Research

Institutional Quality and Foreign Reserves (Job Market Paper)

Global imbalances are composed of foreign-reserve outflows from fast growing emerging market economies. Three main explanations for reserve accumulation given in the literature are precautionary savings, mercantilism and political economy frictions. None of them can explain by itself the levels of foreign reserves, and even less, its high cross-country variation. I develop a DSGE small-open economy model that comprehends all three motives, and use information from a panel of 189 countries to discipline the model. The panel will also document that institutional quality –measured as declining or low level of expropriation risk– is strongly correlated with reserve accumulation. The model shows that, given a certain degree of patience, an increase in political-economy frictions can bring a level of public savings of 4 times the output down to a net debt of -20%, increasing expropriation risk from 0 to up to 45%, which is consistent with the empirical findings.

Debt Overhang, Rollover Risk and Investment in Europe

(With Sebnem Kalemli-Özcan and Luc Laeven)

We find that debt overhang and rollover risk translate into sluggish investment in Europe. Using an extensive pan-European firm-bank matched data set covering public and private firms, we document that firms with higher debt overhang – defined as higher corporate indebtedness relative to earnings – invested less prior to the 2008 European crisis, and this negative effect intensified during the crisis. In the run-up to the crisis European firms financed investment increasingly using debt, including short term debt, exposing firms to rollover risk in the event of a reversal in lending conditions. During the crisis period, the investment of firms with longer maturity debt was less curtailed, consistent with an in- crease in rollover risk, while markets for short-term debt collapsed. We document that the worsening of debt overhang and increasing rollover risk during the crisis can be linked to an increase in sovereign risk in peripheral European countries. Rollover risk in peripheral Europe increased especially for firms with preexisting borrower relationships with banks whose balance sheets deteriorated because of large holdings of peripheral sovereign bonds, highlighting the role of sovereign-bank linkages in affecting firm investment. A simple back of the envelope calculation based on our firm-level estimates suggests that the debt overhang and rollover risk channels together explain more than half of the actual decline in aggregate corporate investment in the aftermath of the crisis.