3

Job Market Paper

This paper studies the welfare consequences of the debt-financed fiscal stimulus implemented in the United States during the 2020 recession. I develop an open-economy heterogeneous-agent model calibrated to the U.S. and compute a transition between a pre-stimulus stationary equilibrium and a new equilibrium with a higher debt-to-GDP ratio resulting from the fiscal response to the recession. The transition path incorporates the observed evolution of government policies from 2020 to 2024. The model reproduces the dynamics of U.S. households’ self-reported well-being through a novel empirical validation exercise that mimics their survey responses and rationalizes a puzzling fact in the literature: household well-being remained depressed during 2023 and 2024 despite low levels of unemployment and inflation. The mechanism behind this result is a gradual reallocation of assets: low- and middle-income households spend their stimulus transfers early in the transition and subsequently decumulate savings, while high-income households absorb these assets and expand their wealth holdings, leaving the average household worse off through 2023-2024. The government policy generates lifetime welfare gains concentrated at the bottom of the wealth distribution, while those at the top experience small losses. Stimulus checks and the revaluation of assets are the key drivers of these results. In the counterfactual exercises, I find scope for further increases in debt and better-designed tax policies that increase welfare.

This paper explores the macroeconomic implications of tight global financial conditions in a small open economy New Keynesian model with sovereign default. My analysis shows that the interplay between the government incentives to repay the debt and inflation during periods of high world interest rates has distinct implications for monetary policy. I show that a monetary easing may emerge when a world interest rate hike induces a substantial increase in the probability of default, depressing domestic demand and leading firms to reduce inflation. This default amplification channel complements the expenditure-switching and expenditure-reducing channels found in standard open economy models, and rationalizes why emerging economies might reduce monetary policy rates when the Federal Reserve tightens. An increase in sovereign risk reduces aggregate domestic demand beyond these conventional channels, leading a real exchange rate depreciation to be contractionary for output.

Motivated by an unprecedented deviation from fiscal rules observed during the COVID-19 pandemic, we develop a sovereign debt model with strategic enforcement of fiscal rules. Empirically, we document that the presence of fiscal rules is statistically significantly associated with lower sovereign spreads during the COVID-19 crisis. This correlation persists even when nations deviate from the rule, suggesting that financial markets do not penalize deviations from the rule during global crises due to an expectation of post-crisis compliance. To test our hypothesis, we enhance a sovereign debt model with the possibility of deviating from the fiscal rule by imposing an exogenous cost of deviation. We show that, if there is no deviation cost during a global crisis, the model can rationalize quantitatively the sovereign spread compressing effect of fiscal rules. Overall, the findings suggest that fiscal rules can help emerging markets and developing economies signal fiscal responsibility during episodes of global financial stress, reducing borrowing costs relative to countries without fiscal rules.

This paper examines the interaction between the currency denomination of sovereign debt and the composition of its holders. We document that, in emerging economies, local-currency bonds constitute the main instrument of government debt and are predominantly held by domestic investors. We develop a framework that characterizes the trade-offs governments face when domestic and foreign demand for bonds respond differently to policy changes. Domestic investors prefer local-currency bonds because these assets provide insurance against distortionary taxation. The government internalizes how currency denomination influences domestic demand and default risk, generating a novel endogenous link between the composition of bondholders and the choice of currency. Even abstracting from the standard hedging benefits against output fluctuations, it remains optimal for the government to issue local-currency debt to stimulate domestic demand, consistent with empirical evidence. Finally, we show that imposing minimum domestic holdings of foreign-currency bonds through financial repression can implement the optimal allocation without relying on local-currency issuance.

This paper develops a regime-switching New Keynesian model for a small open economy, with an occasionally binding financial friction that allows for endogenous financial crises. The model has two regimes: a regime for normal economic times, in which financial market access is unconstrained, and a crisis regime, characterized by curtailed access to foreign borrowing. The transition probability between regimes depends on the endogenous variables of the model. We employ this framework to analyze the macroeconomic implications of adapting the Inflation Targeting (IT) strategy in a way that takes into account the possibility to prevent the occurrence of financial crises. We calibrate the model using Colombian historical data. The results show that monetary policy has major limitations when it seeks to prevent financial crises. As the central bank gives more importance to the GDP growth gap, the frequency with which crises occur decreases. However, this reduction is quantitatively small. On the other hand, as the monetary authority responds more strongly to increases in the external debt growth rate, the frequency with which the economy goes into crisis is not significantly different from the current IT scheme. However, the volatilities of inflation and consumption are much higher.