Davide Porcellacchia

Under reviewPaperVoxEU

“The Tipping Point: Low Rates and Financial Stability”

This paper develops a theory to study the effect of low interest rates on bank stability. While low rates reduce bank profits by compressing interest margins, they also boost the value of banks’ long-term assets. The paper's main result is the characterization of a critical interest-rate level. Below this tipping point, the compression of interest margins dominates the revaluation of long-term assets, leading to insolvency and a banking crisis. The tipping point depends on observable bank characteristics. In a quantitative analysis, I find a value of 0.32% for the US economy in the decade before the Global Financial Crisis.

Under reviewPaper

“Paying Interest on Reserves to Promote Liquidity”

Liquidity regulation is the conventional policy deployed to correct insufficient liquid-asset holdings by banks. In a standard banking model in which under laissez faire banks hold excessively illiquid asset porfolios, I find that payment of interest on reserves, by strengthening banks’ incentive to hold liquid assets, equivalently corrects this distortion. In fact, it is the optimal policy intervention, since it does not act as a tax on banks and thus, unlike liquidity regulation, avoids financial disintermediation. In an extension, I show that payment of interest on reserves has a fiscal cost and therefore distortionary taxation implies a lower optimal level of interest on reserves.

with A. Leonello, C. Mendicino and E. Panetti| Under reviewPaper

“Savings, Efficiency and the Nature of Bank Runs”

Does the level of deposits matter for bank fragility and efficiency? In a banking model with endogenous bank runs and a consumption-saving decision, we show that the level of deposits has opposite effects on bank fragility depending on the nature of bank runs. In an economy with panic-driven runs, higher deposits make banks less fragile, while the opposite is true when runs are only driven by fundamentals. The effect of deposits is not internalized by depositors. A saving externality arises, leading to excessive fragility and insufficient liquidity provision. The economy features undersaving when runs are panic driven, and over-saving when fundamental driven.

With K. SheedyDraft available soon

“Monetary Policy Space”

If bank equity values rely heavily on the deposit franchise, equilibrium multiplicity arises. When depositors panic, the value of the deposit franchise collapses and banks fail. In turn, this make panics an equilibrium outcome. This result stems from a simple monetary model with deposits in utility. Studying monetary policy in this model we find that, if the central bank reacts to crises by cutting the interest rate enough, then panics are ruled out. However, this policy can be credibly carried out only if the central bank has monetary policy space, i.e. a sufficiently high interest rate in good times. We provide an analytical specification of the optimal monetary policy space in terms of bank characteristics.

IMF Working Paper, February 2016

“Wage-Price Dynamics and Structural Reform in Japan”

• Cited in the IMF’s World Economic Outlook.

Structural reforms in the liquidity trap need not be deflationary. This paper develops a simple framework to study the role that key characteristics of Japan’s labor and product markets—labor-market duality and weak corporate governance—play in generating unfavorable wage-price dynamics. The model allows a discussion of whether and in what form structural reforms may contribute to Japan’s short-run goal of reflating the economy. It finds that boosting inflation with structural reforms implies an unusual trade-off with employment, that is an inverted Phillips curve. Simultaneous implementation of labor-market and product-market reforms is most effective in terms of reflating the economy.