Juan M. Sánchez

Financing Development: The Role of Information Costs

How does technological progress in financial intermediation affect the economy? To address this question a costly-state verification framework is embedded into a standard growth model. In particular, financial intermediaries can invest resources to monitor the returns earned by firms. The inability to monitor perfectly leads to firms earning rents. Undeserving firms are financed, while deserving ones are under funded. A more efficient monitoring technology squeezes the rents earned by firms. With technological advance in the financial sector, the economy moves continuously from a credit-rationing equilibrium to a perfectly efficient competitive equilibrium. A numerical example suggests that finance is important for growth.

Fiscal Policy and Default Risk in Emerging Markets

Emerging market economies typically exhibit a procyclical fiscal policy: public expenditures rise (fall) in economic expansions (recessions), whereas tax rates rise (fall) in bad (good) times. Additionally, the business cycle of these economies is characterized by countercyclical default risk. In this paper we develop a quantitative dynamic stochastic small open economy model with incomplete markets, endogenous fiscal policy and sovereign default where public expenditures and tax rates are optimally procyclical. The model also accounts for the dynamics of other key macroeconomic variables in emerging economies.

Quantifying the Impact of Financial Development on Economic Development

How important is financial development for economic development? A costly state verification model of financial intermediation is presented to address this question. The model is calibrated to match facts about the U.S. economy, such as the intermediation spreads and the …firm-size distributions for 1974 and 2004. It is then used to study the international data using cross-country interest-rate spreads and per-capita GDPs. The analysis suggests a country like Uganda could increase its output by 116 percent if it could adopt the world’s best practice in the financial sector. Still, this amounts to only 29 percent of the gap between Uganda’s potential and actual output.

Why Doesn't Technology Flow from Rich to Poor Countries?

What is the role of a countrys financial system in determining technology adoption? To examine this, a dynamic contract model is embedded into a general equilibrium setting with competitive intermediation. The terms of finance are dictated by an intermediarys ability to monitor and control a firms cash flow, in conjunction with the structure of the technology that the firm adopts. It is not always profitable to finance promising technologies. A quantitative illustration is presented where financial frictions induce entrepreneurs in India and Mexico to adopt less-promising ventures than in the United States, despite lower input prices.

Reconstructing the Great Recession

This paper evaluates the role of the construction sector in accounting for the performance of the U.S. economy before, during and after the Great Recession. We use input-output analysis to evaluate its linkages with the rest of the economy and measure the transmission of its demand shocks to the overall economy. Such effects are quantified by means of a dynamic multi-sector model parameterized to reproduce the boom-bust dynamics of employment in construction during 2000-13. The model suggests that the interlinkages account for a large share of the actual changes in aggregate employment and gross domestic product during the previous expansion, the recession and the subsequent recovery.

Why Doesn't Technology Flow From Rich to Poor Countries?

What is the role of a countrys financial system in determining technology adoption? To examine this, a dynamic contract model is embedded into a general equilibrium setting with competitive intermediation. The terms of finance are dictated by an intermediarys ability to monitor and control a firms cash flow, in conjunction with the structure of the technology that the firm adopts. It is not always profitable to finance promising technologies. A quantitative illustration is presented where financial frictions induce entrepreneurs in India and Mexico to adopt less‐promising ventures than in the United States, despite lower input prices.

The Role of Information in the Rise in Consumer Bankruptcies

Consumer bankruptcies rose sharply over the last 20 years in the U.S. economy. During the same period, there was impressive technological progress in the information sector. This paper provides a theory to understand and quantify the role of improvements in information technologies in consumer credit markets. Informational frictions restrict the amount of debt that can be borrowed. In fact, in the equilibrium in which investing in information is too expensive, many households borrow such small amounts that the default risk is very low. When information costs drop and informational frictions vanish, those households borrow more and default is likely after a bad shock. Quantitative exercises show that information costs have a significant effect on the bankruptcy rate. Additionally, a drop in information costs generates changes in other variables (e.g. interest rate dispersion) similar to what has occurred over the last 20 years.

Natural Resources and Global Misallocation

Are production factors allocated efficiently across countries? To differentiate misallocation from factor intensity differences, we provide a new methodology to estimate output shares of natural resources based solely on current rent flows data. With this methodology, we construct a new dataset of estimates for the output shares of natural resources for a large panel of countries. In sharp contrast with Caselli and Feyrer (2007), we find a significant and persistent degree of misallocation of physical capital. We also find a remarkable movement toward efficiency during last 35 years, associated with the elimination of interventionist policies and driven by domestic accumulation. Interestingly, when both physical and human capital can be reallocated, capital would often flow from poor to rich countries.

Mortgage Defaults and Prudential Regulations in a Standard Incomplete Markets Model

A model of mortgage defaults is built into the standard incomplete markets model. Households face income and house-price shocks and purchase houses using long-term mortgages. Interest rates on mortgages are determined in equilibrium according to the risk of default. The model accounts for the observed patterns of housing consumption, mortgage borrowing, and defaults. Default-prevention policies are evaluated. The mortgage default rate, housing demand, households’ ability to self-insure, and welfare are hump-shaped in the degree of recourse (the level of defaulters’ wealth that can be garnished). Two forces affect default. More recourse implies that the punishment for default is harsher; this reduces the default rate. But more recourse also decreases the interest rates offered; this increases borrowing and the default rate. Introducing loan-to-value (LTV) limits for new mortgages contains borrowing, lowering the default rate with negligible negative effects on housing demand. The combination of recourse mortgages and LTV limits reduces the default rate while boosting housing demand. The behavior of economies with alternative prudential regulations is evaluated during a boom-bust episode in aggregate house prices. In the economy with both recourse mortgages and LTV limits, the mortgage default rate is less sensitive to fluctuations in aggregate house prices.

Designing UISAs for Developing Countries

The benefits of implementing Unemployment Insurance Savings Accounts (UISAs) are studied in the presence of the multiple sources of information frictions often existing in developing countries. A benchmark incomplete markets economy is calibrated to Mexico in the early 2000s. The unconstrained optimal allocation would imply very large welfare gains relative to the benchmark economy (similar to an increase in consumption of 23% in every period). More importantly, in presence of multiple sources of information frictions, about half of those potential gains can be accrued through the implementation of UISAs with replacement rates between 40-50%, contribution rates between 10-15%, an initial liquidity transfer of about 20 quarters of average income, and higher payroll taxes to finance those initial stocks.