and increases the standard deviation of the labor income tax by 73%. The transmission of exogenous shocks to real aggregate quantities is however almost unaffected by the possibility of default. For example, the presence of sovereign risk would increase the standard deviation of log real GDP by less than 1% in the experiment above. Similarly, the welfare consequences of sovereign risk are found to be of negligible size as well.

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Working Papers:

On Household Labour Supply in Sticky-Wage HANK Models
(with R. Gerke, S. Giesen and M. Lozej)
Deutsche Bundesbank Discussion Paper, 01/2024.

[Abstract] [Link]

Heterogeneous-agent New Keynesian models with sticky nominal wages usually assume that wage-setting unions demand the same amount of hours from all households. As a result, unions do not take account of the fact that (i) households are heterogeneous in their willingness to work, and that (ii) some households might have to work more hours than they would like to. In this paper, we consider two departures from the standard modelling approach. First, we consider a model version in which unions can demand different hours from different households, directly taking household heterogeneity into account. In this case, we show that unions find it optimal to ration hours worked for all households, such that nobody works more than desired. Compared to the standard case in which all households work the same amount by assumption, the response of output, wages and inflation to monetary policy shocks becomes notably less pronounced. This attenuation reflects that hours worked respond differently across the income distribution. The second model version we consider maintains the assumption that all households work the same amount but prohibits unions from requiring any household to work more than it would like to. This modification substantially lowers the effective stickiness of nominal wages, resulting in markedly different wage and inflation dynamics.

Convenient but Risky Government Bonds
(with M. Kaldorf)
Deutsche Bundesbank Discussion Paper, 15/2023.

[Abstract] [Link]

How does convenience yield interact with sovereign risk and the supply of government bonds? We propose a model of sovereign debt and default in which convenience yield arises because investors are able to pledge government bonds as collateral on financial markets. Convenience yield is dependent on the valuation of collateral, which is negatively dependent on the supply of government bonds, and haircuts that increase with sovereign risk. Calibrated to Italian data, convenience yield contributes substantially to the public debt-to-GDP ratio and can rationalise prolonged periods of negative bond spreads, even in the presence of default risk. We show that the debt elasticity of convenience yield is the most important driver of our results. Decomposing it into the debt elasticity of a collateral valuation and a haircut component, we find that, under empirically relevant conditions, a higher debt elasticity of haircuts can reduce fiscal discipline.

Make-Up Strategies with Incomplete Markets and Bounded Rationality
(with M. Dobrew, R. Gerke and S. Giesen)
Deutsche Bundesbank Discussion Paper, 01/2023.

[Abstract] [Link]

We study the impact of market incompleteness and bounded rationality on the effectiveness of make-up strategies. To do so, we simulate a heterogeneous-agent New Keynesian (HANK) model with reflective expectations and an occasionally-binding effective lower bound (ELB) on the policy rate. Our simulations show that make-up strategies can mitigate the negative consequences of the ELB for inflation and real economic activity. This result holds both for our HANK model as well as a corresponding representative-agent (RANK) model with complete markets, suggesting that market (in)completeness is not important for the effectiveness of make-up strategies. However, the stabilisation benefits of make-up strategies are small when agents’ cognitive ability is consistent with micro-evidence. This result is independent of market (in)completeness, emphasising the importance of rational expectations for make-up strategies. Furthermore, while market incompleteness and bounded rationality complement each other in attenuating the effects of forward guidance in our model, we do not observe such a complementarity with respect to the benefits of make-up strategies.

Financial Regulation, Interest Rate Responses, and Distributive Effects (2021)
(with C. Loenser and A. Schabert)

[Abstract] [Link]

This paper examines financial regulation and distortionary taxes in a heterogeneous-agents economy with pecuniary externalities induced by a collateral constraint. Limiting the loan-to-value ratio benefits only few unconstrained borrowers and reduces ex-ante social welfare. A Pigouvian-style symmetric debt tax (that subsidizes savings) raises collateral prices and lowers interest rates, which stimulates borrowing and generates welfare gains for almost all income groups. A Pigouvian-style asset subsidy induces a wealth appreciation, while an asset tax particularly benefits low-wealth borrowers and enhances social welfare. Overall, collateral effects are of minor importance and interest rate rather than asset price responses are decisive for welfare effects.

Debt, Default, and Commitment (2019)

[Abstract] [Link]

This paper extends Eaton and Gersovitz (1981)’s model of sovereign debt with incomplete markets and equilibrium default to explore the role of commitment for debt, default and welfare. While the government makes an ex-ante optimal state-contingent plan for its future actions, including debt repayment, it will re-optimize its plan ex post with an exogenously given probability, nesting the standard Markov case without commitment and the full-commitment Ramsey case if the probability is one and zero, respectively. If and to what extend the government commits to default in some states is found to depend on preferences, default costs and the degree of commitment. Model versions with full (or high intermediate) commitment are shown to have some advantages relative to the usually studied no-commitment case, which is illustrated for a quantitative application to the recent European debt crisis.

Monetary Conservatism, Default Risk, and Political Frictions (2017)

[Abstract] [Link]

This paper studies the consequences of delegating monetary policy to an inflation conservative central banker as in Rogoff (1985) for an emerging economy that faces three frictions which might undermine the success of such a policy reform: (i) incomplete financial markets, (ii) risk of default and (iii) political distortions. To do so, a quantitative sovereign default model is developed in which monetary and fiscal policies are set by two different authorities that both cannot commit to future policies. Inflation conservatism tends to result in lower and more stable inflation as well as a higher average debt burden, more frequent default events and more volatile fiscal policy. Whether the economy benefits from the appointment of a conservative central banker depends on the degree of inflation conservatism, the amount of political distortions and the volatility of fiscal shocks.

Markovian Households (2016)

[Abstract] [Link]

This paper studies the consumption-savings problem of two-person households whose individual members cannot commit to future actions and might not cooperate. The interaction between household members is modeled as a stationary Markov-perfect game with the household’s asset position as the single endogenous state variable. Intuitive first-order conditions are derived that show when lack of cooperation distorts household decision making relative to the case of full cooperation. A model version with idiosyncratic labor income risk then is used to explore the implications of lack of cooperation for precautionary savings, intra-household risk sharing and welfare.

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Work in Progress:

Present Bias and Public Debt

[Abstract]

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Policy Papers:

A Primer on Optimal Policy Projections
(with T. Dengler, R. Gerke, S. Giesen, D. Kienzler, A. Scheer and J. Wacks)
Deutsche Bundesbank Technical Papers, 01/2024.

[Abstract] [Link]

Optimal policy projections (OPPs) offer a flexible way to derive scenario-based policy recommendations. This note describes how to calculate OPPs for a simple textbook New Keynesian model and provides illustrations for various examples. It also demonstrates the versatility of the approach by showing OPP results for simulations conducted using a medium-scale DSGE model and a New Keynesian model with heterogeneous households.

A Comparison of Monetary Policy Rules in a HANK Model
(with M. Dobrew, R. Gerke and S. Giesen)
Deutsche Bundesbank Technical Papers, 02/2021.

[Abstract] [Link]

This paper provides a comparison of monetary policy rules with make-up and/or asymmetric elements for a heterogeneous agent New Keynesian (HANK) model. The model features incomplete financial markets, nominal price and wage rigidities, rational expectations, an occasionally binding effective lower bound (ELB) on the short-term nominal interest rate as well as aggregate demand and cost-push shocks. Simulations show that symmetric policy rules with make-up elements can substantially lower the downward inflation bias induced by the ELB and reduce macroeconomic volatility. Asymmetric policy rules can address the downward inflation bias as well but lead to a substantial overshooting of the inflation target if they also feature make-up elements. The predictions of the HANK model for the considered policy rules are close to those obtained for a corresponding (representative agent) model version with complete markets.

The Incentive Effects of Monetary Policy on Fiscal Policy Behaviour
(with R. Gerke)
Deutsche Bundesbank Technical Papers, 04/2021.

[Abstract] [Link]

How do prolonged low-interest-rate episodes affect fiscal discipline? This paper investigates this question by using a quantitative model with endogenous public debt management and sovereign default. Following a persistent interest rate reduction, sovereign risk and government bond yields decline. An impatient fiscal policy maker responds to improved financing conditions by relaxing its policy stance and accumulating more debt. Due to the increased debt burden, a subsequent interest rate reversal can put substantial pressure on the public budget, raising the likelihood of default. The longer the interest rate cut is expected to last, the more pronounced the fiscal response will be.

A Comparison of Monetary Policy Rules in an Estimated TANK Model
(with R. Gerke, S. Giesen, D. Kienzler and A. Scheer)
Deutsche Bundesbank Technical Papers, 05/2021.

[Abstract] [Link]

We compare the stabilisation properties of history-dependent and asymmetric interest rate rules, taking into account the constraint posed by the effective lower bound on nominal interest rates. Specifically, we use a medium-scale Two-Agent New Keynesian (TANK) model that was estimated on euro area data. Our simulation results suggest that under rational expectations history-dependent rules can attenuate or even undo the sizeable negative inflation bias that we observe under standard inflation targeting. They can also better stabilise inflation, but output becomes more volatile. Asymmetric rules furthermore reduce the negative inflation bias. However, the reduction in inflation volatility is less pronounced compared to history-dependent rules. We further show that an appropriate calibration of an asymmetric inflation targeting rule improves its performance along specific dimensions.