Model (non-)disclosure in supervisory stress tests (joint with Marc de la Barrera and Ying Gao)
We study the Federal Reserve's problem of disclosing the models it uses in supervisory stress tests of large banks. Banks argue that nondisclosure leads to inefficiencies stemming from uncertainty, but regulators are concerned that full disclosure can lead to banks gaming the system. We formalize the intuition behind this trade-off in a stylized model where both the regulator and banks have imperfect, private ``models" about a risky asset, and the regulator uses its own model to `stress test' the investment. We show that if the regulator uses its model to test the banks' investment, full disclosure is suboptimal, and the regulator may benefit from hiding the model when the bank's model is more precise than the regulator's own model. The key idea is that hiding the regulator's model forces the bank to guess it using the bank's own models, effectively eliciting the bank's private information. We also show that if the regulator can fine-tune disclosure policies, the regulator can approximately enforce the first-best action of banks, as if the regulator fully knew all the private information held by banks. The intuition is closely related to the Cremer and McLean (1988) information rent extraction result.
Work in Progress
Phillips Curve and Optimal Monetary Policy Targets under Imperfect Labor Reallocation (joint with Marc de la Barrera and Masao Fukui)
This paper studies optimal monetary policy in a multisector economy with endogenous, costly reallocation of workers across sectors. We first provide a sufficient condition for which labor relocation does not affect aggregate inflation – depending on the Domar weights and labor share of each sector. When this condition fails to hold, sector reallocation may create additional inflationary pressure, or deflationary pressure in response to shocks. Turning to optimal policy, the central bank no longer has one “output gap” to target when there are multiple labor types, and it faces a trade-off across aggregate inflation, relative price distortion, and relative output gaps across sectors. We use this framework to investigate the effectiveness of alternative monetary policy targets, both analytically and numerically.
Quality-Variety Tradeoff and Endogenous Specialization of Cities
This paper studies the relationship between city size and the specialization of firms, and how it drives spatial agglomeration. I develop a theory of firm investment in quality differentiation and diversification where firms in large cities invest more in quality, while firms in small towns diversify and sell across multiple subsectors. I study how the firm's entry investment decision is affected by the markup it can charge, and the implications of this “specialist versus generalist” dichotomy for the efficient level of entry or productivity investment. I explore the dynamics of this relationship in the long-run, including how the most productive firms in cities may “franchise” to different regions, and the potential tradability of services. This framework allows us to quantify the extent to which endogenous quality investment can explain the agglomeration effects in large cities beyond the selection of productive firms into cities, and the effects this has on aggregate markup and overall economic welfare.
Exchange Rate Pegs, Foreign Exchange Reserves and Monetary Policy
I study an open economy with nominal rigidity and financial friction in bond markets. Under financial friction, the central bank can affect the nominal exchange rate through both monetary policy and intervening in the bond market. I lay out the trade-offs of these different policies, and solve the problem of maintaining a peg for a growing country, both for a small open economy and for a large economy that can affect global dynamics. Turning to welfare analysis for the rest of world, I show that to a first order, the pegging country's use of the two instruments are equivalent to the rest of world, and study monetary policy response of the rest of world to the peg. I plan to use this framework to revisit questions of currency pegs, the reserve level required to maintain a currency peg against currency attacks, and evaluate the policy problem of moving from a peg to a float.