Curriculum Vitae

Research Interests

International macroeconomics and monetary economics

Job market paper

International Debt Deleveraging

I provide a framework for understanding debt deleveraging in a group of financially integrated countries. During an episode of international deleveraging world consumption demand is depressed and the world interest rate is low, reflecting a high propensity to save. If exchange rates are allowed to float, deleveraging countries can depreciate their nominal exchange rate to increase production and mitigate the fall in consumption associated with debt reduction. The key insight of the paper is that in a monetary union this channel of adjustment is shut off, and therefore the falls in consumption demand and in the world interest rate are amplified. Hence, monetary unions are especially prone to hit the zero lower bound on the nominal interest rate and enter a liquidity trap during deleveraging. In a liquidity trap deleveraging gives rise to a union-wide recession, which is particularly severe in high-debt countries. The model suggests several policy interventions that mitigate the negative impact of deleveraging on output in monetary unions.

Other working papers

Debt Deleveraging, Debt Relief and Liquidity Traps

I study debt relief policies during debt-driven slumps using a model of deleveraging. Deleveraging can push the economy into a liquidity trap characterized by involuntary unemployment and low inflation. A debt relief policy, captured by a transfer of wealth from creditors to debtors, increases aggregate demand, employment and output. Debt relief may benefit creditors as well as debtors and lead to a Pareto improvement in welfare. The benefits from a policy of debt relief are greater the more the central bank is concerned with stabilizing inflation. Moreover, targeting inflation during a liquidity trap can generate multiple equilibria. In this case it is possible to design debt relief policies that eliminate undesirable equilibria.

Financial Crises and Exchange Rate Policy

This paper develops a dynamic small open economy model highlighting a fundamental trade-off between financial and price stability. The key element of the analysis is a pecuniary externality arising from frictions in the international credit markets. The goal is to study the performance of alternative exchange rate policies in sudden stop-prone economies. The main result is that the presence of pecuniary externalities in the credit markets makes a narrow focus on price stability sub-optimal.

Reserve Accumulation, Growth and Financial Crises (with Gianluca Benigno)

We present a model that reproduces two salient facts characterizing the international monetary system: Fast growing emerging countries i) Run current account surpluses, ii) Accumulate international reserves and receive net private inflows. We study a two-sector, tradable and non-tradable, small open economy. There is a growth externality in the tradable sector and agents have imperfect access to international financial markets. By accumulating foreign reserves, the government induces a real exchange rate depreciation and a reallocation of production towards the tradable sector that boosts growth. Financial frictions generate imperfect substitutability between private and public debt flows so that private agents do not perfectly offset the government policy. The possibility of using reserves to provide liquidity during crises amplifies the positive impact of reserve accumulation on growth.  The optimal reserve management entails a fast rate of reserve accumulation, as well as higher growth and larger current account surpluses compared to the economy with no policy intervention. The model is also consistent with the negative relationship between inflows of foreign aid and growth observed in low income countries.

The Financial Resource Curse (with Gianluca Benigno)

This paper presents a model of financial resource curse, i.e. episodes of abundant access to foreign capital coupled with weak productivity growth. We study a two-sector, tradable and non-tradable, small open economy. The tradable sector is the engine of growth, and productivity growth is increasing in the amount of labor employed by firms in the tradable sector. A period of large capital inflows, triggered by a fall in the interest rate, is associated with a consumption boom. While the increase in tradable consumption is financed through foreign borrowing, the increase in non-tradable consumption requires a shift of productive resources toward the non-tradable sector at the expenses of the tradable sector. The result is stagnant productivity growth. We show that capital controls can be welfare-enhancing and can be used as a second best policy tool to mitigate the misallocation of resources during an episode of financial resource curse.

PhD

London School of Economics

Department of Economics

Houghton Street

London WC2A 2AE, United Kingdom

Tel: +44 (0)20 7955 6891

Email: L.Fornaro@lse.ac.uk