Projects

Project Leader: Prof. Dr. Alfred Maußner; until 2015

Participants: Michael Flor, Halvor Ruf

Subproject 1:  Q targeting and monetary policy

This subproject will construct a NK model that is able to account for both the well known stylized  facts of the business cycle and the empirically documented facts of asset pricing. This model serves as a framework to study asset price targeting by the central bank, i.e. the question whether or not monetary policy that also takes account of asset price developments will stabilize prices, production, and employment and will be welfare enhancing.

Subproject 2: Distributional effects of unanticipated inflation

This subproject will extend the model of Heer and Maußner (2011) on the the burden of unanticipated inflation to include nominal bonds, real estate, and involuntary unemployment. This model should serve as a framework to work out the effects of inflation and asset price bubbles on the distribution of income.

Working Papers:

• Flor, M. (2014): Post Reunification Economic Fluctuations in Germany: A Real Business Cycle Interpretation.

• Heer, B. and A. Maußner (2014): Q-Targeting in New Keynesian Models.
• Heiberger, C. and H. Ruf (2014): Epstein-Zin Utility, Asset Prices, and the Business Cycle Revisited.

Project Leader: Prof. Dr. Holger Daske; until 2015

Participants: Dr. Jannis Bischof, Dipl.-Kfm. Ferdinand Elfers

As part of the Basel II accord (Pillar 3), extensive capital and risk disclosure regulations have been introduced for the banking sector in order to enhance mechanisms of market discipline. Adoption of these requirements is heterogeneous across countries and across banks. We aim to exploit this variation to study the effect of transparency requirements as a means of banking regulation. More specifically, we analyze the impact of risk disclosures on cost of funding and depositor behavior as well as how these disclosure-induced changes in banks’ cost of capital reversely affect risk taking and capital adequacy of banks, i.e. contribute to financial stability by reducing the probability of bank failures.

Project Leader: Prof. Tom Krebs, Ph.D.

Participants: Dr. Matthias Mand

In this research project, we study boom-bust cycles in housing and credit markets that are driven by economic fundamentals and amplified by financial market imperfections. In particular, we ask to what extent government policy (subsidization of homeownership, tax reforms) and financial innovation contribute to the occurrence of boom-bust cycles in economies with two financial market imperfections: limited contract enforcement and incomplete markets.
To this end, we first develop a micro-founded macroeconomic model with heterogeneous households and these two financial frictions. We use a version of the model economy calibrated to the US data to simulate the quantitative impact of changes in government policy and financial innovation on the cyclical variations in house prices, household debt, default rates, and other macroeconomic variables. We also consider a second version of the model calibrated to German data and German institutions and conduct a comparative analysis between the US and Germany. Finally, we discuss the distributional consequences of changes in government policy and financial innovation and their effect on long-run economic growth, with a special emphasis on the human capital channel.

Publications:

• Krebs, T., M. Kuhn and M. Wright (2015): Human Capital Risk, Contract Enforcement, and the Macroeconomy, American Economic Review, 105(11): 3223–72.
• Krebs, T., M. Kuhn and M. Wright (2017): Under-insurance in human capital models with limited enforcement, Review of Economic Dynamics, 25: 121–50.

Working Papers:

• Krebs, T., M. Mand and M. Wright (2014): The Taxpayer Relief Act of 1997 and the U.S. Housing Boom.
• Krebs, T. and M. Mand (2018): Macroeconomic Implications of the Long-Run Decline in Real Interest Rates.

Project Leader:  Prof. Ester Faia, Ph.D., Prof. Dr. Jan Pieter Krahnen

We explore the role of bank debt for the propagation of risk in the economy and for the interaction with monetary and fiscal policy. We also consider the possible role of implicit government guarantee of the monetary policy when banks have an incentive to do risk taking (for instance in models of the interbank market). Some work will also assess the empirical relevance of the risk taking channel using time series evidence. 

Working Papers:

• Angeloni, I., E. Faia and M. L. Duca (2013): Monetary Policy and Risk Taking.
• Bluhm, M., E. Faia and J. P. Krahnen (2013): Endogenous Banks' Networks, Cascades and Systemic Risk.
• Bluhm, M., E. Faia and J. P. Krahnen (2014): Monetary Policy Implementation in an Interbank Network: Effects on Systemic Risk.
• Bluhm, M. and J. P. Krahnen (2014): Systemic Risk in an Interconnected Banking System with Endogenous Asset Markets.
• Bassanin, M., E. Faia and V. Patella (2018): Ambiguous Leverage Cycles.
• Curatola, G. and E. Faia (2018): Divergent Risk-Attitudes and Endogenous Collateral Constraints, CEPR D.P. 11678.
• Faia, E. and S. Karau (2018): Banks' Systemic Risk and Monetary Policy.
• Faia, E. and M. Paiella (2018): P2P Lending: Information Externalities, Social Networks and Loans' Substitution, CEPR D.P. 12235.

Project Leader: Prof. Dr. Valeriya Dinger

Participants: Vlad Marincas

The role of bank undercapitalization as an important determinant of the propagation of macroeconomic shocks through the financial system has been repeatedly illustrated by the most recent as well as earlier financial crises. Recognizing the risks of bank undercapitalization, policy makers have recently proposed a number of measures targeting higher levels of bank capital. An evaluation of the possible macroeconomic effects of the new capital rules is badly needed but still challenging since many aspects of bank capital decisions have not been thoroughly studied, yet. In particular, most existing research with regard to the effects of capital regulation has focused on studying banks’ decisions to adjust lending, leaving the decisions of banks to actively change the volume of equity widely unexplored.

In this project we plan to close this gap and empirically examine the decision of a bank to issue new equity. More specifically, we intend to answer the following questions: (i) Which are the determinants of a bank’s decision to issue new equity? Do severe undercapitalization and systemic distress create effective incentives or disincentives with regard to the issuing decision? (ii) Does the information revealed by an individual bank’s equity issue have an effect on the behavior of the bank’s peers? Is this effect stabilizing or rather destabilizing the financial system as a whole? (iii) What is the interaction between a bank’s decision to issue equity and its asset dynamics? What does a structural estimation with regard to this interaction imply for the magnitude of the costs of issuing equity or liquidating bank assets? How do these costs affect the macroeconomic outcomes of stricter capital regulation? Could a regulatory framework be designed so that issuing costs are reduced and banks’ incentives to recapitalize are increased? The answers to these questions will contribute to a better understanding of the mechanism of the relation between bank capitalization and macroeconomic performance. They will also provide valuable information that can be used by researchers and policy makers when designing a regulatory framework that gives banks sufficient incentives to recapitalize thus reducing the risk of adverse macroeconomic outcomes.

Publications:

• Dinger, V. and F. Vallascas (2016): Are Banks More Likely to Issue Equity When They Are Less Capitalized?, Journal of Financial and Quantitative Analysis, 51(5): 1575-1609.

Working Papers:

• Dinger, V., V. Marinc, and F. Vallascas (2018): Systemic Effects of Bank Equity Issues: Competition, Stabilization and Contagion, IEW W.P. 111.

Project Leader: Prof. Dr. Hendrik Hakenes, Prof. Dr. Isabel Schnabel

Participants: Dipl.-Vw. Andreas Barth, Dipl.-Vw. Florian Hett

It has been argued that the severity of the recent financial crisis can be explained by macroeconomic feedback effects from the distress at individual financial institutions through market prices to the financial sector as a whole. If a bank suffers a liquidity shock, it may be forced to dispose of some of its assets to remain liquid. This may lead to a depression of asset prices, which affects other financial institutions holding the same assets. Other banks can now sell their assets only at lower prices, or may even be forced to adjust the valuation of these assets immediately if they mark their assets to market. These banks may be forced to carry out further asset sales if they are close to their regulatory capital requirements, reinforcing the original price effect. 
The goal of this project is to develop a theoretical framework of such feedback effects, and to design appropriate regulatory responses. Two important components of the model are the connection of banks through interbank liabilities, and price discounts when selling assets in response to a liquidity shock. The theoretical model will be used to derive specific hypotheses, which are to be tested in the second part of the project. The empirical analysis is going to be based on a detailed data set on the evolution of German banks’ own securities holdings during the recent financial crisis. We test not only for the existence of financial contagion through market prices, but we also quantify the magnitude of the contagion effect and analyze its determinants.

Publications:

• Barth, A. and I. Schnabel (2013): Why Banks Are Not Too Big To Fail – Evidence from the CDS Market, Economic Policy, 28(74): 335–369.
• Boyd, J. H. and H. Hakenes (2014): Looting and Gambling in Banking Crises, Journal of Economic Theory, 149: 43–64.
• Hakenes, H. and I. Schnabel (2014): Bank Bonuses and Bail-outs, Journal of Money, Credit, and Banking, 46(1): 259–288.
• Hakenes, H., I. Hasan, P. Molyneux and R. Xie (2014): Small Banks and Local Economic Development, Review of Finance, 19(2): 653–683.
• Hakenes, H., A. Schäfer and B. Weder di Mauro (2016): Financial Sector Reform After the Crisis: Has Anything Happened?, Review of Finance, 20(1): 77–125.
• Hett, F. and A. Schmidt (2017:) Bank Rescues and Bailout Expectations: The Erosion of Market Discipline During the Financial Crisis, Journal of Financial Economics, 126(3): 635–651.
• Abbassi, P., F. Fecht and J. Tischer (2017): Variations in market liquidity and the intraday interest rate, Journal of Money, Credit and Banking, 49(4): 733–765.
• Gadatsch, N., L. Mann and I. Schnabel (2018): A new IV approach for estimating the efficacy of macroprudential measures, Economics Letters, 168: 107–109.
• Schnabel, I. and C. Seckinger (2018): Foreign Banks, Financial Crises and Economic Growth in Europe, Journal of International Money and Finance, forthcoming.

Working Papers:

• Hakenes, H., I. Schnabel: Separating Trading and Banking:  Consequences for Financial Stability.
• Hakenes, H., I. Schnabel (2014): Regulatory Capture by Sophistication, CEPR Discussion Paper 10100.
• Podlich, N., I. Schnabel and J. Tischer (2017): Banks’ Trading after the Lehman Crisis – The Role of Unconventional Monetary Policy, Deutsche Bundesbank Discussion Paper 19/2017.

Project Leader:  Prof. Gernot J. Müller, Ph.D.

Participants: Thomas Hettig, Patrick Hürtgen, Florian Kirsch, Martin Wolf, Susanne Wellmann

We investigate how fiscal consolidation affects economic activity in times of financial stress. Measures of fiscal consolidation include the reduction of government spending and transfer payments as well as tax increases. Such measures are currently enacted in many OECD countries and further measures are likely to be observed in coming years as governments attempt to reign in public debt. The notion of “times of financial stress” is meant to capture a situation where 1) borrowing costs of governments and/or private agents are high because of increased default risk and 2) the conduct of monetary policy is constrained by the zero lower bound on policy rates. While standard models and most empirical studies suggest that fiscal consolidation is detrimental to economic activity in normal times, i.e. in a situation where borrowing costs are low and monetary policy is unconstrained, the consequences of consolidation in times of financial stress are less well understood. We therefore assess, both theoretically and empirically, the hypothesis that the consequences of fiscal consolidation in times of financial stress differ from its consequences in normal times. In order to do so, we develop tools which allow us to account for state dependence of the effects of fiscal policy measures. First, we specify and solve a quantitative business cycle model with state dependence due to default risk and constraints on monetary policy. Second, we estimate a regime transition vector autoregression model on time-series data from OECD countries. In line with our theoretical work and in order to capture the distinct features of financial stress, we allow for different regimes defined on the basis of observable measures such as sovereign debt ratings, a broad index measure of financial stress, and the level of monetary policy rates.

Publications:

• Corsetti, G.,  K. Kuester, A. Meier, and G. Müller (2013): Sovereign Risk, Fiscal Policy, and Macroeconomic Stability, Economic Journal, 123: F99–F132.
• Corsetti, G.,  K. Kuester, A. Meier, and G. Müller (2014): Sovereign risk and belief-driven fluctuations in the euro area, Journal of Monetary Economics, 61: 53–73.
• Corsetti, G., K. Kuester and G. J. Müller (2017): Fixed on Flexible: Rethinking Exchange Rate Regimes after the Great Recession, IMF Econ Rev, 65(3): 586–632.
• Corsetti, G., E. Mavroeidi, G. Thwaites, and M. Wolf (2019): Step away from the zero lower bound: Small open economies in a world of secular stagnation, Journal of International Economics, 116: 88–102.
• Hettig, T. and G. J. Müller (2018): Fiscal policy coordination in currency unions at the effective lower bound, Journal of International Economics, 115: 80–98.
• Hürtgen, P. and R. Rühmkorf (2014): Sovereign default risk and state-dependent twin deficits, Journal of International Money and Finance, 48B: 357–82.
• Kirsch, F. and R. Rühmkorf (2017): Sovereign Borrowing, Financial Assistance and Debt Repudiation, Economic Theory, 64(4): 777–804.
• Kuvshinov, D., G. J. Müller, and M. Wolf (2016): Deleveraging, deflation and depreciation in the euro area, European Economic Review, 88: 42–66.
• Müller, G. (2014): Fiscal austerity and the multiplier in times of crisis, German Economic Review, 15(2): 243–258.

Working Papers:

• Born, B., G. Müller and J. Pfeifer (2018): Does austerity pay off?
• Kriwoluzky, A., G. Müller and M. Wolf (2018): Exit expectations and debt crises in currency unions.

Project Leader: Prof. Dr. Gerhard Illing

Participants: Sascha Bützer, Matthias Schlegl, Alexander Schwemmer, Thomas Siemsen, Sebastian Watzka

In this project, we plan to analyze the feedback between monetary policy and risk taking of financial intermediaries and contribute to the design of a new framework for macro-prudential regulation. Provision of central bank liquidity as lender of last resort is seen to have contributed to incentives for excessive risk taking in the financial industry. Abundant availability of public liquidity has been a main driving force in the heavy reliance on short term finance and leverage. In the project, we model the impact of liquidity provision by central banks on incentives of financial intermediaries to invest in activities creating systemic risk. Perceived wisdom is that central banks should act as lender of last resort in the case of illiquidity, but not insolvency. In reality, this distinction, however, is blurred in modern financial markets. We plan to introduce joint uncertainty on illiquidity and insolvency risks for central bank intervention and analyze its impact on banks’ behaviour and asset prices. Using this framework, we plan to evaluate recent proposals for changes in the Basel III framework to address both liquidity and solvency risk and analyse optimal regulatory policies. We will also address the trade-off in macro-prudential regulation between benefits from financial stability and potential costs in terms of reduced economic growth.

Publications:

• Illing, G. and S. Watzka (2014): Fiscal Multipliers and Their Relevance in a Currency Union – A Survey, German Economic Review, 15(2): 259–71.
• Cao, J. and G. Illing (2015): Interest rate trap or: Why does the central bank keep the policy rate too low for too long?, Scandinavian Journal of Economics, 117(4): 1256–80.
• Drometer, M., T, Siemsen and S. Watzka (2018): The Monetary Policy of the ECB: Caring for the Weakest Links, Kyklos, 71(4): 537–56.
• Holtfrerich, C.-L., L. P. Feld, W. Heun, G. Illing, G. Kirchgässner, J. Kocka, M. Schularick, W. Streeck, U. Wagschal, S. Walter and C. C. von Weizsäcker (2015): Public debt: Causes, effects and limits, German National Academy of Sciences Leopoldina, Halle.
• Illing, G. (2015): Unkonventionelle Geldpolitik – kein Paradigmenwechsel, Perspektiven der Wirtschaftspolitik, 16(2): 127–150.
• Illing, G. (2018): The limits of a negative interest rate policy (NIRP), Credit and Capital Markets (Kredit und Kapital), forthcoming.
• Illing, G., Y. Ono and M. Schlegl (2018): Credit Booms, Debt Overhang and Secular Stagnation, European Economic Review, 108: 78–104.
• Illing, G. and T. Siemsen (2016): Forward Guidance in a Model with Price-Level Targeting, CESifo Economics Studies, 62(1): 47–67.
• Michaelis, H. and S. Watzka (2017): Are there Differences in the Effectiveness of Quantitative Easing at the Zero-Lower-Bound in Japan over Time?, Journal of International Money and Finance, 70: 204–233.

Working Papers:

• Cao, J. and G. Illing (2018): Money in the Equilibrium of Banking, Norges Bank and University of Munich.
• Corbae, D., P. D'Erasmo, S. Galaasen, A. Irarrazabal, and T. Siemsen (2018): Stress Testing in a Structural Model of the Banking Industry, University of Wisconsin-Madison.
• Michau, J.-B., Y. Ono and M. Schlegl (2018): Wealth Preference and Rational Bubbles, CESifo Working Paper 7148.

Project Leader:  Prof. Dr. Almut Balleer, Prof. Dr. Timo Wollmershäuser 

Participants: Dr. Nikolay Hristov, Dr. Dominik Menno, Dr. Peter Zorn, Rayn Saitov

The aim of this project is to investigate the role of financial market imperfections for the transmission of monetary policy. One part of the project establishes how the transmission of macroeconomic shocks in general and monetary policy shocks in particular change when financial conditions are tight. This is done based on a structural VAR with bank lending rates and a DSGE model that incorporates credit default. We document how the presence of financial frictions substantially magnifies the response to monetary policy, but also how monetary policy is decoupled from bank lending rates in the financial crisis.

Based on these results, we explore the effectiveness of monetary policy in a granular setup. In particular, we investigate how credit constraints and the frequency of price adjustment interact. Existing research on this topic is relatively scarce both in terms of empirical and theoretical contributions. We explore rich plant-level data for Germany from the monthly ifo Business Survey for 2002–2014. The data allows us to document new stylized facts on the relationship between heterogeneous financial frictions and the frequency and direction of price adjustments of firms both inside and outside recessions. Combined with data from other sources, we can also estimate the response of the intensive and extensive margin to monetary policy shocks conditional on financial conditions being tight. The empirical investigation is complemented and guided by a partial-equilibrium menu cost model with a credit constraint. We show that the credit constraint induces important asymmetries in the policy function and price distribution in the model. Through this, both small and large price changes coexist in the model. Also, the frequency of price adjustments now fluctuates in response to aggregate nominal shocks. If the induced asymmetries in the price distribution are substantial, financial frictions weaken the model-inherent selection effect and increase the degree of nominal non-neutrality in the economy. Hence, the interaction of financial frictions and the frequency of price adjustment changes and potentially intensifies the propagation of shocks through the traditional cost channel and therefore induces important consequences for the effectiveness of monetary policy.

Publications:

• Hristov, N. and O. Huelsewig (2017): Unexpected Loan Losses and Bank Capital in an Estimated DSGE Model of the Euro Area, Journal of Macroeconomics, 54(B): 161–186.
• Hristov, N., O. Huelsewig, T. Siemsen and T. Wollmershaeuser (forthcoming): Restoring Euro Area Monetary Transmission: Which Role for Government Bond Rates?, Empirical Economics.

Working papers:

• Bachmann, R. and P. Zorn (2018): What drives aggregate investment? Evidence from German Survey Data.
• Balleer, A., N. Hristov and D. Menno (2017): Financial Constraints and Nominal Rigidities, CEPR Discussion Paper 11790.
• Balleer, A., N. Hristov, D. Menno and P. Zorn (2018): Beyond Calvo: Shocks and Financial Constraints Matter for Pricing, work in progress.
• Hristov, N., O. Huelsewig and T. Wollmershaeuser (2018): Capital Flows in the Euro Area and TARGET2 Balances, CESifo Working Paper 6877.
• Menno, D. and T. Oliviero (2017): Financial Intermediation, House Prices, and the Welfare Effects of the U.S. Great Recession.

Project Leader:  Prof. Michael Haliassos, Ph.D.

Participants: Johannes Wohlfart

Publications:

• Georgarakos, D., M. Haliassos, and G. Pasini (2014): Household Debt and Social Interactions, Review of Financial Studies, 27(5): 1404-33.
• Haliassos, M., T. Jansson, and Y. Karabulut (2017): Incompatible European Partners? Cultural Predispositions and Household Financial Behavior, Management Science, 63(11): 3780-808.
• Quintana-Domeque, C. and J. Wohlfart (2016): Relative Concerns for Consumption at the Top: An Intertemporal Analysis for the UK, Journal of Economic Behavior and Organization, 129: 172–194.
• Roth, C. and J. Wohlfart (2018): Experienced Inequality and Preferences for Redistribution, Journal of Public Economics, 167: 251–262.

Working Papers:

• Arrondel, L., H. Calvo Pardo, C. Giannitsarou, and M. Haliassos (2018): Informative Social Interactions.
• Cerletti, E., E. Faia and M. Haliassos (2018): Housing Wealth: The Role of Social Norms, Background Risks, and Rental Markets. 
• Fuchs-Schuendeln, N. and M. Haliassos (2018): Participation Following Sudden Access.
• Goldfayn-Frank, O. and J. Wohlfart (2018): How Do Consumers Adapt to a New Environment in their Economic Forecasting? Evidence from the German Reunification.
• Haliassos, M., T. Jansson, and Y. Karabulut (2018): Financial Literacy Externalities, CEPR D.P. 12100.
• Roth, C. and J. Wohlfart (2018): Public Debt and the Demand for Government Spending and Taxation.
• Roth, C. and J. Wohlfart (2018): How Do Expectations about the Macroeconomy Affect Personal Expectations and Behavior?, CESifo Working Paper 7154.

Project Leader: Dr. Franziska Bremus, Prof. Dr. Felix Noth

Participants: Thomas Krause, M.Sc.

The global financial crisis has demonstrated that financial markets and the real economy are closely related. We have learned that risk at the level of individual financial institutions can harm the stability of the financial system as a whole. This, in turn, affects macroeconomic performance and potentially slows down economic recovery.
In this project, we will investigate how risk at the level of large banks and macroeconomic performance are related. To that goal, we will build on the theory of granularity. This theory posits that volatility at the level of individual firms can translate into macroeconomic fluctuations if market concentration is high. Moreover, we will explore how regulatory policy affects the link between bank-level and systemic risk.

Publications:

• Bremus, F. and C. M. Buch (2017): Granularity in Banking and Growth: Does Financial Openness Matter?, Journal of Banking & Finance, 77(8): 300–316.
• Bremus, F., C. M. Buch, K. N. Russ and M. Schnitzer (2018): Big Banks and Macroeconomic Outcomes: Theory and Cross‐Country Evidence of Granularity, Journal of Money, Credit and Banking, 50(8): 1785-1825.
• Bremus, F. and K. Neugebauer (2018): Reduced Cross-Border Lending and Financing Costs of SMEs, Journal of International Money and Finance, 80: 35–58.
• Buch, C. M., T. Krause and L. Tonzer (2018): Drivers of Systemic Risk: Do National and European Perspectives Differ?, Journal of International Money and Finance, in press.
• Müller, C. and F. Noth (2018): Market power and risk: Evidence from the U.S. mortgage market, Economics Letters, 169: 72–75.
• Krause, T., T. Sondershaus and L. Tonzer (2017): Complexity and Bank Risk during the Financial Crisis, Economics Letters, 150 (C): 118–121.
• Noth, F. and M. Ossandon Busch (2016): Foreign Funding Shocks and the Lending Channel: Do Foreign Banks Adjust Differently?, Finance Research Letters, 19: 222–227.

Working Papers:

• Bremus, F., T. Krause and F. Noth (2017): Bank-Specific Shocks and House Price Growth in the U.S., DIW Discussion Paper 1636.
• Bremus, F. and M. Ludolph (2018): The Nexus Between Bank Size and Volatility: Does Banking Regulation Matter?, Mimeo.
• Noth, F. and M. Ossandon Busch (2017): Banking Globalization, Local Lending, and Labor Market Effects: Micro-level Evidence from Brazil, IWH Discussion Paper 7/2017.

Project Leader:  Prof. Dr. Christiane Clemens, Prof. Dr. Maik Heinemann; until 2015

Participants: Dipl.-Vw. Björn Büchler, Dipl.-Vw. Marius Clemens, M.A., Dipl.-Vw. Alexander Wulff

Regardless of the substantial amount of research that has been undertaken in the field of heterogeneous-agent models and incomplete markets throughout the last two decades, almost no attention was paid to open-economy issues. The restriction of focus to closed-economy settings constitutes a considerable shortcoming of this approach, given the empirical significance of the subject in todays highly integrated world economy. Our research proposal aims at filling this gap in the existing literature. We intend to explore to what extent the observed patterns of international capital flows and international trade can be explained in models which emphasize the importance of incomplete markets preventing agents from insuring against idiosyncratic risk.
 
Building on the little literature available in the context of open-economy Aiyagari/Huggett-type approaches, the proposed research project intends to conduct a comprehensive analysis of several aspects in this field. Of major interest is how international integration affects the macro-economy regarding domestic output, equilibrium prices, the distribution of income and wealth within and between countries, the direction and magnitude of capital and trade flows in economies, where agents are subject to borrowing constraints and individual risk. The analysis will cover aspects of entrepreneurship and financing constraints as well as international trade in small-open economies and multi-country models. We are interested in the welfare effects of international integration to identify those members of society who are most likely to benefit or to suffer from from international market liberalization.

Working Papers:

• Clemens, C. and M. Heinemann (2013): The Effects of International Financial Integration in a Model with Heterogeneous Firms and Credit Frictions, CESifo Working Paper 4441.
• Clemens, C. and M. Heinemann (2012): Endogenous Growth, the Distribution of Wealth, and Optimal Policy under Incomplete Markets and Idiosyncratic Risk, CESifo Working Paper 3832.

Project Leader:  Prof. Dr. Claudia Buch, Prof. Dr. Monika Schnitzer; until 2015

Participants: Dr. Franziska Bremus

The global financial crisis has initiated an intense regulatory debate which focuses on the origins of systemic risk. One of the key questions arising from this debate concerns the presence of large banks: Does the presence of large banks increase macroeconomic volatility? And what are the implications for regulation?

In this project, we analyze the link between risk at the bank-level, market structure in the banking industry, and macroeconomic volatility. According to the concept of “Granularity”, idiosynchratic shocks to large firms (or: banks) may impact on aggregate volatility if the distribution of firm sizes is skewed. Thus, given a highly skewed bank-size distribution – many small banks coexist with a few very large ones – macroeconomic volatility may be affected by shocks to large banks.
The project therefore addresses, inter alia, the following questions: How does the degree of market concentration in the banking industry affect aggregate stability by translating bank-level shocks to the macroeconomy? How does international financial integration impact on the link between market structure in banking and aggregate stability? How is the link between banking market structure and aggregate volatility affected if we take banks’ incentives to improve their efficiency into account? These questions are treated both theoretically using models which feature heterogeneous banks, and empirically using country- and bank-level data.

Publications:

• Bremus, F. M. (2015): “Cross-border banking, bank market structures and market power: Theory and cross-country evidence”, Journal of Banking & Finance, 50(1): 242–259.

Working Papers:

• Bremus, F. and C.M. Buch (2013): “Granularity in Banking and Growth: Does Financial Openness Matter?”, CESIfo Discussion Paper  4356.
• Bremus, F., Buch, C.M., Russ, K.N. and M. Schnitzer (2013): “Big Banks and Macroeconomic Outcomes: Theory and Cross-Country Evidence of Granularity”, NBER Working Paper 19093.

Project Leader: Prof. Dr. Andreas Schabert

Participants: Dr. Falko Jüßen, Dr. Joost Röttger

This project aims at analyzing monetary and fiscal policy in the aftermath of the subprime crisis that has led monetary and fiscal policy makers in industrialized countries to conduct policy beyond well-explored terrain. Monetary policy rates are held close to the zero lower bound and central banks aimed at easing the monetary stance in a quantitative way. At the same time, fiscal spending has boosted public debt and raised fears of sovereign default in several countries. These developments and the effects of monetary and fiscal policy can hardly be understood by applying pre-2008 state-of-the-art macroeconomic models.
This project’s contribution is to develop macroeconomic models that account for these extraordinary circumstances, like interest rates at the zero lower bound, excessive liquidity demand, or high credit default probabilities, and to use them to analyze the effectiveness of policies recently implemented by several countries, e.g. the impact of unconventional monetary policy, like quantitative and credit easing, on real activity and prices.

Publications:

• Hoermann, M., and A. Schabert (2015): A Monetary Analysis of Balance Sheet Policies, The Economic Journal, 125(589): 1888-1917.
• Juessen, F., L. Linnemann, and A. Schabert (2016): Default Risk Premia on Government Bonds in a Quantitative Macroeconomic Model, Macroeconomic Dynamics, 20(1): 380–403.
• Schabert, A. (2015): Optimal Central Bank Lending, Journal of Economic Theory, 157(3): 485–516.
• Schabert, A., and S. van Wijnbergen (2014): Sovereign Default and the Stability of Inflation-Targeting Regimes, IMF Economic Review, 62(2): 261–287.

Working Papers:

• Bredemeier, C., F. Juessen, and A. Schabert (2018): Fiscal Multipliers and Monetary Policy: Reconciling Theory and Evidence, University of Cologne, Center for Macroeconomic Research, Working Paper.
• Christoffel, K., and A. Schabert (2014): Interest Rates, Money, and Banks in an Estimated Euro Area Model, University of Cologne, Center for Macroeconomic Research, Working Paper.
• Juessen, F., and A. Schabert (2013): Fiscal Policy, Sovereign Default, and Bailouts, University of Cologne, Center for Macroeconomic Research, Working Paper.
• Loenser, C., J. Roettger, and A. Schabert (2018): Pecuniary Externalities and Policy Interventions in a Heterogeneous Agents Economy, University of Cologne, Center for Macroeconomic Research, Working Paper.
• Loenser, C. and A. Schabert (2018): Monetary Policy, Financial Constraints, and Redistribution, University of Cologne, Center for Macroeconomic Research, Working Paper.
• Roettger, J. (2017): Monetary Conservatism, Default Risk, and Political Frictions, University of Cologne, Center for Macroeconomic Research, Working Paper.
• Roettger, J. (2018): Public Policy and Sovereign Risk, University of Cologne, Center for Macroeconomic Research, Working Paper.
• Schabert, A. (2018): Central Bank Asset Purchases as a Corrective Policy, University of Cologne, Center for Macroeconomic Research, Working Paper.

Project Leader: Prof. Dr. Rainer Haselmann, Prof. Dr. Beatrice Weder di Mauro

Participants: Dipl.-Vw. Cornelius Veith

The financial crisis during the last years has highlighted the close link between financial market performance and macroeconomic outcomes. The goal of our project is to establish empirically the transmission channel of a liquidity shock for banks and real outcomes. In particular, we want to examine the following research questions: 1.) How do banks that are affected by the liquidity shock tighten credit standards? Banks can for example tighten credit conditions by increasing the spread of an average loan, increasing collateral requirement or by simply reducing the amount and maturity of loans. 2.) What are the macroeconomic consequences if firms get credit rationed in a developed country like Germany? In how far are firms able to substitute funding? 3.) What role do business-groups play in insuring against external funding shocks? By identifying these research questions we want to contribute to the corporate finance as well as to the macroeconomic literature. Furthermore, our findings should also provide monetary policy makers and financial market regulators a more precise understanding regarding the consequences of their actions.

Publications:

• Ueda and Weder di Mauro (2013): Quantifying structural subsidy values for systemically important financial institutions, Journal of Banking & Finance, 37:3830–3842
• Behn, Haselmann and Wachtel (2016): Pro-Cyclical Capital Regulation and Lending, Journal of Finance, 71(2): 919–56.
• Schäfer, Schnabel and Weder di Mauro (2016): Financial Sector Reform after the Crisis: Has Anything Happened?, Review of Finance, 20(1): 77–125.

Working Papers:

• Behn, Haselmann, Kick and Vig: “The Political Economy of Bank Bailouts”, working paper

Project Leader: Prof. Dr. Frank Heinemann

Liquidity injections during crises and lender-of-last-resort facilities raise concerns of moral hazard on the side of financial intermediaries. Time inconsistency of first-best monetary policy raises the question, how second best policies can be implemented. In an international context, cross-country spillovers of liquidity provision also raise strategic considerations of distinct central banks who may behave as players in a non-cooperative game. In this project, we analyze the strategic effects of liquidity provision and monetary policy responses to asset prices under distinct regimes of macroprudential regulation. Thereby, we want to contribute to the design of a new architecture for monetary policy and macroprudential regulation aimed at a balanced stabilization of inflation, output and financial markets.

In particular, we will focus on three topics:

 1.  Cross-country spillovers of liquidity provisions during financial crises and the interaction of these spillovers with equity and liquidity requirements. Here, we analyze a two-stage game with two central banks who may inject liquidity in the commercial banking sector after a crisis.
2.  Moral hazard effects arising from time inconsistency of monetary policy. They will be explored by laboratory experiments. Here, we are most interested in whether reputation, cheap talk, or transparency can substitute for a commitment device.
3.  Monetary policy responses to asset prices and their effects within a dynamic stochastic general equilibrium (DSGE) framework. The model will introduce a banking sector threatened by inefficient liquidation in case of a crisis into a real business cycle model for analyzing solvency risk and equity requirements and into a monetary New Keynesian DSGE model for analyzing liquiditiy risk and regulation.

Working Papers:

• Radde, S. (2014): Flight to Liquidity and the Great Recession
• Cui, W. and S. Radde (2014): Search-Based Endogenous Illiquidity and the Macroeconomy
• Ahrens, S., N. Nejati, and P. Pfeiffer (2015): Layoff Taxes, Unemployment Insurance, and Business Cycle Fluctuations, Kiel Working Papers 1988.
• Ahrens, S., I. Pirschel, and D. J. Snower (2015): Path-Dependent Wage Responsiveness, Kiel Working Papers 1977.
• Duffy, J. and F. Heinemann (2018): Central Bank Reputation, Cheap Talk and Transparency as Substitutes for Commitment: Experimental Evidence, SFB 649 Discussion Paper 2016–053.
• Meissner, T. and P. Pfeiffer (2017): Measuring Preferences Over the Temporal Resolution of Consumption Uncertainty.

Project Leader: Prof. Dr. Lutz G. Arnold

Participants: Sebastian Zelzner, M.Sc.

The recent financial turbulence and its macroeconomic repercussions have sparked a discussion about the social benefits of financial trading. At the policy level, the discussion centers around the question of how to contain excessive risk taking by banks in view of explicit safety nets and implicit state guarantees. While the significance of this question cannot be overestimated, there is a different concern, which might be of equal importance for long-term growth and economic welfare, viz., that the financial sector attracts too much talent, which could produce larger social benefits in different occupations. The project investigates theoretically under which circumstances the allocation of talent to finance is excessive. To do so, we integrate occupational choice between financial trading and entrepreneurship and a labor market with or without imperfections into the noisy rational expectations equilibrium model of Grossman and Stiglitz (1980). Informed traders make the financial market more informationally efficient, entrepreneurs create output and jobs. The model indicates that financial trading attracts too much, rather than too little, talent. This is shown analytically for small noise trader shocks. Numerical analysis shows that trading also attracts too much talent for large noise trader shocks.

Working Papers:

• Arnold, L. G. and S. Zelzner (2018): The Allocation of Talent to Financial Trading versus Entrepreneurship: Welfare Effects of Trading in General Equilibrium.

Project Leader: Prof. Dr. Leo Kaas, Prof. Dr. Almuth Scholl 

Participants: Alessandro Di Nola, Maren Froemel, Jan Mellert, Anna-Mariia Tkhir

Throughout history, advanced and emerging economies have been confronted by a multitude of sovereign debt and financial crises. The dramatic surge in public debt in many economies triggered by the recent financial crisis raises the question of the stability and sustainability and leads to concerns about possible adverse consequences for the private sector, particularly for the availability of private credit and thus for investment and economic growth.

The objective of this research project is to understand the theoretical mechanisms and quantitative implications of sovereign and private default risks and their interactions on macroeconomic outcomes. To this end, we incorporate debt repudiation in stochastic dynamic general equilibrium models of closed and open economies.

The project is organized along three topics. First, we analyze the dynamic properties of fiscal conditionality imposed by international financial institutions on indebted countries in need of financial assistance. We are especially interested in the role of renegotiations on conditionality and how they affect default risks and macroeconomic outcomes. Second, we explore the effects of public debt and fiscal policy on the availability of private firm credit and on the capital allocation among heterogeneous firms who are financially constrained and possibly subject to default risk. We study how fiscal deficits are transmitted to the private credit market and to aggregate factor productivity. Third, we consider the relation between sovereign debt and political uncertainty so as to understand how policymakers make strategic use of external debt to manipulate re-election probabilities and how this affects the connection between debt crises and political crises.

Publications:

• Azariadis, C., L. Kaas and Y. Wen (2016): Self-Fulfilling Credit Cycles, Review of Economic Studies, 83:1364-1405.
• Fink, F. and A. Scholl (2016): “A Quantitative Model of Sovereign Debt, Bailouts and Conditionality, Journal of International Economics, 98(1):176–190.
• Kaas, L. (2016): Public Debt and Total Factor Productivity, Economic Theory, 61:309–333.
• Scholl, A. (2017): The Dynamics of Sovereign Default Risk and Political Turnover, Journal of International Economics, 108:37–53.
• Scholl, A. (2018): Debt Relief for Poor Countries: Conditionality and Effectiveness, Economica, 85(339):626–648.

Working Papers:

• Cui, W. and L. Kaas (2018): Default Cycles, Manuscript, Goethe-Universität Frankfurt.
• Di Nola, A. (2017): Capital Misallocation During the Great Recession, Manuscript, University of Konstanz.
• Di Nola, A. (2018): Idiosyncratic Firm Risk, Cash Holdings and Lumpy Investment, Manuscript, University of Konstanz.
• Froemel, M. (2014), Imperfect Financial Markets and the Cyclicality of Social Spending, Konstanz Working Paper 2014–11.
• Kaas, L., J. Mellert and A. Scholl (2018), Sovereign and Private Default Risks over the Business Cycle, Konstanz Working Paper 2016–09.
• Mellert, J. (2018): Twin Ds and Credit to the Private Sector, Manuscript, University of Konstanz.
• Prein, T. and A. Scholl (2018): The Impact of Bailouts on Political Turnover and Sovereign Default Risk, Konstanz Working Paper 2018–04.

Project Leader: Prof. Reint Gropp, Ph.D.; until 2015

Project Leader: Prof. Dr. Zeno Enders, Prof. Dr. Hendrik Hakenes

Participants: Jörg Rieger, Ph.D. 

Boom and bust cycles of asset prices occur repeatedly across different economies and time periods. Often, the burst of such a ‘bubble’ is accompanied with a strongly declining economic activity. The project aims at developing a deeper understanding of the mechanisms leading to the emergence of asset price bubbles and how their collapses are transmitted to the real sector of the economy. In this analysis, a special focus will be placed on the role of the financial sector for the emergence and transmission of bubbles.
In particular, we will develop a general framework for the analysis of expectation-driven asset price bubbles in a dynamic stochastic general equilibrium model. Within this model, we intend to explore the macroeconomic consequences of the build-up and subsequent burst of asset price bubbles. Besides investigating the effects on the domestic economy, we also going to explore the international dimension by investigating the contributions of foreign economies to fueling a bubble, and to which extent they are affected after the bubble has collapsed. Finally, a detailed investigation of the trade-offs faced by economic policy will generate concrete suggestions for monetary (and potentially fiscal) policy. Ultimately, these policy implications aim at increasing welfare by reducing volatilities of real variables and avoiding the repeated occurrence of recessions that follow the bursts of bubbles.

Publications:

• Born, A. and Z. Enders (2018): Global Banking, Trade, and the International Transmission of the Great Recession, The Economic Journal, forthcoming.
• Boyd, J. H. and H. Hakenes (204): Looting and Gambling in Banking Crises, Journal of Economic Theory, 149: 43–64.
• Enders, A., Z. Enders and M. Hoffmann (2018): International Financial Market Integration, Asset Compositions, and the Falling Exchange Rate Pass-Through, Journal of International Economics, 110: 151–175.
• Hakenes, H., I. Hasan, P. Molyneux and R. Xie (2014): Small Banks and Local Economic Development, Review of Finance, 19(2): 653–683.

Working Papers:

• Enders, Z. and H. Hakenes (2014): On the Existence and Prevention of Speculative Bubbles.
• Enders, Z. and H. Hakenes (2017): Market Depth, Leverage, and Speculative Bubbles, CESifo Working Paper 6806.
• Rieger, J. (2014): Financial Integration with Heterogeneous Beliefs.
• Rieger, J. (2014): Financial Transaction Tax and Financial Market Stability with Diverse Beliefs.
• Rieger, J. (2015): Portfolio Adjustment Costs and Asset Price Volatility with Heterogeneous Beliefs.
• Rieger, J. (2017): A Model of Speculative House Prices.
• Rieger, J. (2017): Limited Market Participation, Housing and Asset Prices.
• Rieger, J. (2018): Monetary Policy Uncertainty and the Transmission of Monetary Policy Shocks to Financial Markets.
• Rieger, J. (2018): Financial Innovation and Asset Prices with Heterogeneous Beliefs.
• Rieger, J. (2018): Wealth Dynamics and Asset Prices with Recursive Preferences and Heterogeneous Beliefs.

Project Leader: Prof. Dr. Alexander Ludwig

Participants: Dipl.-Vw. Raphael Abiry, Dr. Daniel Harenberg, Dr. Christian Geppert

Following the recent financial market crisis most of the focus of academic researchers, policy makers and the general public is on the short-run policy responses. However, the financial market crisis and the capital markets risks that became apparent also have profound implications for the design of social security systems. As a consequence of demographic change, generous PAYG funded social security systems are under pressure in most industrialized countries. It was therefore seen as conventional wisdom among academic researchers to shift systems towards more prefunding. In the light of the recent crisis, does this conventional wisdom require reconsideration? 
Against this background, the present research project addresses three central research questions: What are the effects of demographic change on wages, asset returns and welfare in a world with profound aggregate risk? What are the welfare effects of Pay- As-You-Go (PAYG) financed social security systems given that contributions are distortionary but, at the same time, social security provides partial insurance for missing markets and improves intergenerational sharing of aggregate risks? Which policy measures should be taken in response to (extreme) aggregate shocks, i.e., what is the optimal design of the PAYG component of social security?

Publications:

• Geppert, C. (2015): Macroeconomic Eff‚ects of Demographic Change: ŒThe Role of Human Capital, Ph.D. thesis, University of Frankfurt.
• Harenberg, D. and A. Ludwig (2015): Social Security in an Analytically Tractable Overlapping Generations Model with Aggregate and Idiosyncratic Risk, International Tax and Public Finance, 22(4): 579–603.
• Harenberg, D. and A. Ludwig (2018): Idiosyncratic Risk, Aggregate Risk, and the Welfare Effects of Social Security, International Economic Review, forthcoming.

Working Papers:

• Geppert, C., A. Ludwig and R. Abiry (2016): Secular Stagnation? Growth, Asset Returns and Welfare in the Next Decades: First Results, SAFE Working Paper 145.

Work in Progress:

• Busch, C. and A. Ludwig: Higher-Order Income Risk over the Business Cycle: A Parametric Approach.