Eric Mengus

Asset Purchase Bailouts and Endogenous Implicit Guarantees

This paper shows that bailouts of private agents can optimally take the form of the purchase of a defaulting asset, even if this also means paying off external asset holders. When anticipated, this form of bailouts leads to an endogenous implicit guarantee, where even an intrinsically worthless asset may be traded at a positive price. In the presence of borrowing constraints and imperfectly observable private liquidity needs, direct transfers are imperfect so that, when more constrained agents are also more exposed to a given asset, the compensation through asset purchases becomes optimal. I then show that this possibility of implicit guarantee is amplified by other frictions as risk-shifting and ultimately leads to a coordination problem for selecting stores of liquidity. Finally, I derive policy implications for financial regulation and international capital flows.

The signaling effect of raising inflation

This paper argues that central bankers should temporarily raise inflation when anticipating liquidity traps to signal their credibility to forward guidance policies. As stable inflation in normal times either stems from central bankers credibility, e.g. through reputation, or from his aversion to inflation, the private sector is unable to infer the central bankers type from observing stable inflation, jeopardizing the efficiency of forward guidance policy. We show that this signaling motive can justify temporary deviations of inflation from target well above 2% but also that the low inflation volatility during the Great Moderation was insufficient to ensure fully efficient forward guidance when needed.

Asset Purchase Bailouts and Implicit Guarantees

This paper shows that bailouts of private agents can optimally take the form of asset purchases, even if this also means paying off external asset holders, in the presence of borrowing constraints and asymmetric information on liquidity needs. The combination of these two ingredients make direct compensation through loans and/or net transfers imperfect. Thus, when more constrained agents are also more exposed to the asset, the compensation through asset purchases becomes desirable. Anticipating these purchases, private agents engage in a collective bet on the defaulting asset, leading to an equilibrium implicit guarantee, where even an intrinsically worthless asset can be traded at a positive price.

Credibility and Monetary Policy

This paper revisits the ability of central banks to manage private sectors expectations depending on its credibility and how this affects the use of interest rate rules and pegs to achieve monetary policy objectives. When private agents can only provide limited incentives for the central bank to follow a policy, we show that resulting limited credibility allows a central bank to prevents the inflation from diverging by defaulting on past promises if necessary. As a result, the Taylor rule, when expected, anchors inflation expectations on a unique equilibrium path as long as the Taylor principle is satisfied. Finally, we also show that limited credibility restricts the impact of long-term interest rate pegs, so as to make current conditions less dependent on future policy changes.We investigate the ability of monetary policy rules to implement a unique equilibrium outcome when the enforcement of rules is limited. We combine the approach of Bassetto (2005) and Atkeson et al. (2010) to study implementation and the one by Chari and Kehoe (1990) to allow policy deviations. Our main result is that, under limited enforcement, there does not exist a policy rule that implements a unique outcome: the private sector can always deter the central bank to stick to the rule. We then provide further results on implementation when private agents expect a given policy and when they hesitate between multiple policies.