Research

Publications 

1. Nonlinear Unemployment Effects of the Inflation Tax with Mohammed Ait Lahcen, Stanislav Rabinovich, and Hugo van Buggenum. Forthcoming, European Economic Review.

   • We argue that long-run inflation has nonlinear and state-dependent effects on unemployment, output, and welfare. Using panel data from the OECD, we document three correlations. First, there is a positive long-run relationship between anticipated inflation and unemployment. Second, there is also a positive correlation between anticipated inflation and unemployment volatility. Third, the long-run inflation-unemployment relationship is not only positive, but also stronger when unemployment is higher. We show that these correlations arise in a standard monetary search model with two shocks - productivity and monetary - and frictions in labor and goods markets. Inflation lowers the surplus from a worker-firm match, in turn making it sensitive to productivity shocks or to further increases in inflation. We calibrate the model to match the US postwar labor market and monetary data and show that it is consistent with observed cross-country correlations. The model implies that the welfare cost of inflation is nonlinear in the level of inflation and is amplified by the presence of aggregate shocks.

2. Global Demand for Basket-Backed Stablecoins with Jean Flemming (slides, video presentation). Review of Economic Dynamics, 2023, vol 48, pp 244-264.

   • We develop a model where persistent trade shocks create demand for a basket-backed stablecoin, such as Mark Carney’s “synthetic hegemonic currency” or Facebook’s recent proposal for Libra. In numerical simulations, we find four main results. First, because of general equilibrium effects of the basket currency, overall demand for that currency is small. Second, despite scant holdings of the basket, its global reach contributes to substantial increases in welfare. Third, we calculate the welfare maximizing composition of the basket, finding that optimal weights depend on the pattern of international acceptance, but that basket composition does not significantly affect welfare. Fourth, despite potential welfare improvements, low demand for the basket currency from buyers limits sellers’ incentives to invest in accepting it, suggesting that fears of a threat to dollar dominance by so-called global stablecoins may be misplaced.

3. A Simple Model of Voluntary Reserve Targets with Tolerance Bands with Francesca Carapella. Journal of Money Credit and Banking, 2023, vol 55, no 2-3, pp 655-672.

   • This note presents a simplified version of the model of voluntary reserve targets (VRT) developed in Baughman and Carapella (2019), with a Walrasian interbank market. First, the model makes transparent the role of target setting in controlling the market rate. Second, the simplicity of the model allows for an analysis of the interaction between VRT and tolerance bands, which are a common tool for controlling rate variability. We find that the persistent overshooting of interbank rates observed duringCapacity Choice and the Cost of Inflation with Stanislav Rabinovich the Bank of England's experiment with VRT may derive from the interaction between target setting and tolerance bands, a new explanation relative to the literature. We also suggest a simple remedy.

4. Capacity Choice, Monetary Trade, and the Cost of Inflation  (Slides) with Stanislav Rabinovich. European Economic Review, 2021, vol 134.

   • Firms often make production decisions before meeting a buyer. We incorporate this often-overlooked fact into an otherwise standard monetary search model and show that it has important implications for the set of equilibria, efficiency, and the cost of inflation. Our model features a strategic complementarity between the buyers' ex ante choice of money balances and sellers' ex ante choice of productive capacity. When resale value of unsold inventories is high, sellers carry excess capacity and the equilibrium is unique. But, when resale value is low, there is a continuum of equilibria, all of which are inefficient and welfare-ranked. Effects of inflation are highly nonlinear. When inflation is high, the buyer's money holdings bind, and inflation therefore reduces trade through a standard real-balance channel. When inflation is low, the seller's capacity constraint binds, real balances have no effect at the margin, and inflation has no effect on output or welfare.

5. Self-Confirming Price Dispersion in Monetary Economies with Stanislav Rabinovich. Journal of Economic Theory, 2019, vol 183, pp 284-311. (published version, slides)

   • In a monetary economy, we show that price dispersion arises as an equilibrium outcome without the need for costly simultaneous search or any heterogeneity in preferences, production costs, or search technologies. A distribution of money holdings among buyers makes sellers indifferent across a set of posted prices, leading to a non-degenerate price distribution. This price distribution, in turn, makes buyers indifferent across a range of money balances, rationalizing the non-degenerate distribution of money holdings. We completely characterize the distribution of posted prices and money holdings in any equilibrium. Equilibria with price dispersion admit higher maximum prices than observed in any single-price equilibrium. Also, price dispersion reduces welfare by creating mismatch between posted prices and money balances. Inflation exacerbates this welfare loss by shifting the distribution towards higher prices.

6. Voluntary Reserve Targets with Francesca Carapella, Journal of Money Credit and Banking, 2019, vol 52, no 2-3, pp 583-612.

   • This paper updates the standard workhorse model of banks’ reserve management to include frictions inherent to money markets. We apply the model to study monetary policy implementation through an operating regime involving voluntary reserve targets (VRT). When reserves are abundant, as is the case following the unconventional policies adopted during the recent financial crisis, operating regimes based on reserve requirements may lead to a collapse in interbank trade. We show that, no matter the relative abundance of reserves, VRT encourage market activity and support the central bank’s control over interest rates. In addition to this characterization, we consider (i) the impact of anticipated and non-unanticipated liquidity injections by the central bank on market outcomes and (ii) a comparison with the implementation framework currently adopted by the Federal Reserve. Overall, we show that a VRT framework may provide several advantages over other frameworks.

Working Papers

1. Racial Unemployment Gaps and the Disparate Impact of the Inflation Tax with Mohammed Ait Lahcen and Hugo van Buggenum.

   • We study the nonlinearities present in a standard monetary-labor-search model modified to have two groups of workers facing exogenous differences in job finding and separation rates. We use our setting to study the racial unemployment gap between Black and white workers in the United States. A calibrated version of the model is able to replicate differences between the two groups in the level and volatility of unemployment. We show that the racial unemployment gap rises during downturns, and that its reaction to shocks is state-dependent. In particular, following a negative productivity shock, when aggregate unemployment is above average the gap increases by 0.6pp more than when aggregate unemployment is below average. In terms of policy, we study the implications of different inflation regimes on the racial unemployment gap. Higher trend inflation increases both the level of the racial unemployment gap and the magnitude of its response to shocks. 

2. On Cross-Border Payments and the Industrial Organization of Correspondent Banking with Cathy Zhang and Ashley Wumian Zhao

   • Despite advances in domestic payments arrangements, cross-border payments remain  costly and slow. This paper builds a model of cross-border payments where market power in correspondent banking relationships reduces efficiency. We consider two policy experiments: the introduction by one country of an internationally held CBDC, and development of an internationally interoperable settlement system. Both policies can at least attenuate the inefficiencies in cross-border payments, but neither is automatically a complete solution nor are they without difficulties. For an international CBDC, we identify a political economy barrier: banks of the country potentially introducing the CBDC disproportionately suffer losses while benefits tend to accrue to foreign depositors, so a central bank concerned with its domestic banks' profitability may be unlikely to take such an action. Interoperability does not face the same barrier, as benefits accrue more symmetrically, but we argue that technical and other issues inherent to interoperability may be difficult to overcome.

3. CBDC Remuneration and Financial Stability with Francesca Carapella

   • Deadlines and fixed end dates are pervasive in matching markets including school choice, the market for new graduates, and even financial markets such as the market for federal funds. Deadlines drive fundamental non-stationarity and complexity in behavior, generating significant departures from the steady-state equilibria usually studied in the search and matching literature. I consider a two-sided matching market with search frictions where vertically differentiated agents attempt to form bilateral matches before a deadline. I give conditions for existence and uniqueness of equilibria, and show that all equilibria exhibit an ``anticipation effect'' where less attractive agents become increasingly choosy over time, preferring to wait for the opportunity to match with attractive agents who, in turn, become less selective as the deadline approaches. When payoffs accrue after the deadline, or agents do not discount, a sharp characterization is available: at any point in time, the market is segmented into a first class of matching agents and a second class of waiting agents. This points to a different interpretation of unraveling observed in some markets and provides a benchmark for other studies of non-stationary matching. A simple intervention -- a small participation cost -- can dramatically improve efficiency.

4. Deadlines and Matching

   • Deadlines and fixed end dates are pervasive in matching markets including school choice, the market for new graduates, and even financial markets such as the market for federal funds. Deadlines drive fundamental non-stationarity and complexity in behavior, generating significant departures from the steady-state equilibria usually studied in the search and matching literature. I consider a two-sided matching market with search frictions where vertically differentiated agents attempt to form bilateral matches before a deadline. I give conditions for existence and uniqueness of equilibria, and show that all equilibria exhibit an "anticipation effect" where less attractive agents become increasingly choosy over time, preferring to wait for the opportunity to match with attractive agents who, in turn, become less selective as the deadline approaches. When payoffs accrue after the deadline, or agents do not discount, a sharp characterization is available: at any point in time, the market is segmented into a first class of matching agents and a second class of waiting agents. This points to a different interpretation of unraveling observed in some markets and provides a benchmark for other studies of non-stationary matching. A simple intervention -- a small participation cost -- can dramatically improve efficiency.

5. Noisy Search for Multiple Products (Slides) with Kenneth Burdett    

   • Almost all retailers offer multiple products, and consumers search for low prices on a basket of goods. Kaplan and Menzio (2014) document a great deal of price dispersion both within and across stores offering multiple products. This paper extends Burdett and Judd (1983), a canonical model of equilibrium price dispersion, to the case of multiple products. As shown in Burdett and Malueg (1981), when sequentially searching for multiple products, consumers (a) face a lower cost of search per good and (b) may capitalize on low prices for one good while continuing to search for an acceptable price on the others. This leads multi-product consumers to set one reservation price for a basket of goods, and a higher (per good) reservation price for each good alone. This paper characterizes firms' pricing decisions in light of this search behavior. In a simple version of the model where all firms offer every good, the marginal distribution of each price is unique and of the same form as would obtain in a simple single product model, and any joint distribution with support contained in the acceptance set of consumers satisfies equilibrium. This provides theoretical foundation for the common empirical focus on marginal price distributions -- as only these are determined in equilibrium. While the structure of equilibrium is unaffected by the addition of single good demanders, the addition of single good firms can lead to one of several pricing patterns depending on parameters. A consistent prediction is that, if enough firms can offer only a single good, these single product firms crowd out the bottom of the price distribution, with the interesting equilibrium effect of also lowering the highest prices charged by multi-product firms -- an effect which would not obtain in the single product case.  

6. Limited Commitment and the Implementation of Monetary Policy with Francesca Carapella

   • Trade volumes in the federal funds market have remained low since the recent financial crisis. While some argue that this derives from a flood of money in the system, we propose an alternate explanation based on the distinguishing characteristic of the fed funds market: unlike other markets, whose volumes have recovered, fed funds loans are unsecured.  In a model of a money market with unsecured loans subject to endogenous borrowing constraints where the central bank pays interest on reserves (IOR), we show that high levels of IOR reduce trade by tightening credit limits. Friedman's dictum that the central bank should pay a market rate fails to deliver efficiency because IOR decreases the opportunity cost of money holdings relative to credit, so decreases both the profits from lending and the value of borrowing. This results in a tightening of the endogenous borrowing constraint. When IOR exceeds the growth rate of money, credit limits plummet to zero, and no borrowing occurs despite an extant need for funds. Alternate rate schedules besides constant IOR, such as the limited deposit regime employed by Norges Bank in response to dissatisfaction with the functioning of their floor system provide additional incentives to trade which relax credit constraints and improve welfare.

Policy Papers

1. The Stable in Stablecoins with Francesca Carapella, Jacob Gerszten, and David Mills.

   • This note provides a general-audience discussion of stablecoins, the mechanisms they employ to maintain their value, and some policy considerations. 

Cited in the 2023 Economic Report of the President (on page 255).

2. The Financial Stability Implications of Digital Assets with Pablo D. Azar, Francesca Carapella, Jacob Gerszten, Arazi Lubis, JP Perez-Sangimino, David E. Rappoport, Chiara Scotti, Nathan Swem, Alexandros Vardoulakis, Aurite Werman

   • The value of assets in the digital ecosystem has grown rapidly amid periods of high volatility. Does the digital financial system create new potential challenges to financial stability? This paper explores this question using the Federal Reserve’s framework for analyzing vulnerabilities in the traditional financial system. The digital asset ecosystem has recently proven itself to be highly fragile. However, adverse digital asset market shocks have had limited spillovers to the traditional financial system. Currently, the digital asset ecosystem does not provide significant financial services outside the ecosystem, and it exhibits limited interconnections with the traditional financial system. The paper describes emerging vulnerabilities that could present risks to financial stability in the future if the digital asset ecosystem becomes more systemic, including run risks among large stablecoins, valuation pressures in crypto-assets, fragilities of DeFi platforms, growing interconnectedness, and a general lack of regulation. 

3. Federal Funds Rate Control with Voluntary Reserve Targets with Francesca Carapella

   • This note provides a general-audience discussion of the results on monetary policy implementation under a voluntary reserve targets framework derived in two academic papers on the subject.

   • Press Coverage at Central Banking

4. Faster Payments: Market Structure and Policy Considerations with Aaron Rosenbaum, Mark Manuszak, Kylie Stewart, Fumiko Hayashi, and Joanna Stavins.

   • A discussion of market structures that may emerge in the nascent market for faster payments.

5. Theoretical Explorations by the Money Markets Group of Long-run Framework with Gara Afonso, Roc Armenter, Francesca Carapella, Benjamin Lester, and Borghan Narajabad

   • This memo summarizes a project aimed at identifying the key determinants of interest rates, trading volume, and participants in the federal funds (FF) market. We introduce a simple model that captures the key features of the FF market both before and after the 2008-09 financial crisis, and can serve as a laboratory to evaluate and explore proposals regarding the long-run framework.