Category Archives: Research

“On the Equivalence of Private and Public Money,” JME, 2019

Journal of Monetary Economics, with Markus Brunnermeier. PDF.

When does a swap between private and public money leave the equilibrium allocation and price system unchanged? To answer this question, the paper sets up a generic model of money and liquidity which identifies sources of seignorage rents and liquidity bubbles. We derive sufficient conditions for equivalence and apply them in the context of the “Chicago Plan”, cryptocurrencies, the Indian de-monetization experiment, and Central Bank Digital Currency (CBDC). Our results imply that CBDC coupled with central bank pass-through funding need not imply a credit crunch nor undermine financial stability.

“On the Equivalence of Private and Public Money,” JME, 2019

Accepted for publication in the Journal of Monetary Economics, with Markus Brunnermeier. (NBER wp.)

When does a swap between private and public money leave the equilibrium allocation and price system unchanged? To answer this question, the paper sets up a generic model of money and liquidity which identifies sources of seignorage rents and liquidity bubbles. We derive sufficient conditions for equivalence and apply them in the context of the “Chicago Plan”, cryptocurrencies, the Indian de-monetization experiment, and Central Bank Digital Currency (CBDC). Our results imply that CBDC coupled with central bank pass-through funding need not imply a credit crunch nor undermine financial stability.

“Das Geschäftsmodell hinter Libra (Libra’s Business Model),” Jusletter, 2019

Jusletter, 1 July 2019, with Corinne Zellweger-Gutknecht. PDF.

Libra is supposed to be backed; the returns on the securities backing it are going to be distributed among the Libra partners; and Libra’s price is supposed to be managed by a network of market makers. We don’t know much more. Will market makers have the incentive to deliver?

“On the Equivalence of Private and Public Money,” CEPR, 2019

CEPR Discussion Paper 13778, June 2019, with Markus Brunnermeier. PDF. (Local copy of NBER wp.)

We develop a generic model of money and liquidity that identifies sources of liquidity bubbles and seignorage rents. We provide sufficient conditions under which a swap of monies leaves the equilibrium allocation and price system unchanged. We apply the equivalence result to the “Chicago Plan,” cryptocurrencies, the Indian de-monetization experiment, and Central Bank Digital Currency (CBDC). In particular, we show why CBDC need not undermine financial stability.

“On the Equivalence of Private and Public Money,” NBER, 2019

NBER Working Paper 25877, May 2019, with Markus Brunnermeier. PDF. (Local copy.)

We develop a generic model of money and liquidity that identifies sources of liquidity bubbles and seignorage rents. We provide sufficient conditions under which a swap of monies leaves the equilibrium allocation and price system unchanged. We apply the equivalence result to the “Chicago Plan,” cryptocurrencies, the Indian de-monetization experiment, and Central Bank Digital Currency (CBDC). In particular, we show why CBDC need not undermine financial stability.

“Reserves For All? Central Bank Digital Currency, Deposits, and their (Non)-Equivalence,” IJCB

Accepted for publication in the International Journal of Central Banking. PDF.

This paper offers a macroeconomic perspective on the “Reserves for All” (RFA) proposal to let the general public hold electronic central bank money and transact with it. I propose an equivalence result according to which a marginal substitution of outside money (e.g., RFA) for inside money (e.g., deposits) does not affect macroeconomic outcomes. I identify key conditions for equivalence and argue that these conditions likely are violated, implying that RFA would change macroeconomic outcomes. I also relate the analysis to common arguments found in discussions on RFA and point to inconsistencies and open questions.

“Dynamic Tax Externalities and the U.S. Fiscal Transformation,” JME

Accepted for publication in the Journal of Monetary Economics, with Martin Gonzalez-Eiras. PDF. (Appendix: PDF.)

We propose a theory of tax centralization in politico-economic equilibrium. Taxation has dynamic general equilibrium implications which are internalized at the federal, but not at the regional level. The political support for taxation therefore differs across levels of government. Complementarities on the spending side decouple the equilibrium composition of spending and taxation and create a role for inter governmental grants. The model provides an explanation for the centralization of revenue, introduction of grants, and expansion of federal income taxation in the U.S. around the time of the New Deal. Quantitatively, it accounts for approximately 30% of the federal revenue share’s doubling in the 1930s, and for the long-term increase in federal grants.

“Digital Money: Private versus Public,” VoxEU Book, 2019

In Antonio Fatás, editor, The Economics of Fintech and Digital Currencies, VoxEU book, London, March 2019, with Markus Brunnermeier. PDF.

We address five key concerns that are frequently put forward:
1. Aren’t digital currencies just a hype, now that crypto ‘currencies’ like Bitcoin have proved too volatile and expensive to serve as reliable stores of value or mediums of exchange? This confuses things. A central bank digital currency (CBDC) is like cash, only digital; Alipay, Apple Pay, WeChat Pay, and so on are like deposits, only handier; and crypto currencies are not in any way linked to typical currencies, but they live on the blockchain.
2. Doesn’t a CBDC or ‘Reserves for All’ choke investment by cutting into bank deposits? No, because new central bank liabilities (namely, a CBDC) would fund new investments, and this would not in any way imply socialism or a stronger role of government in investment decisions.
3. Wouldn’t a CBDC cut into the profits that banks generate by creating deposits? Less money creation by banks would certainly affect their profits. But if this were deemed undesirable (by the public, not by shareholders and management) then banks could be compensated.
4. Wouldn’t ‘Reserves for All’ render bank runs more likely, undermining financial stability? We argue that, in fact, the opposite seems more plausible.
5. Aren’t deposit insurance, a CBDC, Vollgeld/sovereign money, and the Chicago Plan all alike? There are indeed close parallels between the different monetary regimes. In a sense, “money is changing and yet, it stays the same”.

“On the Equivalence of Private and Public Money,” Mimeo, 2019

Mimeo, January 2019, with Markus Brunnermeier. PDF.

We propose a generic model of money and liquidity. We provide sufficient conditions under which a swap of private (inside) against public (outside) money leaves the equilibrium allocation and price system unchanged. We apply the results to Central Bank Digital Currency, the “Chicago Plan,” and the Indian de-monetization experiment.

“Reserves For All? …” on Several SSRN Top Ten Lists

My July 2018 CEPR working paper “Reserves For All? Central Bank Digital Currency, Deposits, and their (Non)-Equivalence” has made it on several SSRN top ten lists. PDF. (Personal copy.)

Abstract: I offer a macroeconomic perspective on the “Reserves for All” (RFA) proposal to let the general public use electronic central bank money. After distinguishing RFA from cryptocurrencies and relating the proposal to discussions about narrow banking and the abolition of cash I propose an equivalence result according to which a marginal substitution of outside for inside money does not affect macroeconomic outcomes. I identify key conditions on bank and government (central bank) incentives for equivalence and argue that these conditions likely are violated, implying that RFA would change macroeconomic outcomes. I also relate my analysis to common arguments in the discussion about RFA and point to inconsistencies and open questions.

“Reserves For All? Central Bank Digital Currency, Deposits, and their (Non)-Equivalence,” CEPR, 2018

CEPR Discussion Paper 13065, July 2018. PDF. (Personal copy.)

I offer a macroeconomic perspective on the “Reserves for All” (RFA) proposal to let the general public use electronic central bank money. After distinguishing RFA from cryptocurrencies and relating the proposal to discussions about narrow banking and the abolition of cash I propose an equivalence result according to which a marginal substitution of outside for inside money does not affect macroeconomic outcomes. I identify key conditions on bank and government (central bank) incentives for equivalence and argue that these conditions likely are violated, implying that RFA would change macroeconomic outcomes. I also relate my analysis to common arguments in the discussion about RFA and point to inconsistencies and open questions.

“Financial Policy,” CEPR, 2018

CEPR Discussion Paper 12755, February 2018. PDF. (Personal copy.)

This paper reviews theoretical results on financial policy. We use basic accounting identities to illustrate relations between gross assets and liabilities, net debt positions and the appropriation of (primary) budget surplus funds. We then discuss Ramsey policies, answering the question how a committed government may use financial instruments to pursue its objectives. Finally, we discuss additional roles for financial policy that arise as a consequence of political frictions, in particular lack of commitment.

“Fiscal Federalism, Grants, and the U.S. Fiscal Transformation in the 1930s,” UoCH, 2017

University of Copenhagen, Department of Economics Discussion Paper 17-18, July 2017, with Martin Gonzalez-Eiras. PDF.

We propose a theory of tax centralization and intergovernmental grants in politico-economic equilibrium. The cost of taxation differs across levels of government because voters internalize general equilibrium effects at the central but not at the local level. The equilibrium degree of tax centralization is determinate even if expenditure-related motives for centralization considered in the fiscal federalism literature are absent. If central and local spending are complements, intergovernmental grants are determinate as well. Our theory helps to explain the centralization of revenue, introduction of grants, and expansion of federal income taxation in the U.S. around the time of the New Deal. Quantitatively, the model can account for the postwar trend in federal grants, and a third of the dramatic increase in the size of the federal government in the 1930s.

“Sovereign Bond Prices, Haircuts, and Maturity,” NBER, 2017

NBER Working Paper 23864, September 2017, with Tamon Asonuma and Romain Ranciere. PDF. (Local copy.)

Rejecting a common assumption in the sovereign debt literature, we document that creditor losses (“haircuts”) during sovereign restructuring episodes are asymmetric across debt instruments. We code a comprehensive dataset on instrument-specific haircuts for 28 debt restructurings with private creditors in 1999–2015 and find that haircuts on shorter-term debt are larger than those on debt of longer maturity. In a standard asset pricing model, we show that increasing short-run default risk in the run-up to a restructuring episode can explain the stylized fact. The data confirms the predicted relation between perceived default risk, bond prices, and haircuts by maturity.

“Sovereign Bond Prices, Haircuts, and Maturity,” CEPR, 2017

CEPR Discussion Paper 12252, August 2017, with Tamon Asonuma and Romain Ranciere. PDF. (ungated IMF WP.)

Rejecting a common assumption in the sovereign debt literature, we document that creditor losses (“haircuts”) during sovereign restructuring episodes are asymmetric across debt instruments. We code a comprehensive dataset on instrument-specific haircuts for 28 debt restructurings with private creditors in 1999–2015 and find that haircuts on shorter-term debt are larger than those on debt of longer maturity. In a standard asset pricing model, we show that increasing short-run default risk in the run-up to a restructuring episode can explain the stylized fact. The data confirms the predicted relation between perceived default risk, bond prices, and haircuts by maturity.

“Die Vollgeld-Initiative und eine Alternative (The Swiss Sovereign Money Initiative, and an Alternative),” SNB, 2017

In: Thomas Moser, Carlos Lenz, Marcel Savioz and Dirk Niepelt, editorial committee, Monetary Economic Issues Today, Festschrift in Honour of Ernst Baltensperger, Swiss National Bank/Orell Füssli, Zürich, June 2017. PDF of draft.

The sovereign money initiative (Vollgeldinitiative) seeks to gain greater control over the money and credit supply, to increase financial stability and to achieve a fairer distribution of seigniorage income. The initiative’s suggested approach – a ban on active money creation – is inefficient and may even prove ineffective, as it fails to address the core problems. A variant of the initiative, which would allow the public access to electronic central bank money on a voluntary basis, would offer greater benefit at lower cost.

“Sovereign Bond Prices, Haircuts, and Maturity,” IMF, 2017

IMF Working Paper 17/119, May 2017, with Tamon Asonuma and Romain Ranciere. PDF.

Rejecting a common assumption in the sovereign debt literature, we document that creditor losses (“haircuts”) during sovereign restructuring episodes are asymmetric across debt instruments. We code a comprehensive dataset on instrument-specific haircuts for 28 debt restructurings with private creditors in 1999–2015 and find that haircuts on shorter-term debt are larger than those on debt of longer maturity. In a standard asset pricing model, we show that increasing short-run default risk in the run-up to a restructuring episode can explain the stylized fact. The data confirms the predicted relation between perceived default risk, bond prices, and haircuts by maturity.

Citigroup Advises Against the `Fiscal Theory of the Price Level’

In a recent Citigroup Global Economics View Research report, Willem Buiter discusses “Bad and Good ‘Fiscal Theories of the Price Level’.” Quoting my own work on the Fiscal Theory, Buiter warns that policy makers start to pay attention to the theory:

It does not often happen that a rather obscure technical bit of economic theory
merits an audience wider than the small band of academics who spend their waking
hours pondering such matters because that is the kind of thing they do. This note
addresses one of those occasions. The obscure economic theory in question is the
so-called fiscal theory of the price level (FTPL) …

The destruction of the logic of the FTPL by Buiter and Niepelt ought to have been
the end of the FTPL – their arguments were never refuted. … Recently, some of the originators of the original FTPL have tried to resurrect it …

 

 

Conference in Honor of Bob King at the Study Center Gerzensee

Jointly with the Journal of Monetary Economics and the Swiss National Bank, the Study Center Gerzensee organized a conference in honor of Bob King, long-term supporter of the Study Center.

Program: PDF.

Jaume Ventura’s discussion of a paper on trade and growth by Alvarez and Lucas: PDF.

My discussion of a paper on debt and debt constraints by Bhandari, Evans, Golosov, and Sargent: PDF.

“Fiscal Federalism, Taxation and Grants,” CEPR, 2016

CEPR Discussion Paper 11482, August 2016, with Martin Gonzalez-Eiras. PDF. Also published as CESifo Working Paper 6062, Study Center Gerzensee Working Paper 16-05. PDFPDF.

We propose a theory of tax centralization and inter governmental grants in politico-economic equilibrium. The cost of taxation differs across levels of government because voters internalize general equilibrium effects at the central but not at the local level. This renders the degree of tax centralization and the tax burden determinate even if none of the traditional, expenditure-related motives for centralization considered in the fiscal federalism literature is present. If central and local spending are complements and the trade-off between the cost of taxation and the benefit of spending is perceived differently across levels of government, inter governmental grants become relevant. Calibrated to U.S. data, our model helps to explain the introduction of federal grants at the time of the New Deal, and their increase up to the turn of the twenty-first century. Grants are predicted to increase to approximately 5.5% of GDP by 2060.

“Sovereign Debt with Heterogeneous Creditors,” JIE, 2016

Journal of International Economics 99(S1), March 2016, with Harris Dellas. PDF.

We develop a sovereign debt model with heterogeneous creditors (private and official) where the probability of default depends on both the level and the composition of debt. Higher exposure to official lenders improves incentives to repay due to more severe sanctions but it is also costly because it lowers the value of the sovereign’s default option. The model can account for the co-existence of private and official lending, the time variation in their shares in total debt as well as the low rates charged on both. It also produces intertwined default and debt-composition choices.

“Politico-Economic Equivalence,” RED, 2015

Review of Economic Dynamics 18(4), October 2015, with Martín Gonzalez-Eiras. PDF.

Traditional “economic equivalence” results, like the Ricardian equivalence proposition, define equivalence classes over exogenous policies. We derive “politico-economic equivalence” conditions that apply in environments where policy is endogenous and chosen sequentially. A policy regime and a state are equivalent to another such pair if both pairs give rise to the same allocation in politico-economic equilibrium. The equivalence conditions help to identify factors that render institutional change non-neutral and to construct politico-economic equilibria in new policy regimes. We exemplify their use in the context of several applications, relating to social security reform, tax-smoothing policies and measures to correct externalities.

“Austerity,” CEPR, 2014

CEPR Discussion Paper 10315, December 2014, with Harris Dellas. PDF. Also published as CESifo Working Paper 5146, Study Center Gerzensee Working Paper 14-07. PDF, PDF.

We shed light on the function, properties and optimal size of austerity using the standard sovereign debt model augmented to include incomplete information about credit risk. Austerity is defined as the shortfall of consumption from the level desired by a country and supported by its repayment capacity. We find that austerity serves as a tool for securing a more favorable loan package; that it is associated with over‐investment even when investment does not create collateral; and that low risk borrowers may favour more to less severe austerity. These findings imply that the amount of fresh funds obtained by a sovereign is not a reliable measure of austerity suffered; and that austerity may actually be associated with higher growth. Our analysis accommodates costly signalling for gaining credibility and also assigns a novel role to spending multipliers in the determination of optimal austerity.