Research Statement

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i) Useful Results for the Simulation of Non-Optimal  Economies with Heterogeneous agents,  under revision.  

This paper deals with infinite horizon non-optimal economies with 

aggregate uncertainty and a finite number of heterogeneous agents. It

derives sufficient conditions for the existence of a recursive structure,

an ergodic, a stationary, and a non-stationary equilibria. It also gives an

answer to the following question: is it possible to derive a general 

framework which guarantees that numerical simulations truly reflect 

the behavior of endogenous variables in the model? We provide 

sufficient conditions to give an affirmative answer to this question for 

endowment economies with incomplete markets and uncountable

exogenous shocks. These conditions guarantee the ergodicity of the 

process and hold for a particular selection mechanism. For economies 

with finitely many shocks or for an arbitrary selection in economies with 

uncountable shocks, it is only possible to show that a computable, time 

independent and recursive representation generates a stationary 

Markov process. The results in this paper suggest that often a well-defined 

stochastic steady state in heterogenous agent models is  sensitive to the initial 

conditions of the economy; a fact which imply that heterogeneity may have 

irreversible long-lasting effects.

Link to the paper and on-line appendix : https://damianpierri.com/research

ii) Memory, Collateral and Emerging Market Crises,  Reject and Resubmit at the Journal of Economic Theory.

Joint with K. Reffett

 We present a new Generalized Markov Equilibrium (GME) approach to studying sudden stops and financial crises in emerging countries in the canonical small open economy model with equilibrium price-dependent collateral constraints. Our approach to characterizing and computing stochastic equilibrium dynamics is global, encompasses recursive equilibrium as a special case, yet allows for a much more flexible approach to modeling memory in such models that are known to have multiple equilibrium. We prove the existence of ergodic GME selections from the set of sequential competitive equilibrium, and show that at the same time ergodic GME selectors can replicate all the observed phases of the macro crises associated with a sudden stop (boom, collapse, spiralized recession, recovery) while still being able to capture the long-run stylized behavior of the data. We also compute stochastic equilibrium dynamics associated with stationary and nonstationary GME selections, and we find that a) the ergodic GME selectors generate stochastic dynamics that are less financially constrained with respect to stationary non-ergodic paths, b) non-stationary GME selections exhibit a great range of fluctuations in macroeconomic aggregates compared to the stationary selections. From a theoretical perspective, we prove the existence of both sequential competitive equilibrium and (minimal state space) recursive equilibrium, as well as provide a complete theory of robust recursive equilibrium comparative statics in deep parameters. Consistent with recent results in the literature, relative to the set of recursive equilibrium, we find 2 stationary equilibrium: one with high/over borrowing, the other with low/under borrowing. These equilibrium are extremal and “selffulfilling” under rational expectations. The selection among these equilibria depend on observable variables and not on sunspots.

Link to the paper and presentation:  https://damianpierri.com/research

iii) An ergodic theory of sovereign default

Joint with Hernan Seoane

We present the conditions under which the dynamics of a sovereign default model of private external debt are stationary, ergodic and globally stable. As our results are constructive, the model can be used for the accurate computation of global long run stylized facts. We show that default can be used to derive a stable unconditional distribution (i.e., a stable stochastic steady state), one for each possible event, which in turn allows us to characterize globally positive probability paths. We show that the stable and the ergodic distribution are actually the same object. We found that there are 3 type of paths: non-sustainable and sustainable; among this last category trajectories can be either stable or unstable. In the absence of default, non-sustainable and unstable paths generate explosive trajectories for debt. By deriving the notion of stable state space, we show that the government can use the default of private external debt as a stabilization policy.

Link to the paper: https://ideas.repec.org/p/cte/werepe/36164.html

iv) Asymmetric fiscal policy: theory and practice

Joint with Juan Rincón Zapatero and Kevin Reffett

We build on the asymmetric business cycle theory (Hansen and Prescott, 2005) to develop a novel equilibrium notion which allows to replicate the global dynamics in a possibly inefficient economy subject to fiscal shocks. The theoretical structure is sufficiently general to compute and simulate tax and Government expenditure shocks of an arbitrary magnitude which may affect the behavior of the economy differently depending on the position of the economy along the cycle. We prove the existence of a sequential and of a recursive equilibrium for this economy. Under an additional set of assumptions, the sequential equilibria can be computed directly from the system of equations characterizing the dynamic behavior of the economy. Under milder assumptions, we can compute the recursive equilibria.

Work in progress

i) Persistent current account deficits and balance of payments crises, submitted. 

Joint with G. Montes Rojas and P. Mira

Persistent current account defficits are common among low- and middle-income countries. We evaluate when this situation triggers a crisis and characterize it. Using a non-parametric estimator, we finda critical value for the yearly current account defficit just before the crisis sets of. These findings give rise to a different type of crises: countries that have increased their external indebtedness by an accumulated amount of at least 26%-31% of the GDP in a time span of 3 to 5 years, when they are hit by a crisis, they suffer a more severe recession than an average sudden stop. We call these events persistent balance of payment crises. This generates a consumption fall of 3.1% and a current account reversal 4.9 percentage points. We also contribute to the structural characterization of balance of payment crises. Using a canonical model augmented with an endogenous interest rate, given enough persistence of the GDP, we can replicate these stylized facts. In this sense, the variability of national income in countries which are external net debtors is critical.

Link to the paper: https://damianpierri.com/research

ii) Incomplete interest rate pass through: a recursive partial equilibrium approach

Joint with M. Cherkasky and L. Trajtenberg

The empirical literature provides robust evidence on the incomplete pass through (IPT) of monetary policy instruments on market rates. However, the coefficients found are not similar across regions, ranging between 0.25 and 0.75. Also, the theoretical literature has not provided a comprehensive framework which can explain this fact satisfactorily. This paper proposes a recursive partial equilibrium model that generates a PT coefficient between 0.5 and 0.6. The model is calibrated for Latin American economies where the active (passive) rate is above (below) the policy rate and the spread is stable. These facts allow explaining the IPT: after a tightening in the monetary policy, banks switch the composition of their assets from loans to central bank notes. This change allows them to reduce the effects on earnings caused by the tightening provided that there is an IPT in the passive rate and that this rate is below the policy rate. The stability of the spread explains the PT in the active rate. In order to obtain the IPT coefficients, this paper derives a structural estimation of the supply elasticity of deposits and demand elasticity of loans. The former ranges between 3.0 and 4.0 and the latter between -1.5 and -2.0. These results suggest that the efficiency of the monetary policy might be affected more by an incomplete PT than by the lack of sensibility of loans and deposits.

Link to the paper: https://damianpierri.com/research

iii) Asymmetric business cycles and fiscal policy: the effect of idle capacity.

Joint with G. Montes Rojas and Domenico Ferraro

 We study the asymmetric effect of tax shocks depending on its sign and position along the business cycle. Our empirical findings show that only a tax cut in expansions is statistically significant for investment. We build a novel theoretical structural model to replicate several characteristics of fiscal policy and test their influence on the outcome of exogenous tax changes. This allows us to study the asymmetric effects of tax policies as a consequence of idle capacity and the convexity of the marginal productivity of labor. We allow for differentiated effects depending on time, order of magnitude, sign and position along the cycle in a simple RBC model .

Work in progress  

iv) Default Risk and Fiscally induced sudden stop

Joint with H. Seoane and A. Vicondoa

To our knowledge the literature has taken care separately of sudden stops on private external debt and of defaults on public debt. This paper is the first attempt to model the effects of sovereign default on private expenditure when external debt is mainly issued by the public sector and there is a positive probability of suffering a sudden stop. The model takes the standard structure in models with financial frictions in small open economies as in Bianchi (2011) and introduce default sobering risk using a framework adapted from Lorenzoni and Werning (2019). In order to structurally estimate the model, we compute directly the sequential equilibria exploiting the finite time assumption inherited from Lorenzoni and Werning (2019). 

Work in progress.

v) The importance of the buy side in emerging market crises

Joint with S. Barraza and F. Roldan

The macro literature since Mendoza (91) have modeled emerging market crises as a shortage in international lending. The focus is always on the behavior of the borrower. But, what about the lender? As a consequence of assuming that lenders have great tolerance to risk and that are price takers, financial market equilibrium is dichotomous: the borrowers fix the amount of the debt issuance and the lender decides the price. More to the point, the wealth distribution of lenders is irrelevant.  Based on a novel data set, this paper challenges these assumptions. We document the position in Argentinean sovereign debt bond by bond and broker by broker. We found not only that the availability of funds, represented by the net worth of each “brand” of mutual funds, is crucial but also that investment decisions are irreversible. We also observe that in each debt issuance (primary auctions) the fraction purchased by a particular hedge fund is no larger than 5%, suggesting a competitive behavior.

Work in progress.

vi) Uncertainty and Maturity Structure

Joint F. Roldan

We investigate the effect of heightened uncertainty on the optimal time-consistent fiscal policy. We consider a planner who lacks commitment to future policy actions and faces shocks to the value of government spending. When uncertainty is temporarily large, the planner has an incentive to tilt its debt issuance towards the long end. In `normal times' levels of uncertainty, however, the planner prefers to issue equal amounts at all horizons to avoid costs from lack of commitment, as is well known in the literature.

Work in progress.

i)  Accuracy in Recursive Minimal State Space Methods, submitted

 The existence of a recursive minimal state space (MSS) representation is not always guaranteed. However, because of its numerical efficiency, this type of equilibrium is frequently used in practice. What are the consequences of computing and simulating a model without a constructive proof? To answer this question, we identify a condition which is associated with a convergent and computable MSS representation in a RBC model with state contingent taxes. This condition ensures the existence of a benchmark equilibrium that can be used to test frequently used algorithms. To verify the accuracy of simulations even if this condition does not hold, we derive a closed form recursive equilibrium which contains the MSS representation. Both benchmark representations are accurate and ergodic. We show that state of the art algorithms, even if they are numerically convergent, may underestimate capital (and thus overestimate the benefits of capital taxes) by at least 65%, a figure which is in line with recent findings using accurate benchmarks. When an existence proof is not available, we found 2 sources of inaccuracy: the lack of a convergent operator and the absence of a well-defined (stochastic) steady state. Moreover, we identify a connection between lack of convergence and the equilibrium budget constraint which implies that simulated paths may be distorted not only in the long run but also in any period. When we have a constructive proof, inaccuracy is generated by the lack of qualitative properties in the computed policy functions.

Link to the paper: https://damianpierri.com/research

ii) Theoretical Error Bounds for the Value and Policy Function Iteration Algorithms: An Application for Recursive Dynamic Models with Inequality Constraints.

Winner of the Society for Computational Economics  Contest 2011

This paper derives theoretical error bounds for the Policy and Value Function Iteration algorithms applied to Recursive Dynamic Models with continuous decision variables and inequality constraints. This paper proves two main theorems. The first one uses a recent result due to Santos and Rust (2004). The theorem extends the result by combining a feasible version of the Policy Function Iteration algorithm with the barrier method for a model with an arbitrary number of state and decision variables. This constitutes a significant difference with the original theorem, since it is no longer necessary to assume the interiority of the solutions. The Algorithm converges at a rate of 1.5 for a given grid size. The second theorem, for problems with only one continuous endogenous state variable, uses a feasible version of the Value Function Iteration Algorithm, the barrier method and a cubic Variation Diminishing Spline Approximation. The algorithm converges at a linear rate, given the grid size. Finally, under a certain configuration of the parameters, the maximization problem in this last theorem is in the convex class, which can be solved in polynomial type complexity, and the policy function is first order differentiable. These last results enables the algorithm to avoid the Course of Dimensionality for the maximization problem in the Bellman Equation and the use of first order perturbation methods, thus, constitutes an extension of existing theorems that deals only with equality constraints (see Judd, 1994).

Link to  the paper & Presentation (a new version is  coming joint with L. Bali): https://damianpierri.com/research

i) Life Cycle, financial frictions and informal labor markets, published in the Journal of Applied Economics

Joint with E. Kawamura

In this paper we study the implications of economic policies that affect household's income. We focus on Chile after the massive demonstrations against the existing standard of living observed in 2019. Using a search model with life-cycle features and survey data, we found that an equivalent change in labor tax rates and non-contributary pensions have opposite effects on labor markets, specifically on informality and unemployment duration. Non-contributary pensions offers a milder trade-off as it produces a second order increase in informality. However, due to the presence of informal labor markets and financial frictions, non-retired agents increase their current consumption only after a tax cut. That is, in this framework, a positive wealth shock can reduce consumption. Thus, when we take into account the impact on welfare, as households are assumed to value only consumption, cutting taxes seems to be preferred. We characterize labor market and consumption-savings decisions. We found 2 effects operating simultaneously and in opposite directions: substitution and wealth. Due to the presence of risk averse agents and incomplete capital markets, the latter prevails suggesting that the life cycle aspects of the labor market are critical to understand policy trade-offs.

Link to the paper: https://damianpierri.com/research

ii) A measure of the wealth distribution for Argentina: implications for the labor market and the pension system.

Joint with D. Trupkin

Using a panel of 2 million observations we can keep track of the labor market history of a subset of the formal labor market in Argentina. The data allows me to estimate the wealth distribution of non-retired agents using a search model with risk averse agents. We then can compute the effect of different fiscal policies on the labor market conditional on the position on the income and wealth distribution of each worker. 

Work in progress.