Michael Devereux

This dissertation studies how financial flows move exchange rates and shape stabilization policy. Across three chapters, it (i) measures FX market depth using granular holdings data, (ii) characterizes optimal FX intervention (FXI) with limited reserves, and (iii) examines the opportunity cost of reserve accumulation from an external balance sheet perspective.Chapter 2 uses security-level holdings of mutual funds and a granular instrumental-variable strategy to identify currency demand shocks. These shocks generate significant exchange rate movements in both emerging market (EM) and advanced economy (AE) currencies, consistent with shallow FX markets. For equal-sized flows, EM currencies respond about nine times more than AEs, implying lower depth. Depth is state-dependent: FX markets are highly inelastic when expected exchange rate volatility is high but close to perfectly elastic in tranquil periods. During mutual-fund outflows, EM FX markets are shallower than during inflows. A quantitative small open economy model with segmented FX markets, limited intermediary risk-bearing capacity, and balance sheet constraints rationalizes these patterns.Chapter 3 analyzes optimal time-consistent FXI in a small open economy driven by endowment and currency demand shocks, with endogenous FX market depth and an effective lower bound on reserves. Large flows raise conditional exchange rate volatility and reduce depth, amplifying exchange rate responses. Optimal policy is state-dependent and forward-looking since current interventions affect the risk of reserve depletion. FX sales are more effective than FX purchases, and the optimal response to outflows can be less than or more than one-for-one depending on flow size and the net foreign asset position. Optimal policy yields substantial welfare gains over simple rules, provided reserves are sufficiently above the effective lower bound.Chapter 4 studies stabilization-driven reserve accumulation and its crowding-out of private foreign investment. Reserves used to support FXI can crowd out higher-yielding foreign investment, creating an opportunity cost. The policy problem features two local optima: one with low reserves and positive foreign investment, and one with high reserves and no foreign investment. Which regime is globally optimal depends on the risk–return profile of foreign investment.

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Chapter 2 empirically examines how labor-saving technological change in agriculture affects labor reallocation across sectors in economies with sizable informal sectors, and how labor regulations enforcement shapes this process. To identify the causal effect, I exploit the 2003 legalization of genetically modified (GM) soybeans in Brazil and cross-municipality variation in potential yield gains. Between 2000 and 2010, municipalities with greater potential productivity gains from GM soy experienced larger reallocation of labor from agriculture to formal manufacturing, accompanied by declines in informal manufacturing employment. Further analysis of heterogeneous effects by interacting the GM soybean shock with enforcement capacity shows that the reallocation is significantly less pronounced in areas with stricter enforcement of labor regulations. In Chapter 3, I develop and calibrate a two-sector general equilibrium model that qualitatively replicates the empirical findings from Chapter 2. Agricultural production is modeled using a constant elasticity of substitution (CES) function that allows for differential technological progress of labor and land, capturing the factor-biased nature of GM soy. The manufacturing sector features heterogeneous firms that self-select into being formal or informal. Counterfactual exercises show that intensifying enforcement to halve manufacturing informality reduces labor reallocations to manufacturing by 4.5%. Additional simulations suggest that lowering entry and fixed costs for formal firms promotes labor movement into manufacturing while reducing informality.Chapter 4 analyzes how structural changes in the global input-output networks have influenced economic growth across countries at different stages of development. We find that shifts in global supply chains between 1965 and 2000 benefited developing countries while disadvantaging advanced economies. Counterfactual analysis shows that, without these changes, TFP growth would have been 26.6% and 9.7% lower in China and India, and 4.0% and 16.8% higher in the US and Australia. We further demonstrate that a simple statistic, the domestic intermediate input cost share, effectively captures how global networks amplify productivity shocks. Our findings highlight the importance of supply chain integration and the use of intermediate inputs for economic growth.

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Chapter 2 documents empirical facts about household portfolios, fertility and financial literacy. Using variation in fertility and distinguishing between planned and unplanned children, I study how households adjust their portfolios around childbirth. The results show that households with planned children increase the share of illiquid assets (housing) in their portfolios, while those with unplanned children tilt their portfolios towards liquid assets. Financial literacy and wealth are strongly related to the speed of such adjustments. For poorer households, financial literacy delays the adjustment toward housing while it accelerates such adjustment for those in the middle of the wealth distribution. Among richer households, there is no difference between financially literate and illiterate ones.In Chapter 3, I develop a life-cycle model that replicates the patterns described in Chapter 2. I compare how households with different financial literacy levels respond to similar shocks, and I show that higher financial literacy is associated with smoother portfolio adjustments following a shock onset. All else equal, the more financially literate households appear less susceptible to the detrimental effects of liquidity constraints and the impact of portfolio adjustment costs. The interaction between liquidity constraints and financial literacy plays a key role in the model, as it explains the differential speed and direction of portfolio adjustments observed in the data. Counterfactual exercises show that financial literacy mitigates the negative welfare effects of unexpected fertility shocks by at least 20%.In Chapter 4, we study the accumulation of financial competencies in a model of dynamic skill formation. We find evidence of complementarities between financial literacy, wealth and risk attitudes. Risk tolerance and wealth facilitate experimentation and learning-by-doing. Latent risk attitudes and financial literacy are unevenly distributed across households and do not align with general human capital. Linking estimates with data on household portfolios, we show that early-life differences in financial literacy and its accumulation in the life cycle may account for about one-fifth of the standard deviation of wealth by age 60. Dynamic complementarities in skill formation imply that early interventions may reduce later-life inequality while boosting average wealth growth.

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In this dissertation, I contribute to the theory of macroeconomic aggregation by building a neoclassic environment for production network economies with heterogeneous households and distortions, both for closed and open economies. In this environment, labor supply can be endogenous or exogenous. My main objective is to provide decompositions that capture the effect of microeconomic shocks on aggregate measures of real output, country-level production, and household-specific measures of real consumption. Chapter 2 provides decompositions that capture the effect of distributional variations on aggregate measures of real output and idiosyncratic measures of real consumption. The main theoretical contribution of this chapter is to show that variations in the distributions of labor income and consumption expenditure influence total factor productivity (TFP), and these effects are only neutral under highly restrictive conditions. The TFP decomposition I introduce is the first for a distorted general production network economy with household heterogeneity in preferences and income. Chapter 3 provides a novel country-level aggregate efficiency wedge decomposition that accounts for the possibility that factors of production and dividends cross national boundaries. The main contribution is to provide decompositions and sufficient statistics for the country-level TFP that account for the complexity of global supply chains and factoral reallocation across countries. My findings illustrate the interplay of global supply chains and economic spillovers through intermediate input markets. Chapter 4 provides evidence for how changes in global input-output networks between 1965 and 2000 were advantageous for developing countries and unfavorable for advanced economies. For example, holding the global input-output network fixed, TFP growth in China and India would have been 26.6% and 9.7% lower between 1965 and 2000. Whereas for the US and Australia, TFP growth would have been 4.0% and 16.8% higher. Finally, I show that the dynamics of the domestic intermediate input cost share capture the importance that the structure of the global input-output network has on the amplification of shocks on TFP. These results illustrate the importance of industrial linkages and robust domestic intermediate input markets for economic growth.

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Chapter 2 studies the interaction between a discretionary central bank and a fiscal authority. The analysis focuses on repeated liquidity trap episodes requiring the central bank to rely on forward guidance. Confirming earlier literature, I show that forward guidance policies can be made credible using reputation built during repeated liquidity traps. The key contribution of this chapter is to investigate how the presence of fiscal stabilization policy affects the credibility of the central bank. I show that an increase in the effectiveness of fiscal stabilization policy reduces the range of credible forward guidance announcements that the central bank can implement. Finally, I show that forward guidance can crowd out fiscal effort and result in a loose monetary-tight fiscal policy mix during recessions.Chapter 3 investigates the role of debt maturity within a model of self-fulfilling debt crises. Using one-period bonds, we characterize an interval of debt levels where creditors' panic can force a government to default, and numerically show that the government optimally lowers debt to reduce its vulnerability to this type of crises. After switching to a model with long-term debt repayable with an infinite stream of coupons, we show that the bounds of the interval where crises are self-fulfilling shift upward with higher debt maturity. Finally, we numerically show that the government decreases debt levels faster with long-term debt, therefore rising the economy's welfare compared to the short-term debt case.Fiscal devaluations are policies that can serve as stabilization tools when countries cannot implement nominal devaluations – e.g., within a monetary union. While it has been argued that fiscal policy lags can affect the impact of fiscal devaluations, chapter 4 specifically explores the incidence of implementation lags in fiscal policy in the Euro Area. My findings suggest that fiscal policy in the Eurozone is subject to considerable lags during recessions and expansions. Analysis carried out for Spain shows similar patterns. When fiscal policy cannot adjust at the business cycle frequency, I use a two-period model of tradable and nontradable goods with nominal rigidities and show how lags reduce welfare attained via fiscal devaluations.

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The first chapter studies how low-skilled immigrant entry can explain the falling labour unionization rate in the U.S. economy. This paper argues that the entry of immigrants has significantly altered the incentives of native-born workers to join labour unions and for firms to hire unionized workers, prompting a fall in unionization. The chapter uses spatial variation in immigrant entry to show that a higher entry of immigrants leads to a higher fall in unionization rates across regions in the U.S. It develops a search-theoretic framework to bear out the mechanism and test some over-identifying predictions. The model is further calibrated and finds that low-skilled immigrant entry can explain 48-55% of the total fall in union density.The second chapter exploits plausibly exogenous changes in exchange rates across source countries for immigrants in Canada to evaluate how these changes impact their earnings. It presents evidence that Canadian immigrants, in response to a 10 per cent depreciation of the home currency relative to the Canadian dollar, reduce their annual earnings by 0.36 per cent, mainly by reducing hours worked. The effect is greater for recent male immigrants, who are less educated and their spouses abroad. They also tend to be from lower-income countries and located in immigrant enclaves. Crucially, remittance senders are more affected, but these exchange rate fluctuations do not affect the amount of remittance sent. Thus, suggesting that immigrants tend to be target earners and react accordingly to exchange rate fluctuations.The third chapter examines how immigrants' labour market conditions at the point of entry affect their earnings, labour market outcomes, and reverse migration decisions both in the short and long run. Using administrative tax data, this chapter finds that it takes 12-15 years for an initial adverse effect of entering the labour market when unemployment is high to dissipate completely. It further documents the heterogeneity existing in this impact based on age, gender, marital status, country of origin, and education. The chapter provides novel insights into the outmigration behaviour of immigrants and how it depends on the initial conditions they face post-arrival.

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The first chapter investigates how households’ smooth consumption against idiosyncratic wage shocks in recessions and expansions. Labour market uncertainty amplifies during recessions, captured through the cross-sectional dispersion of wages. I focus on the relative contribution of adjustments in labour supply and net assets as insurance mechanisms. My identification strategy exploits variation in expenditures, hours worked and wages over the business cycle, and is applied to US household panel data. I document a new empirical fact -- the contribution of labour supply to consumption smoothing increases during economic downturns. I then examine the nature of this cyclicality through the lens of a standard life-cycle model with multiple asset-types (liquid and illiquid). The model shows that shifts in portfolio composition towards liquid assets in high uncertainty periods can rationalize the empirical observation.The second chapter examines the joint evolution of a pandemic and its macroeconomic consequences. We outline a macro-pandemic model where individuals can select into working from home or in the market. Market work increases the risk of infection. Occupations differ in the ease of substitution between market and home work, and in the risk of infection. The model is calibrated to British Columbian micro data to examine the implications of individuals exiting market work to insure against the risk of infection. We find that endogenous choice to self-isolate reduces the peak weekly infection rate by 2 percentage points but reduces the trough consumption level by 4 percentage points, even without policy mandated lockdowns.The third chapter examines whether improving access to financial institutions always facilitates consumption smoothing. I document new empirical evidence that emerging economies with better access to banks are worse at consumption smoothing defined as the ratio of consumption volatility to income volatility. Though developed economies with better access to banks are better at consumption smoothing. A simple one-good small open economy model supplemented with trend shocks and financial access heterogeneity is calibrated to match business cycle moments of developed and emerging markets. The model can qualitatively account for the relationship between consumption smoothing and financial access for developed and emerging economies, as seen in the data.

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This dissertation consists of three chapters. The first chapter examines how the export intensity of Chinese firms is related to their productivity, and finds a negative correlation within exporting firms. This pattern remains robust even when controlling for ownership, trade mode, factor intensity, and export subsidies. Firms have to pay marketing costs in order to reach customers. If the elasticity of these costs, with respect to the number of consumers in the domestic market, is higher than in foreign markets, then more productive firms sell relatively more in the domestic market compared with low-productivity firms. Using the marketing cost framework, this chapter further estimates the elasticity of marketing costs in each market and then uses local market competition to explain the heterogeneity in elasticity across markets. When competition is tougher in a market, elasticity is higher there. The second chapter investigates the exchange rate pass-through differences in import prices between two trade modes and finds some robust empirical patterns. First, Chinese-owned assembly firms bear higher exchange rate pass-through than multinational firms. However, joint-owned and foreign-owned assembly firms bear less. Second, the exchange rate pass-through is greater when firms import materials from developed countries. Third, assembly firms can bear higher exchange rate pass-through if they have higher market shares or import less inputs. Finally, high financial development is helpful for assembly firms to bear higher exchange rate pass-through. The last chapter discusses the impact of China's rare earth policy on downstream industries. When China implemented the tough restriction on rare earth exporting in 2010, it caused a significant price gap between the domestic market and foreign markets. Therefore, downstream industries in China enjoy cost advantages relative to foreign competitors. First, this policy has led a rapid increase in exports of Chinese rare earth downstream firms relative to other Chinese firms. The increase of exports is mainly due to the price rather than quantity. Second, this chapter focuses on a typical downstream product -- magnets, and finds that the exports of Chinese metal permanent magnet also increase faster than exports of other countries.

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Leasing is one of the most important sources of external finance to corporate firms. Better understanding of the determinants of corporate leasing behavior is critical for us to study the capital structure and investment of firms. However, it has been overlooked in the theoretical and empirical literature on investment. This thesis studies the determinants of corporate leasing. Each chapter presents a separate essay.The first chapter studies the role of uncertainty and financial constraint in understanding firms' leasing decisions. Although leasing costs more than owning capital in the long run, it provides operational flexibility for firms. In addition, leases are easier to finance than purchases. The benefits of leasing are particularly attractive to firms with high uncertainty and more financial constraints. This chapter develops a dynamic model and predicts that firms with high uncertainty and firms that are more financially constrained lease more of their capital than firms with low uncertainty and firms that are less financially constrained. Using data on publicly-traded firms in the U.S., this chapter provides evidence consistent with the prediction of the model.The second chapter documents that leasing is countercyclical over business cycles. Firms lease more during economic downturns, and are more willing to buy capital during up cycles. One key benefit of leasing is that leases are easier to finance than purchases. This benefit is particularly important to firms with financial constraints. Firms face tighter financing conditions during recessions. Therefore, leasing is more attractive during recessions. This chapter develops a model to explain the observed countercyclical pattern of leasing.The third chapter utilizes data from 81 countries to examine how legal environments affect firms' leasing behavior. The results suggest that leasing is less used in countries with weak legal environments. Firms in countries with weak legal environments tend to avoid the use of leasing contracts because the contracts are costly to enforce. I also find that leasing has a measurable impact on both firm growth and GDP growth. Leasing can help increase capital availability and improve operational efficiency, and thus may contribute to growth. The results provide a policy implication that possible adjustments in legal systems can facilitate the availability of leasing and thus may generate real economics gains.

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Empirical evidence shows that equity home bias is a prevailing fact for most countries, but standard international monetary business cycle models with nominal bonds hardly generate equity home bias for plausible preference parameter values. By incorporating inflation-indexed bonds, I show in chapter 2 that international monetary business cycle models can explain home bias in equities. Inflation-indexed bonds can hedge real exchange rate risk and domestic equities serve as a hedge against domestic labor income risk conditional on real exchange rates. Moreover, this chapter accounts for counter-cyclical movements of net foreign asset positions. These results are robust in environments either with complete markets or with incomplete markets.How does international financial market integration alter international risk sharing? Chapter 3 develops a tractable center-periphery model with portfolio choice to investigate this issue. I compare three stages of financial integration. The first stage is financial autarky. The second stage is the central country becomes financially integrated with peripheral countries, but there is no financial integration between peripheral countries. The third stage is all financial markets are integrated into each other. From financial autarky to partial financial integration, volatility of consumption in all countries drops. From partial financial integration to full financial integration, volatility of consumption in peripheral countries decreases; however, consumption volatility rises in the central country when the central country is relatively large. When peripheral countries are large, the degree of international risk-sharing for all countries increases in the process of financial integration.What's the optimal monetary policy in an economy with financial frictions? Chapter 3 investigates optimal monetary policies in a dynamic stochastic general equilibrium model with sticky prices, sticky wages and credit-market imperfections. Credit frictions distort allocations and prices, and generate large volatility of aggregate variables via the financial accelerator. Policy-makers can take advantage of a debt deflation channel to push down volatility of endogenous variables through the financial decelerator. In the optimized linear interest rate rule, interest rate decreases in asset prices but the response is quantitatively small. This optimized rule exhibits high persistence. Within a class of simple linear interest rate rules, a strict inflation-targeting rule has a larger welfare loss.

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This dissertation consists of three chapters about business cycles in open economies. The first chapter addresses the question of why housing investment is so volatile, especially in economies with developed mortgage markets. To this end, the chapter develops an augmented Real Business Cycle model with a housing collateral constraint. The collateral constraint creates a link between the housing market and borrowing capacity, a link that amplifies the response of housing demand to shocks and becomes stronger in economies with deeper mortgage markets. The second chapter examines an anomaly between international business cycle models and empirical evidence in cross-country employment correlation. It shows that the wealth effect on leisure plays a determining role in generating a negative employment comovement in the models, hence proposing a solution to the anomaly. The last chapter compares macroeconomic consequences of dollarized emerging countries under two alternative monetary policies: the inflation targeting rule and the fixed exchange rate regime. It shows that the floating exchange rate regime can be dominated by the fixed exchange rate regime in the role of cushioning shocks and in welfare terms.

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This thesis consists of three essays on the issues related to endogenous currency of pricing in utility-based open economy models. The first essay endogenizes both the currency of liability denomination and the currency of export pricing to study twin dollarization in East Asian economies, a phenomenon where firms borrow in US dollars and also set export prices in US dollars. This essay shows that twin dollarization is an optional strategy for all firms when exchange rate flexibility is limited, and it can reduce the welfare loss caused by a fixed exchange rate regime. The second essay examines the role of US dollar as an oil currency and its impact on the world dollar standard and the global economy in a two-country general equilibrium model with sticky prices. When the oil price is denominated in US dollars, US firms bear less exchange rate risk than foreign firms when facing oil price shocks. As a result of this asymmetry, all the firms have an incentive to set export prices in dollars, this will generate an endogenously determined dollar standard in international goods pricing. In such a case, the households in the US are better off than those in the rest of the world in term of welfare, though it is costly for the US to have a dollar standard. The third essay re-examines the issue of the degree of exchange rate flexibility in an open economy monetary policy game. It focuses on an environment where the currency of pricing is endogenous, and monetary authorities take into account the way in which firms make this choice. It is shown that there is a unique equilibrium to the monetary policy game, where all firms follow PCP, and Friedman’s classic defense [i.e. Friedman’s classic defence] of flexible exchange rates is upheld. Meanwhile, an alternative method to sustain flexible exchange rates is also provided.

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One principal research in macroeconomics is concerned with the importance of nominal rigidities. This dissertation applies nominal rigidities in closed- and open-economy models to study issues on firms’ pricing decisions, optimal monetary policy in a financially constrained economy, and the choice of exchange rate regime in the presence of transfer problem. Chapter 1 presents empirical evidence for price and wage stickiness, and the development of models with nominal rigidities in macroeconomics and international finance.Chapter 2 incorporates state-dependent pricing in a closed-economy model toexplain the asymmetric responses of output and prices to monetary shocks. The modelfocuses on the effects of strategic complementarity and substitutability in firms’ pricing decisions, as well as the mixed strategies used by an individual firm. The strategic interactions among firms’ pricing decisions lead to asymmetric response of prices and output to monetary shocks. The model implies asymmetries in positive versus negative monetary shocks, and the asymmetric responses are affected by the degree of real rigidity in marginal cost, the magnitude of price-adjusting costs and the market power of an individual firm.Chapter 3 studies the optimal monetary policy of a small open economy with nominal rigidities and exchange-rate sensitive collateral constraints. This model attemptsto explain the observed monetary policy behaviour of emerging markets. The modelimplies pro-cyclical optimal monetary policy when the collateral constraint binds, andan economy with large external shocks that may favour a fixed exchange rate, whichare consistent with the observed features of monetary policy used by emerging markets.The last chapter studies the transfer problem using a two-country DSGE modelwith nominal rigidities. The model compares the effects of a transfer shock underflexible and sticky wages, as well as under fixed and floating exchange rate regimes.The results of this model are consistent with the conventional wisdom in internationalmacroeconomics with nominal rigidities, which suggests that a flexible exchange rate can help reduce internal instability after some negative shocks via exchange rate adjustment. However, the welfare analysis of this model implies the donor country isbetter off to maintain the gold standard instead of going to a floating exchange rate,even with nominal rigidities.

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