Showing papers by "Guido Lorenzoni published in 2018"

House Prices and Consumer Spending

Abstract: Recent empirical work shows large consumption responses to house price movements. This is at odds with a prominent theoretical view which, using the logic of the permanent income hypothesis, argues that consumption responses should be small. We show that, in contrast to this view, workhorse models of consumption with incomplete markets calibrated to rich cross-sectional micro facts actually predict large consumption responses, in line with the data. To explain this result, we show that consumption responses to permanent house price shocks can be approximated by a simple and robust rule-of-thumb formula: the marginal propensity to consume out of temporary income times the value of housing. In our model, consumption responses depend on a number of factors such as the level and distribution of debt, the size and history of house price shocks, and the level of credit supply. Each of these effects is naturally explained with our simple formula.

Moral Hazard Misconceptions: The Case of the Greenspan Put

Abstract: Policy discussions on financial regulation tend to assume that whenever a corrective policy is used ex post to ameliorate the effects of a crisis, there are negative side effects in terms of moral hazard ex ante. This paper shows that this is not a general theoretical prediction, focusing on the case of monetary policy interventions ex post. In particular, we show that if the central bank does not intervene by monetary easing following a crisis, an aggregate demand externality makes borrowing ex ante inefficient. If instead the central bank follows the optimal discretionary policy and intervenes to stabilize asset prices and real activity, we show examples in which the aggregate demand externality disappears, reducing the need for ex ante intervention.

Risk Sharing and Financial Amplification

Abstract: Modern macroeconomic models with a financial accelerator mechanism are built around two main ingredients: a collateral constraint and incomplete financial markets. The first ingredient implies that shocks affecting the balance sheet of productive agents propagate to the rest of the economy, while the second ingredient guarantees that agents cannot "hedge" these shocks. The commonly held view in the literature is that both ingredients are necessary for financial amplification. In this paper we revisit this view. We study a neoclassical model where risk averse entrepreneurs and households can trade a full set of Arrow securities, subject to a collateral constraint for entrepreneurs. We first show that, because of general equilibrium spillovers, the competitive equilibrium does not feature "perfect hedging" for entrepreneurs. Indeed, states of the world in which entrepreneurial net worth is low and the collateral constraint binds are also states in which households' income and consumption are low. Because households are risk averse, insuring those states requires a risk premium in equilibrium, a force that limits the ex-ante incentives of entrepreneurs to hedge. Numerical simulations show that this force is quantitatively relevant, as under plausible calibrations the competitive equilibrium with complete markets features the same degree of financial amplification as the one with incomplete markets. A social planner facing the same frictions can improve on the competitive equilibrium by subsidizing entrepreneurial savings toward bad states of the world.