Working Papers

Abstract: This paper investigates how carbon tax aversion impacts the macroeconomy. Through an analysis of carbon tax announcements in Alberta, we first provide empirical evidence that carbon taxes result in the formation of pessimistic macroeconomic beliefs, characterised by higher inflation expectations and lower expected real income. We term these beliefs as carbon tax aversion in the macroeconomy and incorporate them into a two-sector New Keynesian model that departs from the standard assumption of rational expectations. From our benchmark model, we find that carbon tax aversion exacerbates output losses but stabilizes aggregate prices after carbon tax announcements. With carbon tax aversion, the announcement of a 1% increase in carbon taxes results in larger output losses by 0.3% but smaller decrease in aggregate prices by 0.02%, relative to the rational expectations model. Furthermore, earlier announcements result in lower output losses. Our findings highlight the importance of managing pessimistic beliefs against carbon taxes and the role of central banks in supporting the green transition.

Abstract: Using micro-level administrative data from India, we show the consumption and portfolio rebalancing response of households to changes in interest rate. Exploiting variation in the timing of expiry of term deposits, we find that when interest rate falls, households increase consumption by 6 percent and increase their fraction of wealth into risky assets by 36 percent after the expiry of term deposits. While both existing and new investors “reach for income” by investing in high dividend stocks, new investors also “reach for yield” by investing in high beta and more volatile stocks. The effects on consumption and risky investment are smaller for term depositors with automatic renewal. Households with more liquid wealth have a smaller consumption effect but a larger portfolio rebalancing effect on risky investment. These results highlight that term deposits contract rigidity and household wealth affects the monetary policy pass-through.

Abstract: We examine how investors respond to firms' carbon offset strategies in voluntary carbon markets. Following the retirement of carbon offsets, we find a positive market reaction, with a cumulative abnormal return of 1.1% over 15 trading days. The market response is driven by the quality of offsets rather than their quantity. High-quality offsets, such as removal offsets and recent vintages, generate positive stock market reactions, while the quantity of offsets retired has no significant effect. Additionally, we find that during periods of abnormal temperature changes, which heighten the salience of climate-related actions, firms are more likely to increase high-quality offset retirements. Our results are consistent with a signaling framework, where high-quality offsets serve as credible signals of a firm's genuine commitment to sustainability.

Abstract: This paper exploits a natural experiment in India – Inflation Targeting to study how changes in inflation expectations influence households’ consumption and portfolio choices. Using regional heterogeneity in inflation expectations due to the Inflation Targeting policy, we find that households with high liquid wealth decreased consumption and increased savings when faced with a fall in inflation expectations. Moreover, they rebalanced their portfolio from risky investments towards bank deposits. This is attributed to the nominal rigidity of savings deposit rate. In comparison, households with low liquid wealth consume more and save less as inflation expectations fell. Our findings provide direct evidence on how the transmission of inflation expectations through different economic channels is influenced by the household balance sheet.

Abstract: This paper examines how information frictions affect the conduct of macroprudential policy. Since macroprudential policy directly influences credit prices, it can impact beliefs when agents learn from credit spreads and experience policy misperception. We show that when agents do not accurately internalize and account for the policy effects on credit spreads, they mistakenly attribute changes in credit prices to the aggregate state. Consequently, agents erroneously update their beliefs about the aggregate state, even when the underlying aggregate state remains unchanged. Our findings suggest that instead of correcting externalities with policies, externalities can arise due to policy actions. The optimal policy adjustments depend on whether policy misperception and learning from credit spreads amplify or dampen the initial policy effect. To prevent sub-optimal outcomes, we highlight the importance of clear central bank communication.

Abstract: We examine the impact of subway expansions on mortgage repayment behavior in Delhi, India. Using administrative data from one of India's largest mortgage lenders, we estimate that households in postal codes with newly opened stations experience a 4.42% decrease in mortgage delinquencies and a 1.38% increase in prepayments. These improvements are attributed to households' reduced reliance on automobiles. Vehicle registration records show a 1.2% decline in the market share of four-wheelers, accompanied by a 6.5% drop in vehicle spending. Financially constrained households benefit the most, reducing purchases of low-quality vehicles and showing the largest improvements in mortgage repayment performance.

Abstract: Using global games, we develop a theory of uncertainty contagion by introducing non-rivalrous news production into a two-country model. In our model, news production is allocated between a common aggregate process and an idiosyncratic country-specific process. Since non-rivalrous news about the aggregate process in one country can be reproduced in another, this reduces uncertainty and creates information externalities across countries. When uncertainty about the foreign country-specific process increases, strategic substitutability occurs as foreign and domestic countries reallocate news production away from and toward the aggregate process, respectively. This leads to higher uncertainty about the domestic country specific process in both countries, resulting in international uncertainty contagion. Additionally, this co-movement is stronger during periods of heightened uncertainty about the aggregate process, as countries rely more on foreign news reproduction. Our findings suggest that policies addressing externalities arising from non-rivalrous news production can enhance efficiency.

Abstract: Using both experimental and brokerage administrative data, we document a behavioral pattern in which investors are more likely to engage in within-category rather than cross-category portfolio rebalancing. In our laboratory experiment, subjects are presented with two categories of assets: risk-free and risky. We find that changes in social concerns related to one of the risky assets prompt subjects to rebalance their investments within the risky category, without affecting their risk-free holdings. This pattern is further supported by trade-level administrative data from a financial brokerage firm, where there is active trading in risky assets alongside relatively stable holdings of safe assets. Among risky investments, we find that investors show a tendency to trade within specific categories, such as socially responsible mutual funds. A possible mechanism is that investors simplify the complex global optimization problem by focusing on within-category portfolio rebalancing, which is consistent with notions of categorical thinking and narrow bracketing.

Abstract: This paper examines how beliefs of tail risk events influence macroeconomic expectations in a Bayesian learning model with noisy signals. We show theoretically and empirically that the misperception of tail risk results in overreaction to first and second moment shocks, in contrast to a Gaussian model. First moment shocks cause excessive optimism and pessimism in individuals as they provide valuable information about tail risk. Second moment shocks lead to more pessimistic forecasts as higher uncertainty is linked to an increased likelihood of disasters. As signals become noisier, the response to news regarding a first moment shock becomes more pronounced. Our findings shed light on factors driving overreaction in expectations and highlight the importance of uncertainty shocks in propagating macroeconomic stability.