Fields: Macroeconomics, Banking, Monetary Economics
Published and Forthcoming Papers
Relationship Lending and the Transmission of Monetary Policy
Journal of Monetary Economics, 2011, 58(6-8), pp. 590-600. [Abstract] [PDF] [DOI]
Repeated interactions allow lenders to uncover private information about their clients, decreasing the informational asymmetry between a borrower and his lender but introducing one between the lender and competing financiers. This paper constructs a credit-based model of production to analyze how learning through lending relationships affects monetary transmission. I examine how monetary policy changes the incentives of borrowers and lenders to engage in relationship lending and how these changes then shape the response of aggregate output. The results demonstrate that relationship lending prevails in equilibrium, smoothes the steady state output profile, and induces less volatile responses to certain monetary shocks.
Institutions and Economic Outcomes: A Dominance-Based Analysis (with Gordon Anderson)
Econometric Reviews, 2013, 32(1), pp. 164-182. [Abstract] [PDF] [DOI]
An important issue in both welfare and development economics is the interaction between institutions and economic outcomes. While welfarists are typically concerned with how these variables contribute to overall wellbeing, empirical assessments of their joint contribution are limited. Development economists, on the other hand, have focused extensively on whether institutions cause or are caused by growth yet the relevant literature is still rife with debate. In this article, we use a notion of distributional dominance to tackle both the measurement of multivariate welfare and the evaluation of inter-temporal dependence without hindrance from the mix of discrete (political) and continuous (economic) variables in our data set. On the causality front, our results support the view that institutions promote growth more than growth promotes institutions. On the welfare front, we find that economic growth had a positive impact from 1960 to 2000 but declines in institutional quality over the earlier part of this period were sufficient to produce a decline in overall wellbeing until the mid-1970s. Subsequent improvements in institutions then reversed the trend and, ultimately, wellbeing in 2000 was higher than that in 1960.
Inflation Announcements and Social Dynamics (with Jing Cynthia Wu)
Journal of Money, Credit and Banking, Forthcoming. [Abstract] [PDF]
Available as NBER Working Paper No. 20161
Featured in Bloomberg View
We propose a new framework for understanding the effectiveness of central bank announcements when firms have heterogeneous inflation expectations. Expectations are updated through social dynamics and, with heterogeneity, not all firms choose to operate, putting downward pressure on realized inflation. Our model rationalizes why countries stuck at the zero lower bound have had a hard time increasing inflation without being aggressive. The same model also predicts that announcing an abrupt target to disinflate will cause inflation to undershoot the target whereas announcing gradual targets will not. We present new empirical evidence that corroborates this prediction.
Liquidity Rules and Credit Booms (with Zheng Michael Song), July 2017 [Abstract] [PDF]
We show that stricter liquidity standards can trigger unintended credit booms. Attempts to arbitrage the regulation change the allocation of savings across banks, eliciting strategic responses that also change the allocation of lending across markets. More credit is generated per unit of savings in the new equilibrium. Applying our model to China, we find that a move to stricter liquidity standards in the late 2000s accounts for one-third of the unprecedented credit boom that followed. A quantitative extension allowing for other, non-regulatory shocks also identifies variation in liquidity rules as the dominant force behind observed co-movements in market-determined interest rates.
Liquidity Regulation and Unintended Financial Transformation in China (with Zheng Michael Song), July 2017 [Abstract] [PDF]
We trace the origins of China's rapidly developing shadow banking sector to the adoption of stricter liquidity rules by Chinese regulators in the late 2000s. Our analysis exploits cross-sectional differences in the bindingness of these rules along with time variation in product characteristics. We also discuss alternative hypotheses for the rise of shadow banking in China and explain why these hypotheses cannot account for the origins of the system.
Relationship Lending and the Great Depression: Measurement and New Implications (with Jon Cohen and Gary Richardson), November 2016 [Abstract] [PDF]
Available as NBER Working Paper No. 22891
The Great Depression remains ground zero for studying the non-monetary effects of financial crises. Despite the abundant scholarship on the period, lack of disaggregated data on lending activities has constrained our ability to measure the impact on the real economy of a collapse in long-term lending relationships. We propose here a novel way to extract cross-sectional differences in relationship lending from geographically aggregated financial statements. We find that the banking crises of the early 1930s, by destroying these relationships and the soft yet crucial information garnered from them, explain one-eighth of the economic contraction observed during the Depression. This effect comes specifically from small bank failures which alone explain one-third of the Depression. Large bank failures, on the other hand, were accompanied by a reallocation of deposits towards surviving relationship lenders, leading to economic gains which mitigated the overall negative impact of the banking crises. We show that ignoring cross-sectional differences in continuing relationships on the eve of the Great Depression understates by a factor of 2 the fall in economic activity directly attributable to the banking panics of the early 1930s. We also show that the rebuilding of lending relationships in the mold of those that existed in the 1920s was an important determinant of cross-sectional differences in economic performance during the 1937-38 recession.
Resource Allocation and Inefficiency in the Financial Sector, July 2014 [Abstract] [PDF]
Available as NBER Working Paper No. 20365
Revision requested by Journal of Monetary Economics
I analyze whether banks are efficient at allocating resources across intermediation activities. Competition between lenders means that resources are needed to draw borrowers into credit matches. At the same time, imperfect information between lenders and borrowers means that resources are also needed for screening. I show that the privately optimal allocation of resources is constrained inefficient. In particular, too many resources are spent on getting rather than vetting borrowers but, once properly vetted, not enough matches are retained. Uninformed lending is thus inefficiently high, informed lending is inefficiently low, and a tax on matching activities helps remedy the situation.
Agency Cost Determinants of Bank Risk-Taking, April 2014 [Abstract] [PDF]
Expands and supplants the first part of: Bank Promotions and Credit Quality, October 2012 [PDF]
Is risk-taking ever a privately optimal response to agency problems within banks? In a model where borrower types only matter for safe projects, I show that the answer to this question depends on the nature of the agency problem - that is, whether loan officers are hired to screen or whether they are hired to both screen and monitor. Incentivizing screening favors no risk-taking but involves a non-monotone relationship between performance and compensation. This non-monotonicity undermines incentives to monitor so, when both screening and monitoring are important, the bank instead prefers a strategy which pushes low types into risky projects. That selected risk-taking emerges under impediments to non-monotone compensation is also illustrated in an environment with rank-order tournaments and no monitoring.
Research in Progress
Trading Financial Innovation (with Ana Babus)
Misallocation and Reform (with Zheng Michael Song)
In or Out: Do Bail-In Bonds Really Decrease Bailouts? (with Martin Kuncl), [Abstract]
Bail-in bonds have gained a lot of attention among bank regulators. These bonds supposedly raise the hurdle for a government bailout by converting into loss-absorbing capital once the issuing bank runs into trouble. We argue that banks can short-circuit bail-in requirements by offering investors off-balance-sheet insurance against conversion. The bond itself appears as a bail-in bond on the issuer's balance sheet while the insurance is booked off balance sheet until the bond converts. The government can deter insurance provision by imposing penalties when insurance is discovered, but these penalties may not be credible. We find conditions for an equilibrium in which insurance against conversion is provided by banks and bailed out by the government rather than penalized upon discovery. We also present new empirical evidence in support of our model.
"In the Shadow of Banks: WMPs and Issuing Banks' Risk in China, by Viral Acharya, Jun Qian, and Zhishu Yang," NBER Chinese Economy Meeting, November 2016. [PDF]
"What We Learn from China's Rising Shadow Banking: Exploring the Nexus of Monetary Tightening and Banks' Role in Entrusted Lending, by Kaiji Chen, Jue Ren, and Tao Zha," Pacific Basin Research Conference, FRB San Francisco, November 2016. [PDF]
"How Did Pre-Fed Banking Panics End? by Gary Gorton and Ellis Tallman," AEA Annual Meeting, January 2016. [PDF]
"Reserve Requirements and Optimal Chinese Stabilization Policy, by Chun Chang, Zheng Liu, Mark Spiegel, and Jingyi Zhang," AEA Annual Meeting, January 2016. [PDF]
"Shadow Banking: China's Dual-Track Interest Rate Liberalization, by Hao Wang, Honglin Wang, Lisheng Wang, and Hao Zhou," NBER East Asian Seminar on Economics, June 2015. [PDF]
"The Effects of Unconventional Monetary Policies on Bank Soundness, by Frederic Lambert and Kenichi Ueda," NBER East Asian Seminar on Economics, June 2015. [PDF]
"What is a Sustainable Public Debt? by Pablo D'Erasmo, Enrique Mendoza, and Jing Zhang," Conference for the Handbook of Macroeconomics Vol. 2, April 2015. [PDF]
"Optimal Monetary and Macroprudential Policies: Gains and Pitfalls in a Model of Financial Intermediation, by Michael Kiley and Jae Sim," Bank of Canada Annual Conference, November 2014. [PDF]