We study the role of financial frictions and firm heterogeneity in determining the investment channel of monetary policy. Empirically, we find that firms with low default risk—those with low debt burdens and high “distance to default”— are the most responsive to monetary shocks. We interpret these findings using a heterogeneous firm New Keynesian model with default risk. In our model, low‐risk firms are more responsive to monetary shocks because they face a flatter marginal cost curve for financing investment. The aggregate effect of monetary policy may therefore depend on the distribution of default risk, which varies over time.

Abstract We empirically characterize episodes of large inflation surges observed worldwide in the last three decades. We document four facts. (1) Inflation surges tend to be persistent, with the duration of disinflation exceeding that of the initial inflation increase. (2) Surges are initially unexpected but followed by a gradual catch-up of average short-term expectations with realized inflation. (3) Long-term inflation expectations tend to exhibit increases that persist throughout disinflation. (4) Policy responses are characterized by hikes in nominal interest rates but no tightening of real rates or fiscal balances, departing from textbook policy rules, and instead exhibiting a “fear of tightening.”

We study the macroeconomic implications of asymmetric information in capital markets.We build a quantitative capital-accumulation model in which capital is traded in illiquid markets, with sellers having more information about capital quality than buyers.Asymmetric information distorts the terms of trade for sellers of high-quality capital, who list higher prices and are willing to accept lower trading probabilities to signal their type.Led by the model's predictions, we measure the distortions from asymmetric information by studying the relationship between listed prices and trading probabilities in a unique dataset of individual capital units listed for trade.By combining the empirical measurement with the model, we show that information asymmetries can play a quantitatively large role during economic crises when the degree of asymmetric information deteriorates.

What is the optimal fiscal policy response to a recession when the government is subject to sovereign risk? We study this question in a model of endogenous sovereign default with nominal rigidities. Increasing spending in a recession reduces unemployment, but it exposes the government to a debt crisis. We quantitatively analyze this trade-off between stimulus and austerity and find that expanding government spending may be undesirable, even in the presence of sizable Keynesian stabilization gains and inequality concerns. Consistent with these findings, we show that sovereign risk is a key driver of the fiscal procyclicality observed worldwide.

We study the role of global financial intermediaries in international lending. We construct a model of the world economy, in which heterogeneous borrowers issue risky securities purchased by financial intermediaries. Aggregate shocks transmit internationally through financial intermediaries' net worth. The strength of this transmission is governed by the degree of frictions intermediaries face in financing their risky investments. We provide direct empirical evidence on this mechanism showing that around Lehman Brothers' bankruptcy, emerging‐market bonds held by more distressed global banks experienced larger price contractions. A quantitative analysis of the model shows that global financial intermediaries play a relevant role in driving borrowing‐cost and consumption fluctuations in emerging‐market economies, during both debt crises and regular business cycles. The portfolio of financial intermediaries and the distribution of bond holdings in the world economy are key to determine aggregate dynamics.

We study crises characterized by large adjustments of aggregate consumption through their microlevel patterns. We document the cross-sectional patterns of consumption adjustment across the income distribution and find large adjustments for top-income households, who exhibit consumption-income elasticities similar to or larger than the average. We construct a heterogeneous-agent open economy model of consumption under income fluctuations and show that the data patterns are largely consistent with theories that attribute the dynamics of aggregate consumption to changes in aggregate permanent income. We also discuss our findings’ implications for theories based on the tightening of households’ borrowing constraints and analyze policy implications. (JEL D31, E21, E32, F33, G51, O11, O12)