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This dissertation investigates the effects of frictions that emerge from financial markets on business-cycle fluctuations. The purpose of Chapter 1 is to situate my work in the literature and to stress its contributions. In Chapter 2, I reassess the role of financial frictions in amplifying the impacts of productivity shocks using a framework in which a fraction of firms are borrowing-constrained and land is a collateral asset. A first finding is that amplification effects are much lower when land is supplied elastically. However, financial shocks that affect the maximum allowable ratio of loans to collateral have greater effects on output. Another result pertains to the role of the elasticity of substitution between land and capital in responses to financial shocks: lower values generate greater output responses. While Chapter 2's environment is set up to be in a closed-economy, the last two chapters involve two-country settings. Chapter 3 still intersects with Chapter 2 on some dimensions, in particular, land dynamics and financial frictions that feature borrowing-constrained firms. The borrowing mechanism brings about a distortion in labour markets that interacts with a class of preferences that are non-separable between consumption and leisure. Technology shocks contribute to explain international co-movements, whereas financial shocks allow the model to replicate the lack of international risk sharing that is characterized by the quantity anomaly and the Backus-Smith puzzle. In Chapter 4, I apply Chari, Kehoe and McGrattan’s (2007) business cycle accounting method to a two-country, two-good real business cycle model. Using their approach, I measure the same closed-economy time-varying wedges and I introduce an international wedge that accounts for discrepancies between the growth in real exchange rates and in the stochastic discount factors ratio. In fact, the effects of financial frictions embedded in Chapter 3's framework can be retrieved from a combination of labour and investment wedges. The volatility of the international wedge corresponds to a metric of bilateral risk sharing. An important finding is that, from a non-separable preferences specification of the baseline model, the investment wedge partly accounts for the Backus-Smith puzzle. This suggests that distortions in national capital markets are important to consider for international risk sharing. / Thesis (Ph.D, Economics) -- Queen's University, 2013-04-29 22:56:23.03

The purpose of this study is twofold. Firstly, business cycle theories have been developed as early as 1911 (Shumpeter). These theories are well researched and well documented, and all of these theories concentrate on the real sector. South Africa is an emerging market and since 1994 the country has liberalized its market, a process that holds advantages and disadvantages. This emerging market status as well as the relative size of imports and exports to GDP in South Africa, makes the country very vulnerable to changes in the world economy. Examples of this are the contagion from Asia in 1997, the Russian crisis in 1998, and the impact of September 11 in the US on the South African economy. Business cycles also have changed over the years; they are less volatile and more synchronized over the world and the financial markets play a more important role. This is another reason why it might be useful to identify a financial cycle and investigate its relationship with the real cycle. The SARB (South African Reserve Bank) has some financial indicators in its leading indicator but the latter is mainly driven by real indicators. The financial cycle identified uses the equity market, the capital market and the domestic financial market as components. All of the determinants of these three components are available at a higher frequency than the GDP growth (our proxy for the business cycle); therefore the financial cycle can be used as a leading indicator incorporating international and domestic financial events. Secondly, an ongoing debate in business cycle research is the question of a stable economy (business cycle) influenced by exogenous shocks or an unstable economy with an endogenous business cycle (Classical vs. Keynesian view). This issue will be addressed by modelling the business cycle with a linear as well as a non-linear model. Linear models are usually used to demonstrate exogenous shocks on the business cycle, whereas nonlinear models have more of an endogenous assumption regarding the business cycle. Non-linear models learn over time and adjust to the new level of peaks and troughs and can therefore predict turning points more accurately. This suggests that business cycles have changed since 1960: they became less volatile, more synchronized across the world and the amplitude of peaks and troughs is lower. Because of these characteristics it would be useful to fit a non-linear model to the business cycle. However, exogenous shocks cannot be totally ignored – especially in an emerging market such as South Africa. The STAR (smooth transition autoregressive) model makes room for a linear and a non-linear component, and can over time determine if there is only a linear or non-linear component or sometimes both. The results of this study support the structural or institutional view. They believe economic fluctuations are caused by various structural or institutional changes. Adherents to this view do not believe that the market system is inherently stable or systematically unstable (Classical vs. Keynesian view). They focus on structural changes and unpredictable events. They do not have set ideas on economic policy. According to them the appropriate policy will vary from time to time as circumstances change. / Prof. L. Greyling

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This dissertation consists of three essays on the sources and desirability of economic fluctuations. Chapter 1 focuses on a source of fluctuations that has long been attached to the history of economic thought on business cycles: sticky prices. I provide a microfounded theory for one of the oldest, but so far informal, explanations of price rigidity: the kinked demand curve theory. Assuming that some customers observe at no cost only the price of the store they happen to be at gives rise to a kink in firms' demand curves: a price increase above the market price repels more customers than a price decrease attracts. The kink in turn makes a range of prices consistent with equilibrium, but an intuitive criterion---the adaptive rational-expectations criterion---selects a unique equilibrium where prices stay constant for a long time. The kinked-demand theory is consistent with price-setters' account of price-rigidity as arising from the customer's---not the firm's---side, and can be tested against menu-cost models in micro data: it predicts that prices should be more likely to change if they have recently changed, and that prices should be more flexible in markets where customers can more easily compare prices. The kinked-demand theory has novel implications for monetary policy: its Phillips curve is strongly convex but does not contain any (present or past) expectations of inflation; its trade-off between output and inflation persists in the long-run; changes to the distribution of sectoral productivity shift the Phillips curve; and monetary shocks have a much longer-lasting real effect than in a menu-cost model, despite also being a model of state-dependent pricing. Chapter 2, written with Emi Nakamura and J\'on Steinsson, starts from the assumption of nominal rigidities---asymmetric wage rigidity this time---to investigate the welfare costs of business cycles. We document that the dynamics of unemployment fit what Milton Friedman labeled a plucking model: a rise in unemployment is followed by a fall of similar amplitude, but the amplitude of the rise does not depend on the previous fall. We develop a microfounded plucking model of the business cycle to account for these phenomena. The model features downward nominal wage rigidity within an explicit search model of the labor market. Our search framework implies that downward nominal wage rigidity is fully consistent with optimizing behavior and equilibrium. We reassess the costs of business cycle fluctuations through the lens of the plucking model. Contrary to New-Keynesian models where fluctuations are cycles around an average natural rate, the plucking model generates fluctuations that are gaps below potential (as in Old-Keynesian models). In this model, business cycle fluctuations raise not only the volatility but also the average level of unemployment, and stabilization policy can reduce the average level of unemployment and therefore yield sizable welfare benefits. Chapter 3 is a contribution to a second branch of Keynesian economics, which sees the possibility of inefficient economic fluctuations not as a consequence of sticky prices, but instead as a more intrinsic property of a system of decentralized production. I ask: how do agents coordinate in a world that they do not fully understand? I consider a dispersed-information coordination game with ambiguity-averse agents who do not trust their models. Because distinguishing models is harder in a noisier economy, the model is one of endogenous ambiguity. Because one agent's noise is another's private information, one agent's reliance on his private information increases how much ambiguity his neighbor faces. I revisit the role of private and public information in this new light. On the positive side, I show that the equilibrium depends less on fundamentals as agents become more ambiguity averse, and not at all in the limit where they become infinitely so. I also show that, because it makes agents trust their model more, the release of public information drives the economy toward fundamentals whenever ambiguity-aversion is high enough, in contrast to the standard result under rational expectations. On the normative side, I show that the equilibrium features too much dependence on fundamentals: agents would rather live in a world that they understand better, even if it means living in a world that is less responsive to changes in fundamentals.

Proefschrift--Utrecht. / "Stellingen" ([3] p.) laid in. "Geciteerde literatuur": p. 179-181.

The stylized fact of co-movement of lending and economic activity has been widely interpreted as evidence of a destabilizing feedback mechanism between the banking and real sectors, suggesting the special role of credit supply in amplifying financial and macroeconomic instability. Indeed, this “procyclicality” view significantly influences bank regulations internationally. Under the Basel III, the countercyclical capital buffer is exclusively designed to dampen the volatility of credit supply over the business cycle. The strong co-movement of lending and economic activity, however, is insufficient to confirm the existence of the procyclicality, given that both demand and supply of loans decline during economic downturns. If loan supply does not play a causal role, then any measure to strengthen lending capacity of banks would be ineffective in addressing this procyclicality issue. The literature, however, provides limited, otherwise inexistent, cross-country evidence to answer these fundamental questions. This research gap calls into question the sufficiency of international evidence to assess the effectiveness of the new capital measure, and more broadly, the regulatory reform. This cross-country econometric study covering 39 economies for the period 1990– 2009 examines these fundamental issues in detail. There are three main findings and policy implications. For banking stability, a significant procyclical pattern of loan supply exists, and such pattern is negatively associated with bank capital. These findings together support the view that the countercyclical capital buffers of Basel III could be effective tools for dampening loan volatility over the business cycle. For the regulatory reform, there is prevalent evidence that capital and liquidity are determinants of loan supply. This finding bears out the main Basel III argument that stronger capital and liquidity could strengthen the resilience of the global banking sector to macroeconomic shocks. For macroeconomic stability, empirical findings suggest a moderate macroeconomic effect of loan supply, particularly for developed economies. However, the finding does not imply a small impact of banking instability on the real sector. In fact, banking crises are estimated to have a larger independent negative effect on economic growth after controlling for the macroeconomic effect through impacts of banking crises on loan supply. There are two main policy implications of these findings. First, the main channel through which stronger capital and liquidity of banks help reduce macroeconomic instability would have an impact on reducing the likelihood of the occurrence of a banking crisis. Second, during non-crisis periods, bank regulations aiming at smoothing loan supply may have a relatively moderate impact on reducing macroeconomic instability. For policy to address banking procyclicality, the results show that aside from higher quantitative capital and liquidity requirements, more stringent definitions of capital could dampen loan supply procyclicality, which speaks in favor of recent policy initiatives to strengthen the quality of regulatory capital. More stringent bank regulations are also found to reduce loan supply procyclicality in countries with deposit insurance schemes. To reduce the propagations of loan supply shocks to the real sector, policy to improve the breadth of the stock market and the size of the domestic bond market would be useful. / published_or_final_version / Economics and Finance / Doctoral / Doctor of Philosophy

This dissertation investigates several business cycle relationships when economic agents are heterogeneous. The particular focus is on the interactions between the cross-section of agents and the aggregate state of the economy. The first chapter shows that, when occasionally binding capacity constraints limit the production of heterogeneous firms, demand shocks can endogenously generate a number of important business cycle regularities: recessions are deeper than booms are high, firm-level volatility is countercyclical, the aggregate Solow residual is procyclical and the fiscal multiplier is countercyclical. A baseline calibration of a basic New Keynesian DSGE model with capacity constraints shows that this mechanism can explain more than a quarter of the empirically observed asymmetry in output, and matches the cyclicality of firm-level profitability dispersion and of the measured Solow residual. The model implies fluctuations in the fiscal multiplier of around 0.12 between expansions and recessions. Chapter two takes a different approach to firm level uncertainty, exploring how recessions can cause an endogenous rise in firm risk. If heterogeneous firms face real and financial frictions, then a shock to the mean of aggregate productivity endogenously leads to countercyclical profitability risk through firms' heterogeneous responses in price setting. Additionally, the mechanism endogenously generates countercyclical credit spreads and credit spread dispersion. The model explains a large share of the observed fluctuations in profitability dispersion (69%) and in credit spreads (40%) through fluctuations in aggregate TFP holding productivity risk constant. This suggests that the scope for uncertainty shocks to explain recessions may be smaller than previously thought. The third chapter focuses on distributional effects of oil price shocks on the household side. In the model, household behavior replicates two patterns found in household-level data which show that gas consumption increases with income, but on the intensive margin gasoline consumption as a share of the household's budget decreases with income. The model includes gas consumption in household utility on top of a fixed minimum level of gas consumption. Calibrated simulations suggest that a shock to the gas price is almost twice as costly for relatively poor households than for relatively rich households. / text

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In 1938 Dunlop challenged the assertion in the General Theory that wages moved countercyclically. The resulting debate on the cyclical movement of wages deserves study as an episode in the history of economic thought. This is done in chapter 2 which reviews the theoretical issues and chapter 3 which reviews the empirical work. To understand this history requires some analysis of the meaning and significance of the debate. At one level the debate can be interpreted as the search for a 'stylised fact'. This is apparently an empirical question and part of the thesis will be concerned to use data for various countries, time-periods, cycle phases, and industries to examine whether there is any systematic cyclical pattern in wage movements. The conclusion of the empirical analysis is that there is no such empirical regularity. At a second level the debate was theoretical. The empirical observation that wages moved procyc1ica1ly was thought to falsify a prevailing theory. What is interesting about this debate is the light it sheds on the response of economists to apparent falsification. A third level of the debate is the issue of inference. Keynes tended to treat theory as prior, attacking 'pseudo natural science procedures'. Keynes was not opposed in principle to statistical work informing theory: although in practice he did not attempt the empirical investigation into cyclical wages for which he called. Thus from a different methodological standpoint Burns and Mitchell criticise the theorist who 'often stops before his work is finished'. Current econometrics would emphasise the need for identifying assumptions before estimates could be used to test hypotheses. In this framework, the implications for theory of any reduced form regularity would be ambiguous in the absence on non-data based identifying assumptions. This thesis uses the history of the debate and the empirical analysis to illustrate these themes of observation, theory and inference.