Fields: Macroeconomics, Banking, Monetary Economics
Hachem, K. 2011. "Relationship Lending and the Transmission of Monetary Policy,'' Journal of Monetary Economics, 58(6-8), 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.
Anderson, G. and K. Hachem. 2012. "Institutions and Economic Outcomes: A Dominance-Based Analysis,'' Econometric Reviews, 32(1), 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.
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.
Liquidity Regulation and Unintended Financial Transformation in China (with Zheng Michael Song), September 2016 [Abstract] [PDF]
Available as NBER Working Paper No. 21880
Best Paper Prize, 2016 China Financial Research Conference
China increased bank liquidity standards in the late 2000s. We show that this had vastly unintended consequences. Shadow banking developed among small and medium-sized banks to evade the higher standards. The shadow banks, by also broaching long-standing deposit-rate ceilings, poached deposits from big commercial banks and lent them aggressively. In response, big banks used their interbank market power to restrict loans to shadow banks and lent more to non-financials instead. Our analysis delivers a quantitatively important credit boom and higher and more volatile interbank rates because of, not in spite of, higher liquidity standards.
Inflation Announcements and Social Dynamics (with Jing Cynthia Wu), September 2016 [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 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. The same model also rationalizes why countries stuck at the zero lower bound have had a hard time increasing inflation without being aggressive.
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
Misallocation and Reform (with Zheng Michael Song)
Regulation and Reputation (with Martin Kuncl), [Abstract]
Bail-in bonds have gained a lot of attention among bank regulators. In principle, these bonds raise the hurdle for a government bailout by converting into loss-absorbing capital once the issuing bank runs into trouble. We show that banks can short-circuit bail-in requirements by offering investors implicit guarantees against conversion. The bond itself appears as a bail-in bond on the issuer's balance sheet while the guarantee is booked off balance sheet until the bond converts. If the regulator is expected to penalize guarantees, then the issuer's incentive to offer and honor them can be eliminated. However, guarantees are not discovered by the regulator until the issuing bank runs into trouble so penalties may not be credible. Our model shows that the penalty needed to eliminate guarantees is indeed credible if a bank's probability of running into trouble only depends on an aggregate shock. However, if banks are privately heterogeneous in their probabilities, then there are several equilibria where the penalty is not credible. More precisely, heterogeneity introduces a strong signaling motive to provide guarantees which the regulator must counteract with a substantial penalty. The size of this penalty is not credible since it would involve bankrupting a non-trivial fraction of the banking system. Bail-in requirements are thus much less effective under heterogeneity.
"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]