forthcoming Journal of Monetary Economics, 2020

[Published version] [PDF]

Abstract: During sovereign debt crises, countries experience persistent economic declines, spiking spreads, and outflows of capital and workers. To account for these salient features, we develop a sovereign default model with migration and capital accumulation. The model has a two-way feedback. Default risk lowers workers’ welfare and induces emigration, which in turn intensifies default risk by lowering tax base and investment. Compared with a no-migration model, our model produces higher default risk, lower investment, and a more profound and prolonged recession. We find that migration accounts for almost all of the lack of recovery in GDP during the recent Spanish debt crisis.

Working Papers and In-Progress

  • Inequality, Taxation, and Sovereign Default Risk


Abstract: This paper studies the impact of income inequality on sovereign spreads under elastic labor and endogenous taxation. We first document that high pre-tax income inequality is associated with high spreads both across countries and across U.S. states. We then develop a sovereign default model with endogenous progressive taxation and heterogeneous labor in productivity and migration cost. The government chooses the optimal combination of tax and debt, considering their interaction. Progressive taxes redistribute income but discourage labor supply and induce emigration, eroding the tax base and the government's ability to repay debt. Default risk increases sovereign spreads and borrowing costs. Thus, the government faces a trade-off between redistribution and spreads. In more unequal economies, the government opts for more redistribution and higher spreads. With the model parameterized to state-level data, we find that income inequality is an important determinant of spreads, generating more than 20% higher spreads compared with a model without income inequality. In a recession, more unequal economies suffer a larger increase in spreads.

  • Lumpy Debt, Monetary Policy, and Investment, with Min Fang


Abstract: We study how financial heterogeneity determines firm-level investment responses to monetary policy shocks. In Compustat, a significant amount of firms hold almost zero debt, and among the firms who hold debt, both the amount and the maturity of debt vary greatly. We refer to these financial heterogeneity characteristics as lumpy debt. We first document that lumpy debt significantly affects the responses of firm investment to monetary policy shocks: firms who hold debt, hold more debt, and hold more long-term debt, are less responsive to monetary policy shocks. We then develop a heterogeneous firm model with investment, long-term and short-term debt, and default risk to interpret these facts. In the model, firms with higher leverage or more longterm debt are less responsive to monetary policy shocks because of higher default risk. The effect of monetary policy on aggregate investment, therefore, depends on the distribution of firm financial positions.

  • Sovereign Debt Crisis and Firm Intangible Investment, with Chang Liu