Job Market Paper
This paper develops a heterogeneous agent model of a small open economy and studies how households
differ in their responses to aggregate productivity and interest rate shocks. Poor households display
stronger consumption responses to an aggregate productivity shock because they are more likely to be
constrained in liquid assets. In contrast, rich households display stronger consumption responses to an
interest rate shock because they are more likely to be unconstrained in liquid assets. When the economy
experiences a sudden stop, defined as contractionary shocks to productivity and the interest rate, the
interest rate effect neutralizes the productivity effect. As a consequence, the sudden stop generates
consumption-income elasticities that display little variation along the income distribution,
similar to a permanent shock. My finding captures the observed behavior of households in the Mexican
Peso Crisis of 1994.
The Pure Effects of Household Heterogeneity
Heterogeneous agent models typically introduce heterogeneity, financial frictions, and recalibrate the impatience of households. We study the effect of each term. Pure heterogeneity has no significant effect on household or aggregate consumption policies. Heterogeneity and financial frictions generate empirically realistic marginal propensities to consume, but fail to significantly change the aggregate responses of consumption. Decreasing the impatience of households is necessary to generate significantly stronger aggregate consumption responses.
Income Risk in Emerging Markets
I introduce idiosyncratic income risk into a small open economy model that features an occasionally binding income constraint. Income risk generates poor households that borrow up to the constraint to smooth over their low income state. This differs from representative agent models that require a depressed aggregate state for the representative household to interact with the constraint. As a consequence, the model displays a higher average marginal propensity to consume and volatility of aggregate consumption. The improvements disappear when the collateral constraint is removed from the model. The model with income heterogeneity fails to generate sudden stops. This occurs as the income shock generates rich households that are able to consumption smooth throughout crises.
Borrowing Constraints and Output Volatility
This paper studies a small open economy subject to a borrowing constraint which experiences stochastic volatility in its output endowment. I find that volatility shocks induce substantial changes in borrowing by households, in excess of the precautionary savings response. Household responses to volatility shocks increases the standard deviation of borrowing, but not the standard deviation of consumption, suggesting small welfare costs. Stochastic volatility increases the frequency of financial crises in a decentralized economy that overborrows due to a pecuniary externality, but not a socially optimal economy.