A Theory of Money Creation by Banks and Central Banking in a Two-Date Economy
This paper considers money creation by banks and central banking in a model where a means of payment is issued by both the central bank and banks, and the private issuance is endogenous in competitive equilibrium. The economy lasts for two dates, but the central bank gets its purely nominal issues circulated. In circumstances where banks issue too little money, quantitative easing policy improves efficiency by substituting inflation for bank default as the way to make the real value of money contingent on a productivity shock. This paper also considers interest-rate policy and leverage regulation. The importance of competition between banks is underlined.
Search Engines vs. Steam Engines: Technological Change, Occupation Choice and the Income Distribution, with Greg Wright
This paper considers the implications of two types of technological change for the income distribution with a unified model in which occupational choice plays a key role. Type A technological change augments the productivity of unskilled labor and yet leads to greater income inequality, while raising the level of overall income. Type B expands the range over which Increasing Returns to Scale (IRS) operate in some occupations, by increasing the scale of operation for all workers. This hurts the least talented workers while possibly benefitting the most talented ones, and increases income inequality. The paper compares the theoretical results with U.S. data and finds support for the predictions.
Increasing Returns to Scale: A Model of Bank Size, The
Economic Journal, 125 (2015), 989-1014
This paper examines the causal effects of bank size on banks' survival, asset quality, and leverage. Two forces drive these effects: increasing returns to scale derived from banks' expertise; and competition. The first enables bigger banks to survive competition better, have higher asset-quality, and be more leveraged. It drives banks into a race for expansion. This race toughens competition between banks, which edges out small banks and may deteriorate all banks' asset quality. Consequently, the banking industry will be dominated by a small number of highly leveraged banks. In this paper, financial intermediation arises endogenously and coexists with direct finance.
A Model of Leverage Based on Risk Sharing, Economics Letters, 2013, 119, 97 – 100.
This paper offers a new approach, based on risk sharing, to
endogenize the leverage of financial intermediaries. It endogenizes debt as the
optimal contract for external financing, thereby capturing two features of
leverage: debt serves to boost the return on equity; and equity provides "safety
net" for debt. The paper derives a novel prediction that when the asset-side
risk rises, the leverage ratio is reduced, but the profit margin of leveraging
is actually widened.
THE DYNAMICS OF NAMES: A MODEL OF REPUTATION, International Economic Review 52(2011), 1039-58
The paper studies reputation of names and its dynamics. Firstly, the paper shows that pure names, backed by nothing intrinsic, can bear reputation. Although the context is purely of adverse selection, a mechanism in the spirit of Kreps (1990) helps sustain reputation. Secondly, it examines how the dynamics of reputation affects the extent of sorting and the level of social efficiency, and derives the dynamics in the equilibria with the highest efficiency. Lastly, it finds a comparative statics result which empirically predicts that brandnames can be fully established sooner in an industry where high-end products have larger profit margins.
The Allocation of Liability, Delegated Monitoring, and Modes of Financing
Based on the allocation of liability, the paper examines all the modes of organizing finance and delegated monitoring in an economy with costly state verification. Besides the mode of financial intermediation (FI), a mode of direct finance, Conglomeration, accommodates delegated monitoring and obtains the benefit of diversification also, which, therefore, do not necessarily make FI viable, as the extant literature claims. The paper empirically predicts that the prevalence of bank financing could increase with the costs of banks' services or the rates of banks' loans. The paper is the first to examine the market organization of a financial service through the allocation of liability.
Intrinsic Cycles in Intermediately Developed Economies, with Sanjay Banerji
The paper shows that in intermediately developed economies,
the interactions between incentives, risk sharing, and wealth may drive economic
cycles, where the economy oscillates between two equilibrium modes. When the
economy is poor, it is in the incentivized mode, where the young agents take
risks, work hard, and are more productive. Consequently, the economy gets
richer, making it harder to incentivize the young generation. Eventually the
economy falls into the disincentivized mode, where young agents obtain full
insurance, shirk, and are less productive. As a result, the economy becomes
poorer and eventually falls back into the incentivized mode. Such oscillations
arise only when the productivity of the economy falls in a medium range.
Risk Sharing, (Over)Leverage, and the Dimensions of Competition
The paper examines the leverage of financial intermediaries in a general equilibrium framework. The paper's approach to leverage is driven by risk sharing and captures two features: Debt serves to boost the return of equity and equity to "safe net" debt. The paper finds that if entrepreneurs compete only in the dimension of price, the equilibrium leverage rate is above the social best one; and if they compete in both price and investment scale, the two rates coincide, even under the market segmentation which drives financial intermediation. In the latter case, the credit market is cleared not by price, but by contract which specifies both price and scale. The paper argues that overleverage is more likely to occur where firms are small and dispersed while banks are large and concentrated, and shows that it can be rectified by proper capital adequacy regulation.
Ownership, Control, and Incentive
The paper shows that the principal can enhance her control over the agent's human capital by acquiring the physical capital that is critical for him to create value. However, the enhancement in the control necessarily reduces his incentive to make human capital investment ex ante and to exert effort ex post. This trade-off between control and incentive thus decides the boundary of the firm. The paper also presents a rationale for M-form firms: centralized ownership of physical capital to facilitate coordination, and dispersed payoff rights to incentivize divisions.
Collusion, Incentives and Information: The role of Experts in Corporate Governance with Sanjay Banerji
The paper shows that the severer moral hazard problems of the CEO and poorer ability of the outside expert not only diminish the value of the firm on their own but also worsen the problem of collusion which is more likely to arise in times of boom. The shareholders then incur extra costs, attributed to increased incentive and severance payments to the CEO. The expert's incentives to acquire reputation or the public signals from media etc. mitigate such problems but cannot undo them completely. The paper derives empirical predictions on experts' turnovers, fees, and their impacts on corporate restructuring.
Reputation and Scale
The paper offers an explanation for why large scales are necessary to establish reputation. In the model, each producer yields one widget and chooses the quality investment each period. Low quality widgets always fail and high quality succeed with some probability. Due to noisiness of single performance, a producer cannot establish reputation in the market. This noisiness problem is resolved by the Law of Large Numbers, as the performance of many widgets is informative of the average quality. When the scale is large, however, defaulting to invest a small number of widgets seems undetectable, which, if true, will break down the equilibrium expectation of the average quality. This incentive problem is resolved by Central Limit Theorem, which ensures increasing marginal return of making the investment. Thus the operators of large scales are always able to establish reputation. The paper sheds light on the existence of professional firms and middlemen.
EC908 Topics in Financial Economics