My main field of research is international finance, though my work also has strong political economy and macroeconomic themes. Some of the issues I have studied include international financial crises, central bank independence, exchange rates, current account imbalances and political budget cycles. What excites me most about these topics is that there are so many interesting and important problems where economic research can help provide a more disciplined structure for policy analysis.
My 2009 book with Carmen M Reinhart, This Time Is Different: Eight Centuries of Financial Folly, develops a novel database for studying international financial crises based on annual data for seventy countries covering 800 years. Our research shows that financial crises are far more universal, and there are far more quantitative similarities in the aftermath, than previously believed. Our new data set allows us to look at the evolution of key macroeconomic indicators around a financial crisis, including unemployment, housing and stock prices, growth and debt. Our results are surprising given the vastly different political, institutional, legal and economic circumstances across which various crises have unfolded, and suggest deeper behavioral links. Our research project includes a number of related journal articles, including several in the American Economic Review, that can be found on my webpage, along with heavily annotated data sets. Although our work is quite academic, our benchmark post-crisis trajectories, published in The American Economic Review and NBER Papers just as the crisis began, proved quite useful for policymakers in the aftermath of the 2008 global financial crisis. This was especially true given the collapse of conventional empirical macroeconomic models. Another prediction of the model is that public debt explodes after a financial crisis, a necessary response given collapse of private debt markets. In later work, for example, “Dealing with Debt” (JIE 2015), we show that in the past advanced countries have taken more heterodox approaches to dealing with very high debt overhang than is commonly remembered.
In my 1989 Journal of Political Economy and related 1988 IMF Staff Papers publications with Jeremy Bulow, we introduced the first formal model of the moral hazard faced by international lending institutions and, more broadly, their G-7 sponsors. This idea later become popularized in the 1999 Meltzer commission report, and even more so after the 2008 financial crisis. Our 1989 American Economic Review paper explored the fundamental question of why sovereign countries ever choose to repay external debts. Bulow and I concluded that simplistic models based on a purely reputational cutoff from international debt markets were insufficient, and that repayment of foreign debts ultimately had to rely either on creditor country legal institutions or, at a deeper level, on a broader interpretation of reputation extended to multiple dimensions of international relations (although then it starts to be difficult to attach falsifiable assumptions). Recent evidence on the Argentine and Greek defaults seems to strongly support the primacy of a legal rights approach over a pure reputation model (Greek bonds under UK law paid much more than Greek bonds issued under Greek law; Argentina’s debt values changed dramatically after unexpected legal rulings in New York courts; Greece was able to borrow much more than a normal sovereign because as long as it remains in the European Union, it is subject to European courts). This along with the moral hazard issues that fall naturally out of our approach, do not fall so easily out of a pure reputation model.
In a 1988 Brookings paper, Bulow and I questioned the conventional wisdom that insolvent developing countries could gain by tens of billions of dollars by repurchasing their debt at deeply discounted market prices. This was an important policy problem at the time, given the tens of billions of dollars being spent, with the blessing and encouragement of the official community. We argued that, contrary to received wisdom, this practice was a boondoggle for private bank creditors and provided very little benefit to impoverished debtors.
In the field of monetary policy, my 1985 Quarterly Journal of Economics paper took a novel institutional approach to solving the credibility problem in monetary policy that had been identified by (later) Nobel prize winners Kydland and Prescott. At the time of its writing, very few countries had independent central banks incentivized to hit inflation targets. Now it is the norm across much of the world. My paper showed, in the context of a very simple strategic model, why central bank independence can benefit a country even when, in the short term, the objective function of society and the central bank might seem to conflict. During the high-growth era in the run-up to the 2008 financial crisis, inflation rates fell throughout the world, leading some to question whether anti-inflation credibility was ever a problem. This, of course, overlooks the role of central bank independence, as well as the extent to which boom times can mask deeper underlying problems. More recently, I have written on how over the long run, advanced economies may want to consider phasing out paper currency, both as a way of dealing with the zero bound on nominal interest rates and to help increase tax and legal enforcement efficiency.
In the field of exchange rates, my 1983 Journal of International Economics paper with Richard Meese still stands as providing the central empirical fact about major currency exchange rates (that movements are almost as hard to explain ex post as they are to predict ex ante). This paper is often cited (although we disagree) as a rationale for fixing exchange rates. My 1996 Journal of Economic Literature paper shows that one structural factor that does seem to help long-term real exchange rate movements are deviations from “purchasing power parity,” albeit only very slowly at horizons of many years.
My exchange rate research also includes ongoing work with Carmen Reinhart on "The Modern History of Exchange Rate Arrangements: A reinterpretation," Quarterly Journal of Economics, 2004. The paper puts together a vast new data set on both market and parallel exchange rates, and argues that exchange rate regimes should be categorized on a de facto rather than de jure basis. The punch line of the paper is that official historical categorization of exchange rate regimes is little better than random; countries that declare themselves to be floating very often allow almost no movement in their exchange rates. Historically, countries that declared themselves to have a fixed rate, very often have allowed major floating through the back door of a dual or parallel market. In ongoing research, we are revisiting currency regimes in light of developments with the euro and Chinese yuan.
In 1996, I completed a treatise/graduate text with Maurice Obstfeld on Foundations of International Macroeconomics. (We are now working on a second volume!) The book (832pp.) attempts to provide the first modern integrative treatment of the core issues in international macroeconomics. In addition to unifying a field that had previously been considered quite scattered and disconnected, the book contains a significant amount of new research. Perhaps the most important contribution was a model to replace the Mundell-Fleming-Dornbusch open economy model that had previously been the workhorse of virtually all policy analysis in international economics, both in and outside the government. Our “new open economy macroeconomics” model inherits many of the empirical sensibilities of the earlier framework while providing microfoundations and integrating dynamics in a coherent way for the first time. This new approach has allowed researchers to analyze intertemporal issues such as the current account and government budget deficits, and view macroeconomic policy from a welfare-theoretic perspective. There is, of course, now a large literature on new open economy macroeconomics. An application is our 2002 Quarterly Journal of Economics paper that looks at the potential welfare gains to greater coordination in the establishment of central bank monetary rules.
In the field of political business cycles, my 1988 Review of Economic Studies paper with Anne Sibert and my 1990 American Economic Review paper explore the incentives politicians have to time budget splurges prior to elections. We show that this can be the natural outcome of a signaling process whereby politicians attempt to signal competence to voters. My AER paper explores possible solutions to mitigate the problem.