Research

Abstract: Most developing countries are characterized by two facts: (1) net emigration, and (2) net remittances received. This paper studies how these two facts interact with the sovereign default risk. In theory, the effect of remittances is ambiguous. On the one hand, they are an additional source of income that increases its ability to repay. On the other hand, by reducing the production share of income, it undermines the default penalties available to international lenders that enforce repayment. Using a panel of developing countries, we document a positive correlation between spreads and net remittances. We then construct a sovereign default model with emigration and remittances. Critical to the ability of the model to reproduce the positive correlation is the countercyclical nature of emigration and remittances. Because the government internalizes that default leads to an increase in remittances that partially cushions against the default penalties, in equilibrium, countries with a large income share from remittances face a steeper government bond spread schedule and hold lower debt levels. Our model, calibrated to countries' average emigration and net remittances, successfully replicates the observed correlations between emigration, remittances, and spreads.

Abstract: This paper studies optimal tax progressivity and its interplay with income inequality and government debt. Such concerns are major policy issues for many countries, especially emerging economies. The model captures the dynamics of government debt, default and taxation within an unequal economy. Income inequality increases both optimal tax progressivity and government borrowing costs. Quantitatively, I calibrate the model to the key characteristics of the Brazilian income distribution. Using before-tax and after-tax data, I uncover the Pareto weights that justify Brazil's current redistribution policy. The current tax progressivity is approximately half of what would be considered optimal under an equal-weight utilitarian government. The current Pareto weights demonstrate a significant imbalance: the weight allocated to the richest decile is 156 times greater than that assigned to the poorest decile. A heavy debt burden forces a lower degree of tax progressivity and smaller Pareto weights on the poor.

Abstract: This paper documents that Chinese firms increasingly finance innovation using their innovation stock, measured as patents. Drawing on patent collateral data from both the US and China, we first show that (1) In China, the total number and share of patents pledged as collateral have been rising steadily, similar to the US facts documented in Mann (2018), (2) Chinese firms employ patents as collateral on a smaller scale and with a lower intensity than US firms, and (3) Chinese firms also increase innovation after adopting patent collateral as US firms. We then construct a heterogeneous firm general equilibrium model featuring idiosyncratic productivity risk, innovation capital investment, and borrowing constrained by patent collateral. The model emphasizes two barriers that hinder the use of patent collateral: high inspection costs and low liquidation values of patent assets. We parameterize the model to firm-level panel data in the US and China and find that both barriers are significantly more severe in China than in the US. Finally, counterfactual analyses show that the gains in innovation, output, and welfare from reducing the inspection costs in China to the US level are substantial, moreso than enhancing the liquidation value of patent assets.

Abstract: This paper studies interactions between trade friction and sovereign default risk. Trade barriers are measured as the gap between observed trade flows and predicted trade flows using relative expenditures and prices. We build a general equilibrium sovereign default model with trade and decompose the trade barriers into one conventional trade wedge term stemming from trade friction and one financial friction component. The trade friction exacerbates the risk of sovereign default, which in turn impacts the private sector by increasing their borrowing cost. The interaction between trade and financial friction further magnifies the trade barriers. The model generates comovements between trade and financial friction as in the data. We find that financial friction component accounts for 47\% of the measured trade barriers.

Abstract: This paper analyzes the impact of a balanced budget rule (BBR) on government financing costs and its implications for the government balance sheet. Exploiting the variation in BBR implementation across US states, we find that states with more stringent BBRs exhibit significantly lower bond spreads and credit default swap spreads, demonstrating the crucial role of default risk. A sovereign default model, which features long-term debt, endogenous investment and output, as well as a BBR, aligns with the empirical result. Calibrated to Illinois, our quantitative analysis suggests that implementing a BBR could dramatically decrease the state bond spread, gradually lower the debt, and improve welfare in the long run.

Abstract: U.S. states are sovereign entities and can't declare bankruptcy as cities and municipalities. This paper examines the impact of a switch in sovereign bankruptcy rules that allows declaring bankruptcy from an economics model perspective. Allowing bankruptcy increases ex-ante risks for the government to refuse repayment, but provides ex-post benefits of reducing default costs and saving federal bailouts. This paper provides a simple framework to analyze this trade-off. Event analysis shows that an unexpected switch in bankruptcy rules that allows for bankruptcy would decrease government debt-to-GDP ratio by 9.2 percentage points, increase consumption by 0.69 percent, but increase spread by 1.1 percentage points.

Abstract: This paper measures the output and TFP losses from sovereign risk, considering firm-level intangible investment. Using Italian firm-level data, we show that firms reallocated from intangible assets to tangible assets during the 2011-2012 Italian sovereign debt crisis. This asset reallocation is more pronounced among small firms and high-leverage firms. This reallocation affects aggregate output and TFP. To explain the reallocation pattern and quantify the output and TFP losses, we build a sovereign default model incorporating firm intangible investment. In our model, sovereign risk deteriorates bank balance sheets, disrupting banks’ ability to finance firms. Firms with greater external financing needs are more exposed to sovereign risk. Facing tightening financial constraints, firms shift their resources towards tangibles because they can be used as collateral. We find that elevated sovereign risk explains 45% of the observed output losses and 31% of the TFP losses in Italy from 2011 to 2016.

Abstract: Income inequality and worker migration significantly affect sovereign default risk. Governments often impose progressive taxes to reduce inequality, which redistribute income but discourage labor supply and induce emigration. Reduced labor supply and a smaller high-income workforce erode the current and future tax base, reducing government’s ability to repay debt. I develop a sovereign default model with endogenous nonlinear taxation and heterogeneous labor to quantify this effect. In the model, the government chooses the optimal combination of taxation and debt, considering its impact on workers’ labor and migration decisions. Income inequality accounts for one-fifth of the average US state government spread.

Abstract: We study how debt maturity heterogeneity determines firm-level investment responses to monetary policy shocks. We first document that debt maturity significantly affects the responses of firm-level investment to conventional monetary policy shocks: firms who hold more long-term debt are less responsive to monetary shocks. The magnitude of responses due to debt maturity heterogeneity is comparable to the well-documented responses due to debt level heterogeneity. Evidence from credit ratings and borrowing responses indicates that the higher future default risk embedded in long-term debt plays an essential role. We then develop a heterogeneous firm model with investment, long-term and short-term debt, and default risk to quantitatively interpret these facts. Conditional on the level of debt, firms with more long-term debt are more likely to default on their external debt and consequently face a higher marginal cost of external finance. As a result, these firms are less responsive in terms of investment to expansionary monetary shocks. The effect of monetary policy on aggregate investment, therefore, depends on the distribution of debt maturity.

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.