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Exchange Rate Expectations and Aggregate Dynamics (Job Market Paper)

The paper explores the role of expectations in the economy’s response to exchange rate fluctuations. Using data from the Central Reserve Bank of Peru, I analyze firm-level exchange rate forecasts and find that firms deviate from rational expectations by overreacting to new information and overestimating the persistence of the current exchange rate. I also demonstrate that firms anticipating depreciation are more likely to reduce employment and production. Based on these observations, I develop a behavioral general equilibrium model of a small open economy, in which exchange rate is driven by a financial shock to the uncovered interest parity (UIP) condition. Firms set their prices infrequently and associate expected depreciation with a higher future path of marginal costs. They overestimate the persistence of the shock and contract more than under the rational expectations benchmark, potentially reversing the sign of output response. If households and financial institutions share this bias, the impact of the shock becomes amplified, contributing to greater exchange rate volatility.

Financial Crisis and Permanent Output Drop: a Model of Reverse Causality

Why are financial crises followed by slow recoveries? This paper introduces a channel that generates credit tightening in response to an exogenous trend shock to output, reverting the direction of causality prevalent in the literature. When a negative trend shock hits the economy, endogenous borrowing constraint tightens much more than after a transitory shock. In a heterogeneous household model with a no-default borrowing limit, a trend shock causes a sizable fall in credit supply and household debt deleveraging. In contrast, after a temporary shock, household debt increases. The model offers an alternative approach to generating the connection between financial tightening and persistent output losses. In addition, the paper addresses the policy implications of the endogenous borrowing limit. Lowering the penalty for default benefits the defaulting households at the cost of the tightening endogenous constraint. The non-defaulting households must reduce borrowing, so in the quantitative model, the aggregate consumption falls.  

Research In Progress

Exchange Rates Expectations of Firms: Survey Evidence from Peru