Publications by Type: Journal Article

Journal Article
Baqaee, David, and Emmanuel Farhi. Forthcoming. “The Macroeconomic Impact of Microeconomic Shocks: Beyond Hulten's Theorem.” Econometrica. Abstract

We provide a nonlinear characterization of the macroeconomic impact of microeconomic productivity shocks in terms of reduced-form non-parametric elasticities for efficient economies. We also show how structural microeconomic parameters are mapped to these reduced-form general equilibrium elasticities. In this sense, we extend the foundational theorem of Hulten (1978) beyond first-order terms to capture nonlinearities. Key features ignored by first-order approximations that play a crucial role are: structural elasticities of substitution, network linkages, structural returns to scale, and the extent of factor reallocation. In a business-cycle calibration with sectoral shocks, nonlinearities magnify negative shocks and attenuate positive shocks, resulting in an aggregate output distribution that is asymmetric (negative skewness), fat-tailed (excess kurtosis), and has a lower mean, even when shocks are symmetric and thin-tailed. Average output losses due to short-run sectoral shocks are an order of magnitude larger than the welfare cost of business cycles calculated by Lucas1(987). Nonlinearities can also cause shocks to critical sectors to have disproportionate macroeconomic effects, almost tripling the estimated impact of the 1970s oil shocks on world aggregate output. Finally, in a long-run growth context, nonlinearities, which underpin Baumol's cost disease, account for a 20 percentage point reduction in aggregate TFP growth over the period 1948-2017 in the US.

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Farhi, Emmanuel, and Matteo Maggiori. Forthcoming. “China vs. U.S.: IMS Meets IPS.” American Economic Review, Papers and Proceedings. Abstract
Currently both the International Monetary System (IMS) and the International Price Systems (IPS) are dominated by the U.S. The emergence of China, both as reserve currency and as a currency of invoicing, is likely to disrupt this status quo. We provide a framework to understand the forces that will shape this transition and identify sources of instability. We highlight the risk of an abrupt shift triggered by a run on the dollar.
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Farhi, Emmanuel, and Francois Gourio. Forthcoming. “Accounting for Macro-Finance Trends: Market Power, Intangibles, and Risk Premia.” Brookings Papers on Economic Activity.
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Barbiero, Omar, Emmanuel Farhi, Gita Gopinath, and Oleg Itskkoki. Forthcoming. “The Macroeconomics of Border Taxes.” NBER Macroeconomics Annual.
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Farhi, Emmanuel, and Ivan Werning. Forthcoming. “Monetary Policy, Bounded Rationality, and Incomplete Markets.” American Economic Review. Abstract
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Farhi, Emmanuel, and Jean Tirole. Forthcoming. “Deadly Embrace: Sovereign and Financial Balance Sheets Doom Loops.” Review of Economic Studies. Abstract


The recent unravelling of the Eurozone's financial integration raised concerns about feedback loops between sovereign and banking insolvency. This paper provides a theory of the feedback loop that allows for both domestic bailouts of the banking system and sovereign debt forgiveness by international creditors or solidarity by other countries. Our theory has important implications for the re-nationalization of sovereign debt and the rationale for banking unions.


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Farhi, Emmanuel, and Matteo Maggiori. 2018. “A Model of the International Monetary System.” Quarterly Journal of Economics 133 (1): 295-355. Abstract

We propose a simple model of the international monetary system. We study the world supply and demand for reserve assets denominated in different currencies under a variety of scenarios: a Hegemon vs. a multipolar world; abundant vs. scarce reserve assets; a gold exchange standard vs. a floating rate system. We rationalize the Triffin dilemma, which posits the fundamental instability of the system, as well as the common prediction regarding the natural and beneficial emergence of a multipolar world, the Nurkse warning that a multipolar world is more unstable than a Hegemon world, and the Keynesian argument that a scarcity of reserve assets under a gold standard or at the zero lower bound is recessive. Our analysis is both positive and normative.

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Caballero, Ricardo J., Emmanuel Farhi, and Pierre-Olivier Gourinchas. 2017. “The Safe Asset Shortage Conundrum.” Journal of Economic Perspectives 31 (3): 29-46. Abstract
A safe asset is a simple debt instrument that is expected to preserve its value during adverse systemic events. The supply of safe assets, private and public, has historically been concentrated in a small number of advanced economies, most prominently the United States. Over the last few decades, with minor cyclical interruptions, the supply of safe assets has not kept up with global demand. The reason is straightforward: the collective growth rate of the advanced economies that produce safe assets has been lower than the world's growth rate, which has been driven disproportionately by the high growth rate of high-saving emerging economies such as China. The signature of this growing shortage is a steady increase in the price of safe assets; equivalently, global safe interest rates must decline, as has been the case since the 1980s. The early literature, brought to light by Ben Bernanke's famous "savings glut" speech of 2005, focused on a general shortage of assets without isolating its safe asset component. The distinction, however, has become increasingly important over time, particularly in the aftermath of the subprime mortgage crisis and its sequels. We begin by describing the main facts and macroeconomic implications of safe asset shortages. Faced with such a structural conundrum, what are the likely short- to medium-term escape valves? We analyze four of them, each with its own macroeconomic and financial trade-offs.
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Caballero, Ricardo J., Emmanuel Farhi, and Pierre-Olivier Gourinchas. 2017. “Rents, Technical Change, and Risk Premia: Accounting for Secular Changes in Interest Rates, Returns to Capital, Earnings Yields, and Factor Shares.” American Economic Review, Papers and Proceedings 107 (5): 614-620. Abstract

The secular decline in safe interest rates since the early 1980s has been the subject of considerable attention. In this short paper, we argue that it is important to consider the evolution of safe real rates in conjunction with three other first-order macroeconomic stylized facts: the relative constancy of the real return to productive capital, the decline in the labor share, and the decline and subsequent stabilization of the earnings yield. Through the lens of a simple accounting framework, these four facts offer insights into the economic forces that might be at work.

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Caballero, Ricardo J, and Emmanuel Farhi. 2017. “The Safety Trap.” Review of Economic Studies 85 (1): 223-274. Abstract

In this paper we provide a model of the macroeconomic implications of safe
asset shortages. In particular, we discuss the emergence of a deflationary 
safety trap equilibrium with endogenous risk premia. It is an acute
form of a liquidity trap, in which the shortage of a specific form of
assets, safe assets, as opposed to a general shortage of assets, is the
fundamental driving force. At the ZLB, our model has a Keynesian cross
representation, in which net safe asset supply plays the role of an
aggregate demand shifter. Essentially, safety traps correspond to liquidity
traps in which the emergence of an endogenous risk premium significantly
alters the connection between macroeconomic policy and economic activity.
``Helicopter drops'' of money, safe public debt issuances, swaps of private
risky assets for safe public debt, or increases in the inflation target,
stimulate aggregate demand and output, while forward guidance is less
effective. The safety trap can be arbitrarily persistent, as in the secular
stagnation hypothesis, despite the existence of infinitely lived assets. 

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Farhi, Emmanuel, and Ivan Werning. 2017. “Fiscal Unions.” American Economic Review 107 (12): 3788-3834. Abstract

We study cross-country risk sharing as a second-best problem for members of a currency union using an open economy model with nominal rigidities and provide two key results. First, we show that, if financial markets are incomplete, the value of gaining access to any given level of aggregate risk sharing is greater for countries that are members of a currency union. Second, we show that, even if financial markets are complete, privately optimal risk sharing is constrained inefficient. A role emerges for government intervention in risk sharing to both guarantee its existence and to influence its operation. The constrained efficient risk sharing arrangement can be implemented by contingent transfers within a fiscal union. The benefits of such a fiscal union are larger, the bigger the asymmetric shocks affecting the members of the currency union, the more persistent these shocks, and the less open the member economies.

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Farhi, Emmanuel, and Ivan Werning. 2017. “Fiscal Multipliers: Liquidity Traps and Currency Unions.” Handbook of Macroeconomics 2: 2417-2492. Abstract

We provide explicit solutions for government spending multipliers during a liquidity trap and within a fixed exchange regime using standard closed and open-economy New Keynesian models. We confirm the potential for large multipliers during liquidity traps. For a currency union, we show that self-financed multipliers are small, always below unity, unless the accompanying tax adjustments involve substantial static redistribution from low to high marginal propensity to consume agents, or dynamic redistribu- tion from future to present non-Ricardian agents. But outside-financed multipliers which require no domestic tax adjustment can be large, especially when the average marginal propensity to consume on domestic goods is high or when government spending shocks are very persistent. Our solutions are relevant for local and national multipliers, providing insight into the economic mechanisms at work as well as the testable implications of these models.

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Caballero, Ricardo, Emmanuel Farhi, and Pierre-Olivier Gourinchas. 2016. “Safe Asset Scarcity and Aggregate Demand.” American Economic Review, Papers and Proceedings 106 (5): 513-518.
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Farhi, Emmanuel, and Ivan Werning. 2016. “A Theory of Macroprudential Policies in the Presence of Nominal Rigidities.” Econometrica 84 (5): 1645-1704. Abstract

We provide a unifying foundation for monetary policy and macroprudential policies in financial markets for economies with nominal rigidities in goods and labor markets and constraints on monetary policy such as the zero lower bound or fixed exchange rates. Macroprudential interventions in financial markets are beneficial because of an aggregate demand externality. Ex post, the distribution of wealth across agents affects aggregate demand and output through Keynesian channels. However, ex ante, these effects are not privately internalized in the financial decisions agents make. We obtain a simple formula that characterizes the size and direction for optimal financial market interventions as a function of a small number of empirically measurable sufficient statistics. We also characterize optimal monetary policy. We then show how to extend our framework to also incorporate financial markets frictions giving rise to pecuniary externalities. Finally, we provide a number of relevant concrete applications of our general theory.
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Lead article.

Farhi, Emmanuel, and Xavier Gabaix. 2016. “Rare Disasters and Exchange Rates.” Quarterly Journal of Economics 131 (1): 1-52. Abstract
We propose a new model of exchange rates, based on the hypothesis that the possibility of rare but extreme disasters is an important determinant of risk premia in asset markets. The probability of world disasters as well as each country’s exposure to these events is time-varying. This creates joint fluctuations in exchange rates, interest rates, options, and stock markets. The model accounts for a series of major puzzles in exchange rates: excess volatility and exchange rate disconnect, forward premium puzzle and large excess returns of the carry trade, and comovements between stocks and exchange rates. It also makes empirically successful signature predictions regarding the link between exchange rates and telltale signs of disaster risk in currency options.
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Lead Article.

Aguiar, Mark, Manuel Amador, Emmanuel Farhi, and Gita Gopinath. 2015. “Coordination and Crisis in Monetary Unions.” Quarterly Journal of Economics 130 (4): 1727-1779. Abstract

We study fiscal and monetary policy in a monetary union with the potential for rollover crises in sovereign debt markets. Member-country fiscal authorities lack commitment to repay their debt and choose fiscal policy independently. A common monetary authority chooses inflation for the union, also without commitment.  We first describe the existence of a fiscal externality that arises in the presence of limited commitment and leads countries to over borrow; this externality rationalizes the imposition of debt ceilings in a monetary union. We then investigate the impact of the composition of debt in a monetary union, that is the fraction of high-debt versus low-debt members, on the occurrence of self-fulfilling debt crises. We demonstrate that a high-debt country may be less vulnerable to crises and have higher welfare when it belongs to a union with an intermediate mix of high- and low-debt members, than one where all other members are low-debt. This contrasts with the conventional wisdom that all countries should prefer a union with low-debt members, as such a union can credibly deliver low inflation. These findings shed new light on the criteria for an optimal currency area in the presence of rollover crises.

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Farhi, Emmanuel, and Jean Tirole. 2015. “Liquid Bundles.” Journal of Economic Theory 158: 634-655. Abstract

Parties in financial markets, industries, compensation design or politics may negotiate on either a piecemeal or a bundled basis. Little is known about the desirability of bundling when values are common and/or information endogenous. The paper shows that bundling encourages information-equalizing investments, thereby facilitating trade. It accordingly revisits and qualifies existing knowledge on security design.

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Aguiar, Mark, Manuel Amador, Emmanuel Farhi, and Gita Gopinath. 2014. “Sovereign Debt Booms in Monetary Unions.” American Economic Review, Papers and Proceedings 104 (5): 101-106.
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Epstein, Larry, Emmanuel Farhi, and Tomasz Stralezcki. 2014. “How Much Would You Pay To Resolve Long-Run Risk?” American Economic Review 104 (9): 2680-2697. Abstract

Though risk aversion and the elasticity of intertemporal substitution have been the subjects of careful scrutiny when calibrating preferences, the long-run risks literature as well as the broader literature using recursive utility to address asset pricing puzzles have ignored the full implications of their parameter specifications. Recursive utility implies that the temporal resolution of risk matters and a quantitative assessment of how much it matters should be part of the calibration process. This paper gives a sense of the magnitudes of implied timing premia. Its objective is to inject temporal resolution of risk into the discussion of the quantitative properties of long-run risks and related models.

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Farhi, Emmanuel, and Ivan Werning. 2014. “Dilemma not Trilemma? Capital Controls and Exchange Rates with Volatile Capital Flows.” IMF Economic Review (Special Volume in Honor of Stanley Fischer) 62: 569-605. Abstract

We consider a standard New Keynesian model of a small open economy with nominal rigidities and study optimal capital controls. Consistent with the Mundellian view, we find that the exchange rate regime is key. However, in contrast with the Mundellian view, we find that capital controls are desirable even when the exchange rate is flexible. Optimal capital controls lean against the wind and help smooth out capital flows.

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