Speculation, in the spirit of Harrison and Kreps (1978), is introduced into a standard real business cycle model. Investors (speculators) hold heterogeneous beliefs about firm growth. Firm ownership, and thus, the firm’s discount factor varies with waves of optimism and leverage. These waves ripple into firm investments in hours. The firm’s discount factor links the equity premium and labor volatility puzzles. We obtain an upper bound to the amplification that can be generated by speculation for any model of beliefs—a factor of 1.5. A calibration based on diagnostic beliefs amplifies hours volatility by a factor of 1.15 and produces a bubble component of 20 percent.

We present a simple dynamic model of OTC markets. When the market opens, agents with a cash deficit search for lenders with cash surplus. By a closing time, positions that remain open are closed with a lender of last resort. We derive a closed form solution for the liquidity yield function, a function that maps a settlement deficit/surplus into a settlement cost/benefit. This is a kinked function whose slope depends on features of the OTC market and the distribution of settlement needs. The liquidity yield enters as an additional consideration in portfolio theory.

This paper integrates an implementation of monetary policy through the banking system into an incomplete-markets economy with nominal rigidity. Monetary policy sets policy rates and alters the supply of reserves. These tools grant independence control over credit spreads and an interest-rate target. Through these tools, monetary policy affects the evolution of real interest rates, credit, output, and the wealth distribution. We decompose their effects into a combination of the interest and credit channels that depend on the size of the central bank’s balance sheet. The model provides insights regarding when are counter-cyclical central bank balance sheets ideal. This model highlights a trade-off between worse micro economic insurance (insurance across agents) and better macroeconomic insurance (insurance across states).

We present a theory of the asset and liability composition of bank balance sheets. Trade requires the use of assets as means of payments. Because of information asymmetries, some assets are poor means of payment: they are illiquid and do not circulate. Banks swap those assets for their liabilities. Banks' liabilities can be designed to circulate although fully backed by assets that do not. Liquid assets, that could circulate on their own, are brought to the banks' balance sheet to enhance liquidity creation. Hence, liquid and illiquid assets are complementary factors for liquidity creation. We study banks' asset choice and liability design and implement it with standard instruments, such as saving deposits, time deposits, and bank loans. We argue that the optimal asset and liability composition resembles bank balance sheets in practice.

The Covid-19 crisis has led to a reduction in the demand and supply of sectors that produce goods that need social interaction to be produced or consumed. We interpret the Covid-19 shock as reducing utility stemming from “social” goods in a two-sector economy with incomplete markets. We compare the advantages of lump-sum transfers versus a credit policy. For the same path of government debt, transfers are preferable when debt limits are tight, whereas credit policy is preferable when they are slack. A credit policy can target fiscal resources toward agents that matter most for stabilizing demand. We illustrate this result with a calibrated model. We discuss various shortcomings and possible extensions to the model.

We append the expectation of a monetary-fiscal reform into a standard New Keynesian model. If a reform occurs, monetary policy will temporarily aid debt sustainability through a temporary burst in inflation. The anticipation of a possible reform links debt levels with inflation expectations. As a result, interest rates have two effects: they influence demand and affect expected inflation in opposite directions. The expectations effect is linked to the impact of interest rates on public debt. While lowering inflation in the short term is possible through demand control, inflation tends to rise again due to its impact on inflation expectations (sticky inflation). Optimal monetary policy may allow low real interest rates after fiscal shocks, temporarily breaking away from the Taylor principle. We assess whether the Federal Reserve's ``staying behind the curve'' was the right strategy during the recent post-pandemic inflation surge.

This paper reformulates the New Keynesian model to incorporate output adjustments through job flows---the extensive margin. Critically, we distinguish the stock of workers available for production from flows into the workforce. Shifting from the adjustment from the intensive to the extensive employment margin, the model introduces predetermined labor supply and output, altering key properties of the New Keynesian framework. First, the Taylor principle is inverted: stability is achieved when nominal rates respond less than one-for-one to inflation. Second, the model significantly alters the output responses to monetary policy changes. We argue that this represents a challenge for the literature and propose avenues for possible resolutions. Our analysis contributes to the ongoing discussion on labor-market frictions and capacity constraints and their monetary-policy implications.

This paper presents an equilibrium asset-demand system amenable for comparative-statics analysis of changes in the size and composition of central bank balance sheets. The analysis produces a set of sufficient statistics—key financial ratios and elasticities asset flows with respect to interest rates and the price level. In frictionless financial markets without nominal rigidities, changes in the size or composition of the balance sheet size has no real effects. However, when financial markets are segmented and nominal rigidities exist, the estimated elasticities identify the strength of different channels by which changes in the size have effects. In turn, the composition of the central bank balance sheet is irrelevant unless (a) intermediaries are heterogeneously exposed to liquidity risk or (b) assets differ in risk or collateral properties. We estimate and calibrate these elasticities for the European Union and decompose the transmission of quantitative easing policies.

This paper examines the role of bank heterogeneity in the transmission of monetary policy through the bank-lending channel. We specifically focus on ex-post heterogeneity in capital ratios and it's exposure to interest-rate risk. We introduce a heterogeneous-bank model, calibrated to replicate key features of the Euro area banking system. The model shows that banking systems with a high proportion of fixed-rate loans amplify the impact of monetary tightening and deteriorating financial stability. In turn, high-leverage banks tend to transmit monetary policy more effectively due to their higher marginal propensity to lend, making them more sensitive to changes in policy rates.

This paper studies the mechanics of shocks to the supply and demand for dollar reserve assets (dollar flows) in small open economies. The domestic financial system issues dollar liabilities in small open economies that enable international transactions. The financial system maintains dollar reserve assets that settle international payments with their liabilities to provide that service. The supply of reserve assets can increase with surprises in the current account. The demand for reserves can increase when domestic liquidity risks increase. We instrument for dollar demand and supply shocks and estimate the impulse responses of the composition of the financial system's balance sheet, the exchange rate, interest rates, and macroeconomic variables for a small-open economy in Peru. We then present a model consistent with these impulse responses. The model rationalizes the joint control of inflation and exchange rates. We produce counterfactuals that shed light on the desirability of exchange rate interventions.