Jingye Wang

         Prepared for Brookings Papers on Economic Activity (Fall 2025)

Abstract: We develop a general-equilibrium model in which the safety of a country’s currency and the choice of its exchange-rate regime arise endogenously. Calibrated to pre-2025 data, the model replicates the U.S. dollar’s safety premium, low Treasury yields, and its status as the world’s anchor currency. Introducing a trade war that isolates U.S. goods markets from the world erodes the U.S. dollar’s safety premium, raises U.S. interest rates, and lowers the world market value of U.S firms. For sufficiently high tariffs, small economies optimally re-peg to the euro, precipitating a phase shift to a euro-centric international monetary system and a global welfare loss. The analysis implies that persistent trade wars may threaten the financial privileges the United States derives from the dollar’s international role.

Abstract: Canonical long-run risk and habit models reconcile high equity premia with smooth risk-free rates by inducing an inverse functional relationship between the variance and the mean of the stochastic discount factor. We show this highly successful resolution to closed-economy asset pricing puzzles is fundamentally problematic when applied to open economies with complete markets: It requires that differences in currency returns arise almost exclusively from predictable appreciations, not from interest rate differentials. In the data, by contrast, exchange rates are largely unpredictable and currency returns differ because interest rates differ widely across currencies. We show that no complete-markets model with canonical long-run risk and habit preferences can match this fact. We argue this tension between canonical asset pricing and international macroeconomic models is a key reason why researchers have struggled to reconcile the observed behavior of exchange rates, interest rates, and capital flows across countries. The lack of such a unifying model is a major impediment to understanding the effect of risk premia on international markets.

Abstract: The "Lucas Paradox" states that there are large and persistent differences in capital-output ratios across countries, suggesting capital is not flowing to countries where it is relatively scarce. In the data, capital-output ratios vary a lot cross-sectionally even within developed countries, and they are negatively correlated with currency risk premia and risk-free rates. To rationalize these patterns, I build a quantitative multi-country model of capital accumulation with external habit and heterogeneous exposures to a global productivity shock. I show that currency risk in this model generates cross-country variations in risk-free rates and capital-output ratios that are consistent with the data. I estimate the model using GDP data from countries issuing the G10 currencies and find two main results: (1) The heterogenous loadings that I extract from GDP data alone are highly correlated with capital-output ratios; and (2) when I feed the estimated loadings into the model, model-generated capital-output ratios account for roughly 55% of the cross-country variation in the data. I conclude that variation in currency risk and therefore currency risk premia have significant effects on the real economy.