https://eml.berkeley.edu/~webfac/gorodnichenko/gertler.pdf

A model of unconventional monetary policy

We develop a canonical framework to think about credit market frictions and aggregate economic activity in the context of the current crisis. We use the framework to address two issues in particular: first, how disruptions in financial intermediation can induce a crisis that affects real activity; and second, how various credit market interventions by the central bank and the Treasury of the type we have seen recently, might work to mitigate the crisis. We make use of earlier literature to develop our framework and characterize how very recent literature is incorporating insights from the crisis.

/pdf/financial-intermediation-and-credit-policy-in-business-cycle-4jebeme7xo.pdf

Financial Intermediation and Credit Policy in Business Cycle Analysis

http://www3.tcmb.gov.tr/konferanslar/fsr/Sherman.pdf

Econometric measures of connectedness and systemic risk in the finance and insurance sectors

lapse using the highly unequal geographic distribution of wealth losses across the United States. We estimate a large elasticity of consumption with respect to housing net worth of 0.6 to 0.8, which soundly rejects the hypothesis of full consumption risk-sharing. The average marginal propensity to consume (MPC) out of housing wealth is 5–7 cents with substantial heterogeneity across ZIP codes. ZIP codes with poorer and more levered households have a significantly higher MPC out of housing wealth. In line with the MPC result, ZIP codes experiencing larger wealth losses, particularly those with poorer and more levered households, experience a larger reduction in credit limits, refinancing likelihood, and credit scores. Our findings highlight the role of debt and the geographic distribution of wealth shocks in explaining the large and unequal decline in consumption from 2006 to 2009. JEL Codes: E21, E32, E44, E60.

/pdf/household-balance-sheets-consumption-and-the-economic-slump-4xo9n6fpzz.pdf

Household Balance Sheets, Consumption, and the Economic Slump*

We provide a framework for studying the relationship between the financial network architecture and the likelihood of systemic failures due to contagion of counterparty risk. We show that financial contagion exhibits a form of phase transition as interbank connections increase: as long as the magnitude and the number of negative shocks affecting financial institutions are sufficiently small, more "complete" interbank claims enhance the stability of the system. However, beyond a certain point, such interconnections start to serve as a mechanism for propagation of shocks and lead to a more fragile financial system. We also show that, under natural contracting assumptions, financial networks that emerge in equilibrium may be socially inefficient due to the presence of a network externality: even though banks take the effects of their lending, risk-taking and failure on their immediate creditors into account, they do not internalize the consequences of their actions on the rest of the network.

https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID2500504_code1428438.pdf?abstractid=2207439&mirid=5&type=2

Systemic Risk and Stability in Financial Networks

We present a theory of Keynesian supply shocks: supply shocks that trigger changes in aggregate demand larger than the shocks themselves. We argue that the economic shocks associated to the COVID-19 epidemic—shutdowns, layoffs, and firm exits—may have this feature. In one-sector economies supply shocks are never Keynesian. We show that this is a general result that extend to economies with incomplete markets and liquidity constrained consumers. In economies with multiple sectors Keynesian supply shocks are possible, under some conditions. A 50% shock that hits all sectors is not the same as a 100% shock that hits half the economy. Incomplete markets make the conditions for Keynesian supply shocks more likely to be met. Firm exit and job destruction can amplify the initial effect, aggravating the recession. We discuss the effects of various policies. Standard fiscal stimulus can be less effective than usual because the fact that some sectors are shut down mutes the Keynesian multiplier feedback. Monetary policy, as long as it is unimpeded by the zero lower bound, can have magnified effects, by preventing firm exits. Turning to optimal policy, closing down contact-intensive sectors and providing full insurance payments to affected workers can achieve the first-best allocation, despite the lower per-dollar potency of fiscal policy.

https://www.nber.org/system/files/working_papers/w26918/w26918.pdf

Macroeconomic Implications of COVID-19: Can Negative Supply Shocks Cause Demand Shortages?

This paper studies the welfare properties of competitive equilibria in an economy with financial frictions hit by aggregate shocks. In particular, it shows that competitive financial contracts can result in excessive borrowing ex ante and excessive volatility ex post. Even though, from a first-best perspective the equilibrium always displays under-borrowing, from a second-best point of view excessive borrowing can arise. The inefficiency is due to the combination of limited commitment in financial contracts and the fact that asset prices are determined in a spot market. This generates a pecuniary externality that is not internalized in private contracts. The model provides a framework to evaluate preventive policies which can be used during a credit boom to reduce the expected costs of a financial crisis.

Inefficient Credit Booms

This paper studies the welfare properties of competitive equilibria in an economy with financial frictions hit by aggregate shocks. In particular, it shows that competitive financial contracts can result in excessive borrowing ex ante and excessive volatility ex post. Even though from a first-best perspective the equilibrium always displays under-borrowing, from a second-best point of view excessive borrowing can arise. The inefficiency is due to the combination of limited commitment in financial contracts and the fact that asset prices are determined in a spot market. This generates a pecuniary externality that is not internalized in private contracts. The model provides a framework to evaluate preventive policies, which can be used during a credit boom to reduce the expected costs of a financial crisis. Copyright 2008, Wiley-Blackwell.

/pdf/inefficient-credit-booms-17ugs3tl6d.pdf

This paper presents a model of business cycles driven by shocks to consumer expectations regarding aggregate productivity. Agents are hit by heterogeneous productivity shocks, they observe their own productivity and a noisy public signal regarding aggregate productivity. The public signal gives rise to ''noise shocks, " which have the features of aggregate demand shocks: they increase output, employment, and inflation in the short run and have no effects in the long run. Numerical examples suggest that the model can generate sizable equilibrium (DSGE) models of the business cycle include a large number of shocks (to technol ogy, monetary policy, preferences, etc.), but typically do not include expectational shocks as independent drivers of short-run fluctuations.1 This paper explores the idea of expectation-driven cycles, looking at a model where technology determines equilibrium output in the long run and consumers receive noisy signals about technology in the short run. The presence of noisy signals produces expectational errors. This paper studies the role of these expectational errors in gener ating volatility at business cycle frequencies. The model is based on two ingredients. First, consumers take time to recognize permanent changes in aggregate fundamentals. Although they may have good information on the current state of the individual firm or sector where they operate, they have only limited information regarding the long-run determinants of aggregate activity. Second, consumers have access to public information that is relevant to estimate long-run productivity. This includes news about technological innovations, publicly released macroeconomic and sectoral statistics, financial market prices, and public statements by policy makers. However, these signals provide only a noisy forecast of the long-run effects of technological innovations. This opens the door to "noise shocks," which induce consumers to temporarily overestimate or underestimate the productive capacity of the economy.

http://dspace.mit.edu/openaccess-disseminate/1721.1/51815

A Theory of Demand Shocks

/pdf/a-theory-of-demand-shocks-2yugp0n772.pdf

Guido Lorenzoni

Papers

Macroeconomic Implications of COVID-19: Can Negative Supply Shocks Cause Demand Shortages?

Inefficient Credit Booms

Inefficient Credit Booms

A Theory of Demand Shocks

A Theory of Demand Shocks