When firms have a lot of debt: are capital flows beneficial, helping individuals hedge against risks to their wealth? What is the impact of demand imbalances and cost increases when credit imperfections interact with nominal rigidities? What can we conclude about monetary policy in the eurozone?

These are very relevant questions in a world caught between the capital flows and financial instability characteristic of 2000-2015 and other trends (some slowdown in globalization, resurgent inflation and higher interest rates).

Capital flows and macroeconomic policy in open economies

The objective of the first part of the project is to model how debt leverage, when contract enforcement is constrained and the capital structure of firms is inelastic, affects the financial health of firms, as well as the consequences on the labor market and asset returns. The impact of these factors on employment and wages has been studied in widely cited papers in the corporate finance literature, and we intend to incorporate it into an open macroeconomic model along the lines of Backus, Kehoe and Kydland (1994).

The immediate application of this framework seeks to find answers to the "puzzles" related to cross-country financial investment flows. Then, by introducing nominal rigidities, we want to examine the tightening of monetary policy within the Eurozone, as the pace of rate hikes affects the welfare of society depending on the connection between the financial sector and the labor market. This analysis can also provide insights into other relevant issues, such as those related to the linkages between the US and Emerging Markets.

Finally, we will use our framework to gain a deeper understanding of the relationship between capital flows and inequality. According to the empirical literature, this relationship depends on labor income versus capital income, but that channel has not been fully captured by the literature on global imbalances.

Principal Investigator