Bond Finance, Bank Credit, and Aggregate Fluctuations in an Open Economy
joint with Roberto Chang and Andrés Fernández Martin
Journal of Monetary Economics, January 2017
Carnegie-Rochester-NYU Conference Series on Public Policy:
"Globalization in the Aftermath of the Crisis", April 8-9, 2016

Corporate sectors in emerging market economies have noticeably increased their reliance on foreign financing, presumably reflecting low global interest rates. The evidence also shows a rebalancing from bank loans towards bonds. To study these developments, we develop a dynamic open economy model where these modes of finance are determined endogenously. The model replicates the stylized facts following a drop in world interest rates; in particular, rebalancing towards bonds occurs because bank credit becomes relatively more expensive, reflecting the scarcity of bank equity. More generally, the model is suitable for studying the interactions between modes of finance and the macroeconomy.
Final version, November 2016
NBER Working Paper version, June 2016
Online Appendix

Interest Rates, Leverage, and Business Cycles in Emerging Economies:
The Role of Financial Frictions
joint with Andrés Fernández Martin
American Economic Journal: Macroeconomics, July 2015

Countercyclical country interest rates have been shown to be an important characteristic of business cycles in emerging markets. In this paper we provide a microfounded rationale for this pattern by linking interest rate spreads to the dynamics of corporate leverage. For this purpose we embed a financial accelerator into a business cycle model of a small open economy and estimate it on a novel panel dataset for emerging economies that merges macroeconomic and financial data. The model accounts well for the empirically observed countercyclicality of interest rates and leverage, as well as for other stylized facts.

Final version, March 2014
Additional materials
Old version, June 2012

Kiss Me Deadly: From Finnish Great Depression to Great Recession
joint with Markus Haavio and Juha Kilponen

We investigate the causes of the Finnish Great Depression, 1990-1993. We find that the collapse of the overheated financial and banking sectors starting in 1989 was the trigger of the economic crisis. Foreign shocks, which include the collapse of trade with USSR in 1991, can account for at most about half of the slump, and these shocks occurred only when the economy was already in free fall. Also, the deleveraging and restructuring process of the financial system substantially prolonged the subsequent recovery.
Our methodology involves estimating a structural VAR model with sign and exogeneity restrictions. Importantly, we are able to distinguish between financial shocks affecting the demand for intermediated loans and those shifting the loan supply curve. Hence we also contribute to the discussion on which financial shocks actually matter.
Latest version, November 2014
Online appendices, November 2014
Longer, Bank of Finland Working Paper version, October 2014
Media coverage: A-studio, YLE TV1, 29.10.2014 (in Finnish, time 0:22-0:28)

Open Economies, Interest Rates, and Revealed Preferences

We apply the weak axiom of revealed preferences (WARP) in the context of a two-period model of current account determination. According to this argument, certain changes in net exports and net foreign asset positions should be precluded. In particular, a country which initially ran a trade deficit (was a net debtor), should remain in deficit (remain a net debtor) after the exogenously given interest rate drops. Similarly, a country running a trade surplus (or is a net lender) should remain so if the interest rate goes up. The argument holds for both in endowment economy as well as in a model with production. Our methodology involves solving for the key problem, i.e. isolating the substitution effect from the income and wealth effects which are due to changes in GDP, investment and net factor income from abroad.

Coming soon!

Incomplete Markets, Optimal Portfolios, and International Consumption Correlations

In this paper, we revisit the consumption correlation as well as the Backus-Smith puzzles by inspecting the role of financial markets.
Relative to the existing literature, we introduce explicit international trade in stocks and bonds in an otherwise standard
model of international business cycles. The results show that markets with symmetric trade in stocks allow for a high degree of risk sharing and closely mimic the Arrow-Debreu economy despite being formally incomplete. Risk sharing decreases in asymmetric stock and nominal bond markets, but is still higher than in a single commodity bond economy. The results, therefore, cast doubt on the explanation of the two puzzles based on highly restricted asset trade and large degree of market incompleteness. We also provide empirical evidence that output net of investment and government spending tends to be less correlated across countries than consumption, much less than output itself. This constitutes a new form of the consumption correlation puzzle. The puzzle can be accounted for in the presence of high home bias and low elasticities of substitution between domestic and foreign baskets.