This dissertation consists of three essays about heterogeneous agents in the dynamic economy and how to deal with the asymmetric information arose by heterogeneity. Firstly, I consider the optimal taxation issue in a dynamic endogenous growth model with considering human capital accumulation, and agents ability is heterogeneous and private information. Moreover, the agents with higher ability have positive external effects on others. By using the two-sector endogenous model, I show that it is optimal to impose different income and capital income taxes on people with different abilities. Specifically, positive marginal income tax is adopted for people with lower ability while no tax is imposed for people with higher ability; marginal capital income tax is zero whatever the agent’s is low or high. As for people using the capital and labor for human capital accumulation, the government should subsidize them whatever their ability is. Secondly, I study the optimal monetary and fiscal policy with heterogeneous agents based on the search-theoretical environment where money is essential and consider the private information. I first solve the households’ problem in the centralized and decentralized market, and find out the optimal conditions. Then, in this section, I describe the problem that social planner faces by involving uncertainty and agents whose types are continuous. By comparing the optimal conditions in this generous setting, I show that the Friedman rule is no longer optimal when jointed with nonlinear taxation of income. Moreover, the capital income taxation is not zero. Moreover, I constructs a general theoretical model to consider two kinds of financial frictions in the economy with financial intermediaries. By quantitative analysis the model with three separate shocks which are a negative collateral shock, a negative productivity shock and a positive shock to bankers’ divert rate, I find that a negative collateral shock which tightens firms’ financing constraints on investment can generate an equity price boom which is different from what is observed in recessions. Therefore, the collateral shock is not the main reason for the business cycle, while the negative productivity shock and bankers’ moral hazard problem are more important aspects to explain current economy.

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Thesis (Ph.D.)--Boston University / PLEASE NOTE: Boston University Libraries did not receive an Authorization To Manage form for this thesis or dissertation. It is therefore not openly accessible, though it may be available by request. If you are the author or principal advisor of this work and would like to request open access for it, please contact us at open-help@bu.edu. Thank you. / One of the lessons from the recent global financial crisis is the importance of macro-financial linkage in the economy. Based on this background, this dissertation analyzes the effects of financial frictions on the aggregate activities of the economy, wealth distribution and business cycles. The first chapter investigates the effects of financial development on aggregate capital accumulation and wealth distribution by constructing a heterogeneous-agent general equilibrium model with two idiosyncratic risks, endogenous occupational choice and Holmstrom and Tirole (1999) type financial contracts to prevent moral hazard issue. The benchmark model is calibrated to match the empirical data, where the wealth distribution has a right-hand fat tail and a small number of entrepreneurs hold a large amount of wealth. We find that financial development measured by decrease of monitoring cost contributes to the economy's higher capital accumulation and lower wealth Gini coefficient. The second chapter develops a dynamic stochastic general equilibrium (DSGE) model with financial frictions arising from the moral hazard problem as in Holmstrom and Tirole (1997) together with regulatory capital requirements on the banks. In contrast with the standard BGG (1999) financial accelerator model, we consider the agency problem from hidden action and regulatory capital requirements on the banks in order to examine whether changes of regulatory capital requirements result in credit crunches in the transmissions of aggregate technology and monetary policy shocks. The third chapter explores quantitative experiments using the above DSGE model. We examine whether there exists a "financial accelerator" effect from these kinds of financial frictions and a "credit crunch" from shocks. We find that there exists a "financial accelerator" effect and that financial deepening measured by decrease of financial intermediary's monitoring costs could contribute to mitigating business cycle fluctuations. In particular, no financial frictions with zero monitoring cost could decrease the variance of aggregate investment to around 18.5%. We also find that imposing and increasing capital requirements on the banks could cause decrease of bank's lending ("credit crunch"), thereby amplifying business cycles. / 2031-01-02

Thesis advisor: Susanto Basu / This dissertation examines the fluctuations of the aggregate economy when frictions in financial markets are present. I focus on the the asymmetric information problems between creditors and debtors on the quality of debtor's projects and I analyze how these frictions cause the fluctuations in aggregate economy which is potentially inefficient. The first chapter examines the interaction between the perverse incentives and the general equilibrium effects of misallocated bank credit. This essay is intended to elucidate the mechanism of zombie lending in Japan. By incorporating a soft budget problem into a neo-classical dynamic general equilibrium model, the model shows that an inefficient zombie lending regime can be selected as an equilibrium. In this equilibrium, the incentives and the general equilibrium effects are interdependent. The inefficient use of resources crowds out investment when banks have incentives to bail out insolvent firms. On the other hand, the general equilibrium effects give rise to the perverse incentives endogenously through the formation of the liquidation value and the continuation value of insolvent firms. In the worst case, agents fail to resolve non-performing loan problems, and the model economy permanently falls into an inefficient regime. The second chapter proposes a model that generate boom-and-bust cycles by securitization of subprime mortgages. I construct a dynamic housing choice model in which mortgages are financed by securitization and I assume that creditors have errors in measuring the default risks of subprime mortgages. With this setup, the resource availability for housing fluctuates endogenously and it causes the boom-and-bust cycles. Particularly, there are two channels that change the resource availability: the security design of the securitized assets and the evolution of house price inflation. I illustrate that subprime mortgages can be cheaply financed by securitization when creditors mismeasure the quality of the subprime mortgages. This ignites a boom in the model. However, the boom can be terminated as the profitability of securitization declines along with the decline in the expectation of house price inflation. This is because the house price inflation is tied with the liquidation value of the defaulted mortgages. As the expectation of the house price inflation slows down, the subprime mortgages become more risky and the securitization becomes less profitable. Eventually, issuers of securitized assets withdraw from the securitization market and the boom collapses. The last chapter explores the transmission mechanisms of international business cycles when the borrowing capacity of multinational enterprises (MNEs) is limited. I embed MNEs that face borrowing constraints in a two-country international business cycle model. I show that the net worth of MNEs plays a significant role in generating the international business cycle co-movement: the wealth effect in response to the change in MNEs' net worth has a strong multiplier effect on domestic and foreign investment of MNEs. Output moves in the same direction between the two countries due to the synchronized investment. The model is also able to generate reasonable cross-country correlations in real estate price and consumption. / Thesis (PhD) — Boston College, 2010. / Submitted to: Boston College. Graduate School of Arts and Sciences. / Discipline: Economics.

I study optimal monetary and macroprudential policies in a New Keynesian DSGE framework with leverageconstrainedbanks. In particular, I assess the desirability of alternative operational policy rules when theeconomy is hit by mortgage default shocks and show that their implications for inflation dynamics and policytrade-offs depend on whether the shocks originate in the household sector or in the entrepreneurial sector ofthe economy. Moreover, I find that the strategy of ‘leaning against the wind’ (LAW) of credit growth deliverssystematically poorer stabilization outcomes than standard flexible inflation-targeting when there exists anon-trivial trade-off between stabilizing output and inflation, but outperforms conventional monetary policyfor shocks that generate a comovement between the two, irrespective of the real or financial nature of theshock.I show that optimal macroprudential regulation that is as concerned with output as monetary policy candrastically reduce, and in many cases completely eliminate, the incentive to lean against the wind. I arguethat this is due to the ability of full-fledged optimal macroprudential policy to break the favourable complementaritybetween stabilizing credit growth and stabilizing output growth which underlies the incentive tolean against the wind. Macroprudential policy proves a superior substitute to LAW because it can achieve thesame financial stability objectives without systematically imposing costs in terms of price stability.

Distortions that affect macroeconomic outcomes are an important avenue through which we can explain differences in cross country output and productivity. In this thesis I concentrate on two types of distortions, political economy and informational distortions. In Chapter one, I build a model of intermediated corruption where interactions between government bureaucrats and those who bribe them are mediated by a third party. I show that intermediation has significant effects on the incidence of corruption and the prices entrepreneurs pay for permits. When corruption is particularly acute, measures that increase the frequency with which government bureaucrats are audited often have the undesirable result of increasing the prevalence of corruption because of intermediation. In Chapter two I explore the link between corruption and inequality by building a model in which tax collectors are corrupt. I find that as inequality increases, the frequency of corrupt transactions increases as well. I also find that where corruption is more severe, because wealthier individuals tend to pay lower taxes, inequality is higher. I perform a few quantitative experiments to better understand this linkage. Chapter three explores distortions that are caused by adverse selection in markets with search frictions. I find that when participants are concerned about the information they reveal through their interactions in the market, the distortions to liquidity are deeper and that equilibrium selection is significantly affected. I also find that markets with reputational concerns are more sensitive to outside shocks.

Distortions that affect macroeconomic outcomes are an important avenue through which we can explain differences in cross country output and productivity. In this thesis I concentrate on two types of distortions, political economy and informational distortions. In Chapter one, I build a model of intermediated corruption where interactions between government bureaucrats and those who bribe them are mediated by a third party. I show that intermediation has significant effects on the incidence of corruption and the prices entrepreneurs pay for permits. When corruption is particularly acute, measures that increase the frequency with which government bureaucrats are audited often have the undesirable result of increasing the prevalence of corruption because of intermediation. In Chapter two I explore the link between corruption and inequality by building a model in which tax collectors are corrupt. I find that as inequality increases, the frequency of corrupt transactions increases as well. I also find that where corruption is more severe, because wealthier individuals tend to pay lower taxes, inequality is higher. I perform a few quantitative experiments to better understand this linkage. Chapter three explores distortions that are caused by adverse selection in markets with search frictions. I find that when participants are concerned about the information they reveal through their interactions in the market, the distortions to liquidity are deeper and that equilibrium selection is significantly affected. I also find that markets with reputational concerns are more sensitive to outside shocks.

This dissertation consists of three chapters. In the first chapter, we study the role of financial frictions on the demand side of the economy. In particular, we study the interaction between firm and household credit constraints over the business cycle. We construct a real business cycle model with explicit modeling of price and quantity side of housing. This allows us to include both firm and household financing frictions. The model is estimated for the U.S economy using quarterly data on key macroeconomic variables over the period 1970 - 2006. Household and firm financial accelerators operate primarily through movement in house and capital prices respectively. We find clear evidence of the operation of a financial accelerator mechanism, whereby shocks to the economy are amplified most in the presence of both types of frictions, as opposed to just firm or household frictions. Over the business cycle, total factor productivity shocks in the non-housing sector explain about half of the volatility of GDP and consumption. However, cyclical variations in housing investment and housing prices are predominantly explained by housing preference and housing technology shocks. Finally, spillovers from household financing frictions are mostly concentrated in consumption. However, they also affect business investment via its impact on the demand for capital and consequently its price. The second chapter focuses on financial frictions on the supply side. We study the role of bank capital in the transmission of shocks to the economy. Given the evolutionary change in the financial services industry and the growth of shadow banking in the decades prior to the global recession, we characterize credit intermediation with a heterogeneous banking sector comprised of traditional retail and shadow banking. We approach the shadow banking system from a regulation perspective wherein commercial banks have incentives to transfer loans from on- to off-balance sheet to gain regulatory relief. Since bank capital is costly, banks cover part of their funding needs by loan sale in the secondary market. Furthermore, these transferred loans are bundled together and converted into liquid asset backed securities. Commercial banks’ effective return is subject to their monitoring effort, which is unobservable and hence introduces a moral hazard problem in loan sale. This limits the amount of loan sold in the secondary market. We find that loan sale and securitization enhances credit intermediation in normal times and improves the resilience of the system to productivity shocks. However, it also exposes the economy to shocks emerging in the financial system. In response to financial market shocks, the government via its backstop program, can ameliorate its impact on the economy. Finally, we compare the model economy with Basel I and Basel II capital requirement and find that business cycle fluctuations are amplified under Basel II regime. Furthermore, in response to a negative productivity shock there is a transfer of loans from on to off balance sheet under Basel II rules with procyclical capital constraints. This points towards a need for countercyclical capital requirement as being implemented under Basel III accord. In the third chapter, we focus on the question of trade off between price and financial stability goals for the conduct of monetary policy. The recent crisis has generated renewed interest in Hayekian theory and Minsky’s instability hypothesis, which claims that accommodative monetary policy can be harmful for an economy by promoting excessive risk taking – the so called risk taking channel of monetary policy transmission. Risk Taking Channel has been documented for the U.S and Euro area and we investigate the presence of this in Asia. Using annual and quarterly data on publicly listed banks in Asia, we find that when interest rates are too low - lower than a benchmark - bank risk increases. Furthermore, there is also a case for greater supervision and capital stringency to alleviate risk taking.

Esta tese é composta por três ensaios sobre a estimação bayesiana de modelos DSGE com fricções financeiras para o Brasil. O primeiro ensaio tem o objetivo de analisar como a incorporação de intermediários financeiros num modelo DSGE influenciam na análise do ciclo econômico, bem como uma política de crédito pode ser utilizada para mitigar os choques no mercado de crédito sobre a atividade. O governo brasileiro expandiu o crédito na economia através das instituições financeiras públicas tendo como custo o aumento da dívida pública. Para isso, foi estimado um modelo inspirado em Gertler e Karadi (2011) para avaliar o comportamento da economia brasileira sob a influência de uma política de crédito. Política de crédito mostrou-se efetiva para mitigar os efeitos recessivos de uma crise financeira que atinja a cotação dos ativos privados ou o patrimônio das instituições financeiras. Contudo, a política monetária tradicional se mostrou mais eficiente para a estabilização da inflação em momentos de normalidade. O segundo ensaio consiste na estimação de um modelo DSGE-VAR para a economia brasileira. A parte DSGE consiste em uma economia pequena, aberta e com fricções financeiras na linha de Gertler, Gilchrist e Natalucci (2007). A estimação do modelo indicou que flexibilização do espaço paramétrico possibilitado pelo modelo DSGE-VAR proporcionou ganhos em relação ao ajuste aos dados em relação a modelos alternativos. O exercício também obteve indicações de que os choques externos apresentam impactos significativos no patrimônio e no endividamento das firmas domésticas. Esse resultado fortalece a evidência de que um canal importante de transmissão dos movimentos da economia mundial para a o Brasil ocorre através das firmas. Por fim, no terceiro ensaio tem como foco a transmissão dos choques no spread de crédito bancário para as demais variáveis da economia e suas implicações para a condução da política monetária no brasil. Para isso, foi estimado um modelo DSGE com fricções financeiras para a economia brasileira. O modelo é baseado em Cúrdia e Woodford (2010), que propuseram uma extensão do modelo de Woodford (2003) para incorporar a existência de um diferencial entre a taxa de juros disponíveis aos poupadores e tomadores de empréstimos, que pode variar por razões tanto endógenas quanto exógenos. Nessa economia, a política monetária pode responder não somente às variações na taxa de inflação e hiato do produto através de uma regra simples, como também por meio de uma regra ajustada pelo spread de crédito da economia. Os resultados mostram que a inclusão do spread de crédito no modelo Novo Keynesiano não altera significativamente as conclusões dos modelos DSGE em respostas a perturbações exógenas tradicionais, como choques na taxa de juros, na produtividade da economia e no dispêndio público. Porém, nos eventos que ocasionam a deterioração da intermediação financeira, por meio de choques exógenos sobre o spread de crédito, o impacto sobre o ciclo econômico foi significativo e a adoção de uma regra de política monetária ajustada pelo spread pode conseguir estabilizar a economia mais rapidamente do que uma regra tradicional. / The present thesis is a collection of three essays on Bayesian estimation of DSGE models with financial frictions in the Brazilian economy. The first essay intends to investigate how the incorporation of financial intermediaries in a DSGE model influences the analysis of the economic cycle, as well as how the credit policy can be employed to mitigate the effects of shocks in the credit market on the economic activity. The Brazilian government expanded the credit in the economy through public financial institutions, which resulted in an increase of public debt. it estimated a model inspired by Gertler and Karadi (2011) to evaluate the performance of the Brazilian economy under the influence of a credit policy. Credit policy was effective to mitigate the recessionary effects of a financial crisis that affects the valuation of private assets and the net worth of financial institutions. However, the traditional monetary policy was more efficient for the stabilization of inflation in times of normality. The second essay consist of a DSGE-VAR model for the Brazilian economy. The DSGE model was estimated for a small, open economy with financial frictions, in line with Gertler, Gilchrist and Natalucci (2007). The results indicates that the estimation of DSGE-VAR provides an advantage for the data fitting in comparison to alternative models. In addition, the results indicate that external shocks have significant impacts in the equity and debt of domestic firms. This result strengthens (supports) the evidence that an important channel of transmission of the movements of the world economy for the Brazil takes place through productive sector. The third essay analyze the transmission of shocks in the banking credit spread for the other variables of the economy and its implications for the conduct of monetary policy in Brazil. We do so by estimating a DSGE model with financial frictions for the Brazilian economy. The model is based on Cúrdia and Woodford (2010), who proposed an extension of the model Woodford (2003) to incorporate the existence of a differential between the interest rates available to savers and borrowers, which can vary by both endogenous and exogenous reasons. In this model, monetary policy can respond not only to changes in the inflation rate and output gap through a simple rule, but also through a rule set by the credit spread of the economy. The results show that the inclusion of credit spread in the New Keynesian model does not significantly changes the conclusions of DSGE models in traditional responses to exogenous shocks, such as shocks in the interest rate, in the productivity of the economy and in public spending. However, in the events that cause the deterioration of financial intermediation through exogenous shocks on the credit spread, the impact on the business cycle was significant and the adoption of a monetary policy rule set by the spread can achieve a faster stabilization of the economy than a traditional rule.