Recent Research

We identify and study two mechanisms that can overturn the stabilizing effects of unemployment insurance (UI) policies. First, households in economies with more generous UI reduce their precautionary savings and borrow more in the mortgage market. Second, the overall share of mortgages as well as the share of mortgages with higher loan-to-income ratios on bank balance sheets increase. As a result, both bank and household balance sheets become more vulnerable to adverse shocks, which deepens recessions. We demonstrate the importance of these channels, by employing a quantitative heterogeneous-agent general equilibrium model and by providing county-level empirical evidence from the U.S. housing and mortgage markets.

While higher interest rates increase the payments for borrowers with adjustable-rate mortgages (ARMs), cutting their disposable income, higher rates also increase lenders’ interest income, strengthening their balance sheets. We find, correspondingly, that—when monetary conditions tighten—banks with higher ARM shares see their stock prices increase, supply more credit, and obtain higher interest income compared to banks with lower ARM shares. Therefore, more ARM credit outstanding may weaken monetary policy transmission. And during a financial crisis, when interest income becomes critical for banks, reductions in interest rates may be challenging for those banks with very high ARM shares.

This paper investigates how mortgage structure shapes the transmission of inflation shocks through a “dual channel” where household wealth effects compete with bank credit supply.

We use disaggregated U.S. data and a border discontinuity design to show that more generous unemployment insurance (UI) policies lower bank deposits. We test several channels that could explain this decline and find evidence consistent with households lowering their deposit holdings due to reduced precautionary savings. Since deposits are the largest and most stable source of funding for banks, the decrease in deposits affects bank lending. Banks that raise deposits in states with generous UI policies reduce their loan supply to small businesses. Furthermore, counties that are served by these banks experience a higher unemployment rate and lower wage growth.

We present two sets of evidence demonstrating that credit supply played a quantitatively significant role in the US housing market circa 2008. First, we develop a general equilibrium model featuring heterogeneous households who make housing tenure decisions and take out long-term mortgages, firms that acquire working capital through short-term bank loans, and banks whose ability to intermediate funds depends on their capital. Second, we provide bank- and county-level empirical evidence supporting the credit supply mechanism. Our quantitative findings show that changes in credit supply, stemming from exogenous shocks to bank leverage and/or endogenous shifts in bank balance sheets, played a significant role in the housing market boom-bust and the overall economy. While a housing demand shock substantially contributed to the house price boom, it had little to no impact on output and wages and played a smaller role in driving consumption. Furthermore, our analysis shows that credit supply expansion causes a decline in the bank lending rate and an increase in both mortgage debt and firm loans, generating positive comovement between them. Conversely, an increase in housing demand raises mortgage demand, causing the bank lending rate to increase and firms to reduce borrowing, thereby generating negative comovement between mortgage debt and firm loans. Our empirical evidence supports the credit supply mechanism.

We differentiate consumption from expenditure by incorporating price search decisions into an otherwise standard life-cycle model. We first analytically show that, under very general conditions, poorer households search more and pay lower prices compared to wealthier ones. As a result, consumption inequality is smaller than expenditure inequality, and the gap between them increases over the life-cycle. Next, using a plausibly calibrated model, we find that life-cycle increase in consumption inequality is about 30% lower than the increase in expenditure inequality. Price search provides an insurance mechanism against income shocks and increases the welfare of a newborn by 3.9%.

We show that higher monetary policy uncertainty lowers bank risk-taking, with especially poorly capitalized banks contracting their loan supply.