Research

This paper explores how high inflation affects household savings, aggregate capital, and informality. Using a large panel of countries, I find that high inflation correlates with high levels of informality and low levels of financial development, even when accounting for GDP per capita. To explain this, I extend the Aiyagari model with an informal sector, where cash is required for transactions. If the elasticity of substitution between formal and informal goods is not extremely high, higher inflation leads households to reserve more cash for informal transactions to make up for the decline in the real return on money and keep consuming informal goods. This reduces disposable income and savings in interest-bearing assets, which tightens the financial sector and restricts credit flows to formal firms, which are more capital-intensive and reliant on external financing. Consequently, the cost of production and price of formal goods rise, as does informality. Quantitative analysis, calibrated to an average of Latin American economies, shows that increasing steady-state annual inflation from 10% to 90% is linked to a decline in the steady-state aggregate capital by 8% and a growth in informality as a share of GDP, from 40% to 54%. 

This paper focuses on a Central Bank that seeks to profit from trading against irrational noisy traders but cannot directly observe their positions as they blend in with rational traders that are going against the noise themselves. The optimal strategy for the Central Bank is to trade against the remaining noise partially, but this results in an inefficiently small position size. With complete information, targeting the actual noise is optimal for higher expected profits. If the Central Bank had a prior on the net open position limit of the rational traders, it would target more than the remaining observable noise. I prove that the Central Bank can learn to differentiate actual noise from rational traders by fixing the prior for many periods, computing the sample variance of the observable noise, and comparing it with the actual noise variance. Finally, if rational traders have better information than the Central Bank about the future real exchange rate, intervening in the market may result in negative expected profits, so total inaction may be recommendable.

I document that the increase in prices and not in quantities are driving the rise in the value of exports of goods in Argentina in this century. I also show the country’s poor performance in capital formation, the low value of its market capitalization, and the tendency of consumers to save and firms to borrow in foreign currency. These three forces could help explain why Argentina is not exporting more. To understand the mechanisms, I build a model in which financial constraints and external debt will keep the economy closer relative to the same economy unconstrained. Moreover, this constrained economy allows for multiple equilibria, which could open room for optimal policy intervention. The critical channel driving the results is the low capital creation  arising from high real exchange rates and the balance-sheet effect, affecting future consumers’ wages through a decrease in the installed capital and its price, which forces the economy to appreciate in the future to compensate for that drop in income and keep the balance of payments in equilibrium. An economy “trapped” in a bad pace will initially export more due to high real exchange rates. Still, it will eventually be forced out of the international markets due to insufficient capital stock.