We consider how fear of model misspecification on the part of the planner and/or the households affects welfare gains from optimal macroprudential taxes in an economy with occasionally binding collateral constraints as in Bianchi (2011). On the one hand, there exist welfare gains from internalizing how borrowing decisions in good times affect the value of collateral during a crisis. On the other hand, interventions by a robust planner that has in mind a model far from the true underlying distribution of shocks, can result in negligible welfare gains, or even losses. This is because a policy that is robust to misspecification, as in Hansen and Sargent (2011), is optimal under a "worst-case'' scenario but not under alternative distributions of the state. A robust planner introduces taxes that are 5 percentage points higher but does not achieve a significant increase in welfare gains compared to a non-robust planner when the true underlying model is not the worst-case. If households also make choices that are robust to model misspecification, the gains are significantly reduced and a highly-robust planner "underborrows" and induces welfare losses. If, however, the worst-case scenario is indeed realized, then welfare gains are the largest possible.
We analyze a union of financially-integrated yet politically-sovereign countries, where
households in the Northern core of the union lend to those in the Southern periphery in a unified
debt market subject to a borrowing constraint. This constraint generates sudden stops throughout
the South, depresses the intra-union interest rate, and reduces Northern welfare below its
unconstrained level, while having ambiguous effects on Southern welfare. During sudden stops,
Pareto improvements can be achieved using North-to-South governmental loans if Southern
governments have the capacity to commit to repay, or using a combination of Southern debt
relief and budget-neutral taxes and subsidies if they do not. From the pre-crisis perspective, it is
Pareto-improving to allow loans and debt relief to be negotiated in later sudden-stop periods as
long as the regions in the union are sufficiently heterogeneous to begin with. We show that our
results are robust to production and to limited financial openness of the union.
Callum Jones, Virgiliu Midrigan, and Mr. Thomas Philippon
We evaluate and partially challenge the ‘household leverage’ view of the Great Recession.
In the data, employment and consumption declined more in states where household debt
declined more. We study a model where liquidity constraints amplify the response of
consumption and employment to changes in debt. We estimate the model with Bayesian
methods combining state and aggregate data. Changes in household credit limits explain
40 percent of the differential rise and fall of employment across states, but a small fraction of
the aggregate employment decline in 2008-2010. Nevertheless, since household deleveraging
was gradual, credit shocks greatly slowed the recovery.
Mr. Adrian Alter, Alan Xiaochen Feng, and Nico Valckx
We confirm the negative relationship between household debt and future GDP growth
documented in Mian, Sufi, and Verner (2017) for a wider set of countries over the period
1950–2016. Three mutually reinforcing mechanisms help explain this relationship.
First, debt overhang impairs household consumption when negative shocks hit.
Second, increases in household debt heighten the probability of future banking crises,
which significantly disrupts financial intermediation. Third, crash risk may be
systematically neglected due to investors’ overoptimistic expectations associated with
household debt booms. In addition, several institutional factors such as flexible exchange
rates, higher financial development and inclusion are found to mitigate this impact.
Finally, the tradeoff between financial inclusion and stability nuances downside risks to
Strong Chinese output growth after the Global Financial Crisis was supported by booming credit. This credit boom carries risks. International experience suggests that China’s credit growth is on a dangerous trajectory, with increasing risks of a disruptive adjustment and/or a marked growth slowdown. Several China-specific factors—high savings, current account surplus, small external debt, and various policy buffers—can help mitigate near-term risks of a disruptive adjustment and buy time to address risks. But, if the risks are left unaddressed, these mitigating factors will likely not eliminate the eventual adjustment, but make the boom larger and last longer. Hence, decisive policy action is needed to deflate the credit boom safely.
Real imports in China have decelerated significantly over the last two years to below
4 percent (yoy) from double-digit growth in previous years. Weaker investment, partly
due to progress in rebalancing from investment to consumption, has been the main factor
accounting for about 40–50 percent of slowdown during this period. Weaker exports also
account for about 40 percent of slowdown, of which about a quarter is due to stronger
RMB. Onshoring—substitution of imported intermediate inputs with domestic
production—has not been an additional drag over this period but it continues to slow
import growth at a similar pace as previous periods. There is large uncertainty about the
impact of rebalancing on the import slowdown due to difficulties in identifying the
counterfactual nonrebalancing path.
Ms. Sally Chen, Minsuk Kim, Marijn Otte, Kevin Wiseman, and Ms. Aleksandra Zdzienicka
Balance sheet recessions have been a drag on activity after the Global Financial Crisis, underscoring the important role of balance sheet adjustment for resuming sustained growth. In this paper we examine private sector deleveraging experiences across 36 advanced and emerging economies countries since 1960. We consider the common features and divergent experiences of deleveraging episodes across countries, and analyze empirically the impact of different aspects of deleveraging during the bust phase of leverage cycles on subsequent medium-term growth. The results suggest that larger and quicker unwinding of non-financial sector debt overhangs is associated with sizable medium-term output gains, and that policies should focus on facilitating up-front balance sheet adjustment.
Mr. Michael Kumhof, Mr. Romain Ranciere, and Pablo Winant
The paper studies how high household leverage and crises can arise as a result of changes in the income distribution. Empirically, the periods 1920-1929 and 1983-2008 both exhibited a large increase in the income share of high-income households, a large increase in debt leverage of the remainder, and an eventual financial and real crisis. The paper presents a theoretical model where higher leverage and crises arise endogenously in response to a growing income share of high-income households. The model matches the profiles of the income distribution, the debt-to-income ratio and crisis risk for the three decades prior to the Great Recession.