Laura Castillo-Martinez

WORKING PAPERS

Price Gaps and Inflation Dynamics with Miguel Bandeira and Shiyuan Wang

September 2026 [pdf]

The inflationary effect of a shock depends not only on its size, but also on the state of the economy when it hits. In menu cost models, this state is captured by the cross-sectional distribution of price gaps: the misalignment between firms’ actual and reset prices. However, this distribution is unobserved. We recast a random menu cost model in state-space form and develop Bayesian methods to recover latent reset prices from observed price paths. Applying the method to almost 35 million UK consumer price observations from 1996 to 2026, we construct a time-varying empirical distribution of price gaps and show that its shape varies substantially over time. Measuring this distribution lets us take the model’s state-dependence predictions directly to the data. We find substantial state dependence in shock transmission: at a two-year horizon, the response to the same monetary tightening ranges from almost fully dampened to amplified by 69 percent across pre-shock gap distributions, with similar patterns for oil-price shocks. The distribution also contains information about where inflation is headed. Gap moments predict future inflation beyond standard macroeconomic controls and improve out-of-sample forecasts relative to a random-walk benchmark up to 37 percent at two years.

Firm Exit and Financial Frictions with Gideon Bornstein

Awarded NSF Grant (co-PI with Gideon Bornstein)

June 2026 [pdf]

Governments often intervene to prevent firm closures during crises, fearing that financially constrained but viable firms may fail. We develop a firm dynamics model with incomplete financial markets and show how financial frictions generate excessive firm exit. A key statistic governing this dynamic inefficiency is the marginal propensity to exit with debt. Using confidential U.S. Census data, we estimate the relationship between debt and exit and use it to discipline the model. The calibrated model implies that eliminating financial frictions reduces firm exit from 9.3\% to 5.0\% and generates welfare gains of 3.6\% in consumption-equivalent terms. We show that the welfare costs of financial frictions rise sharply during financial crises but change little during standard productivity recessions. Finally, we compare government-guaranteed loans and grants, quantifying the trade-off between fiscal cost and effectiveness in preventing excessive exit.

Capital Slack with Isaac Baley, Miguel Bandeira, Andrés Blanco, Madalena Gaspar and Nicolás Oviedo

February 2026 [pdf]

Investment is lumpy: firms remain inactive for long stretches and then adjust capital in bursts. This lumpiness drives a wedge between the capital firms would like to have and the capital they actually install. We recover this wedge—which we term capital slack —by estimating firms’ latent desired capital from plant-level data. We microfound a nonlinear state-space representation using an Ss investment model with fixed adjustment costs and occasional free adjustment opportunities, and apply filtering and smoothing methods to infer reset capital in real time. Aggregating the recovered reset-capital series yields a capital slack index that leads the business cycle and predicts future movements in aggregate investment.

Sudden Stops, Productivity, and the Exchange Rate R&R - REVIEW OF ECONOMIC STUDIES

December 2025 [pdf] [online appendix]

Following a sudden stop, productivity often declines, while real exchange rates adjust through a nominal depreciation, lower domestic prices, or both. Cross-country evidence suggests that productivity declines are larger when nominal depreciation dominates the real exchange rate adjustment. Motivated by this pattern, the paper studies how the nature of exchange-rate adjustment shapes productivity dynamics during sudden stops. Using Spanish manufacturing micro-data from two sudden stops under different reg, it shows that, in a currency union, cleansing through exit is stronger than under a floating regime, with aggregate productivity rising despite weaker firm-level performance. A small open-economy DSGE model with firm dynamics, endogenous markups, and nominal rigidities rationalizes these findings. The model identifies three channels through which a sudden stop affects productivity: pro-competitive, cost, and demand. While only the first operates under a floating regime, all three are active in a currency union. Quantitatively, the model explains about 55 percent of the exit-driven contribution to productivity growth in Spain’s 2010–13 episode.

PUBLICATIONS

How Do Central Banks Control Inflation? A Guide For the Perplexed with Ricardo Reis

Journal of Economic Literature, vol. 64, no. 1, March 2026 (pp. 195-245) [published version] [local copy] [online appendix]

Central banks have a primary goal of price stability. They pursue it using tools that include the interest they pay on reserves, the size and the composition of their balance sheet, and the dividends they distribute. We describe the economic theories that justify the central bank’s ability to control inflation and discuss their relative effectiveness in light of the historical record. We present alternative approaches as consistent with each other, as opposed to conflicting ideological camps. While interest-rate setting is often superior, having both a monetarist pillar and fiscal support is essential, and at times pegging the exchange rate or monetizing the debt is inevitable.

WORK IN PROGRESS

Sufficient Statistics for Investment Dynamics: An Empirical Investigation with Isaac Baley, Miguel Bandeira, Andrés Blanco, Madalena Gaspar and Nicolás Oviedo

We test the sufficient statistics formula for aggregate investment dynamics derived from a lumpy adjustment model. Using state-space methods and Bayesian estimation applied to microdata in Chile and Colombia, we show that sufficient statistics successfully predict cumulative investment responses to aggregate productivity shocks.

SS for SS: State-Space Methods for Lumpy Economies with Isaac Baley and Miguel Bandeira

This paper introduces a general statistical framework to study aggregate shock propagation in a dynamic (S,s) economy. The proposed framework enables researchers to combine micro and macro data to estimate all the parameters in this economy by maximum likelihood or Bayesian methods, estimate the cross-sectional distributions latent states over time, estimate impulse responses to aggregate shocks of any function of the cross-sectional distribution of lumpy variables given any initial distribution of state gaps and to forecast any function of the cross-sectional distribution of lumpy variables.