Job Market Paper
Consumption with Imperfect Perception of Wealth, October 2019
Abstract: Consumers have difficulty tracking their total wealth, or keeping it at the front of their minds when making consumption and saving decisions. In this paper, I show how such imperfect perception of wealth can explain several key deviations of consumption behavior from the permanent income hypothesis, including: excess sensitivity to current income, smaller MPCs out of wealth than out of current income, and excess discounting of future income. My approach provides a behavioral complement to canonical liquidity-constraint-based theory. Importantly, it can explain the empirical evidence on high-liquidity consumers' deviations from the permanent income hypothesis. I further provide an interpretation of the model in which the consumer has separate mental accounts for her current income and her wealth. Thus, the consumer exhibits behavior similar to a two-asset model, in a one-asset context without borrowing constraints. The friction can be quantitatively important in explaining MPCs, and has substantive macro implications for monetary and redistributive policy. Methodologically, the paper develops a tractable method for incorporating imperfect perception of the endogenous state into an otherwise standard Markov decision problem.
A Theory of Narrow Thinking, May 2019 (R&R, Review of Economic Studies)
Abstract: I develop an approach, which I term narrow thinking, to break the decision-maker's ability to perfectly coordinate her multiple decisions. For a narrow thinker, different decisions are based on different, non-nested, information. The narrow thinker then makes each decision with an imperfect understanding of the others. Formally, it is as if the decision-maker is a collection of multiple selves playing an incomplete-information game. The friction effectively attenuates the degree of interaction across decisions and can translate into either over- or under-reaction depending on the environment. Narrow thinking leads to a violation of the fungibility principle and a smooth model of mental accounting. Narrow thinking also reconciles other seemingly disparate phenomena in a unified framework, such as excess smoothness to taste shocks, the small wage elasticity of daily labor supply, and the label effect. Finally, I study an endogenous narrow thinking problem: the decision maker chooses optimally what information each decision is based upon, subject to a cognitive constraint.
Anatomy of Corporate Borrowing Constraints (with Yueran Ma), September 2019
Abstract: Macro-finance analyses commonly link firms’ borrowing constraints to the liquidation value of physical assets. For US non-financial firms, we show that 20% of debt by value is based on such assets (“asset-based lending” in creditor parlance), whereas 80% is based predominantly on cash flows from firms’ operations (“cash flow-based lending”). A standard borrowing constraint restricts total debt as a function of cash flows measured using operating earnings (“earnings-based borrowing constraints”). These features shape firm outcomes on the margin: first, cash flows in the form of operating earnings can directly relax borrowing constraints; second, firms are less vulnerable to collateral damage from asset price declines, and fire sale amplification may be mitigated. Taken together, our findings point to new venues for modeling firms’ borrowing constraints in macro-finance studies. [Online Appendix] [Slides]
Confidence and the Propagation of Demand Shocks (with George-Marios Angeletos), February 2019 (R&R, Review of Economic Studies)
Abstract: This paper revisits the question of why a negative shock to consumer spending can trigger a recession. Our theory centers on an informational or a behavioral friction that plays a dual role. First, it lets the aggregate supply of today’s goods increase with their relative price. Second, it gives rise to a feedback chain between outcomes and beliefs: as output and real returns fall, consumers and firms become pessimistic about the future, which in turn feeds into a further drop in aggregate spending and output, a further drop in confidence, and so on. The first element represents a non-monetary version of Lucas (1972). The second element introduces a novel propagation and amplification mechanism, which can be interpreted as a “confidence multiplier.”
Dampening General Equilibrium (with George-Marios Angeletos), May 2017
Abstract: We formalize the notion that GE adjustment is weak, or that it takes time, by modifying an elementary Walrasian economy in two alternative manners. In one, we maintain rational expectations but remove common knowledge of aggregate shocks and accommodate higher-order uncertainty. In the other, we replace Rational Expectations Equilibrium with solution concepts that mimic Tâtonnement or Cobweb dynamics, Level-k Thinking, and Cognitive Discounting. We show how these modifications amount to attenuating GE feedbacks and explain why they, contrary to pure noise, can generate either under- or over-reaction in aggregate outcomes.
Forward Guidance without Common Knowledge (with George-Marios Angeletos), Septeber 2018, American Economic Review
Abstract: How does the economy respond to news about future policies or future fundamentals? Standard practice assumes that agents have common knowledge of such news and face no uncertainty about how others will respond. Relaxing this assumption attenuates the general-equilibrium effects of news and rationalizes a form of myopia at the aggregate level. We establish these insights within a class of games which nests, but is not limited to, the New Keynesian model. Our results help resolve the forward-guidance puzzle, offer a rationale for the front-loading of fiscal stimuli, and illustrate more broadly the fragility of predictions that rest on long series of forward-looking feedback loops. [Online Appendix]
Low Interest Rates and Risk Taking: Evidence from Individual Investment Decisions (with Yueran Ma and Carmen Wang), June 2019, Review of Financial Studies (Lead Article)
Abstract: How do low interest rates affect investor behavior? We demonstrate that individuals “reach for yield,” that is, have a greater appetite for risk-taking when interest rates are low. Using randomized investment experiments holding fixed risk premiums and risks, we show low interest rates lead to significantly higher allocations to risky assets among diverse populations. The behavior is not easily explained by conventional portfolio choice theory or institutional frictions. We then propose and provide evidence of mechanisms related to investor psychology, including reference dependence and salience. We also present results using observational data on household investment decisions. [Survey Appendix]
Incomplete Information in Macroeconomics: Accommodating Frictions in Coordination (with George-Marios Angeletos), October 2016, Handbook of Macroeconomics, Volume 2
Abstract: This chapter studies how incomplete information helps accommodate frictions in coordination, leading to novel insights on the joint determination of expectations and macroeconomic outcomes. We review and synthesize recent work on global games, beauty contests, and their applications. We elaborate on the distinct effects of strategic uncertainty relative to fundamental uncertainty. We demonstrate the potential fragility of workhorse macroeconomic models to relaxations of common knowledge; the possibility of operationalizing the notions of “coordination failure” and “animal spirits” in a manner that unifies unique- and multiple-equilibrium models; and the ability of incomplete information to offer a parsimonious explanation of important empirical regularities. We provide a general treatment of these ideas, as well as specific applications in the context of business cycles, financial crises, and asset pricing.
Work in Progress
“A Smooth Taylor Principle” (with George-Marios Angeletos)
“Cash Flow Based Lending and Firm Dynamics” (with Zhen Huo and Yueran Ma)