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Title: Financial cycles and macroeconomic stability
Author: Gerba, Eddie
ISNI:       0000 0004 5347 2669
Awarding Body: University of Kent
Current Institution: University of Kent
Date of Award: 2014
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We establish a set of US stylized facts on prices, quantities and balance sheets, assess the consistency of the current generation of financial DSGE models to these, and provide guidance on the challenges ahead. We mainly find four aspects which future financial friction models should take into acc~unt. The first is the profound shift in household financing structure, botli on the asset and liability side, which has meant that they have been left vulnerable. Second, the balance sheet of firms has become increasingly lever aged and coupled with more volatile and pro cyclical equity prices has rrieant that the balance sheet of firms has become ihcreasirlgly procyclical and volatile since the 1990's. The current generation of FA models do capture some aspects of this but produce excessively smooth results. Third, it would be of interest for policy makers to find the optimal level/percentage of foreign ownership of the Federal debt at which the debt portfolio is diversified, but the future government budget constraint and its stabilisation capacity is not put in danger by over-exposure to international shocks. Lastly, models might be extended to include a regime-switching mechanism and explore the effects on model dynamics and model stability when the economy goes from a low volatility-low correlation state to a high volatility-high correlation state. A wider implication of our findings is that accumulation of stocks might alter agents risk preferences, production technologies, or beliefs to such a degi'ee that the optimization problem that those agents face has transformed over time .. The economy is effectively in a different state of nature, and agents may face c;lifferent constraints. Future macroeconomic models need to take a different strategy to modelingthe long-run ratios, since these have increased over the long-run, and .this has had an effect on boththe frequency and the amplitude of the business cycles. Chapter 2 Following recent observations by policymakers of the Bank of England and others that low financial market confidence and pessimistic expectations about bank (and non-bank fii'm) profits over the next three years has lead to unusually low price-to-book ratios, we incorporate a market price mechanism in a general equilibrium framework. More specifically, we introduce an endogenous wedge between inarket and book value of capital, and make investment a function of the wedge in a standard financia1 accelerator model. The price wedge is driven by an information set containing expectations about the future state of the economy. The result is that the impulse responses to exogenous disturbances are some two to three times more volatile than in the benchmark financial accelerator model. Moreover, the model offers an improved matching in firm variables and financial rates to US data compared to the standard Bernanke, Gertler and Gilchrist (1999) model. We also derive a model based quadratic, loss function and measure the extent to which \ monetary policy can feed a bubble by further loosening the credit market frictions that entrepreneurs face. In addition, we take into account the possibility that policymakers have incomplete information about the current state of. the economy and therefore make errors type I and II in deciding what policy to implement. A policy that explicitly targets stock market developments can be shown to improve welfare in terms of miriimizing the consumption losses of consumers, even when we account for a degree of incomplete information of central bankers regarding the current state of the economy. To conclude, we find that for a monetary authority to be indifferent betweeri responding and not responding to stock market developments, the probability of an economy with a positive asset price wedge needs to be between 2 and 6 percent lower than the probability of an economy without a wedge. Chapter 3 Locating the appropriate degree of interaCtion between fiscal and monetary policy . plays remains a key issue in ensuring economic stability. Their joint impact is, however, still unclear. We use a Bayesian TVP-VAR model with a tight identification scheme to examine the interaction between the two policies between 1979 and 2013. We observe significant differences in the transrriission of shocks, in particular between the Great Recession and the Great Moderation. Monetary policy reacts more aggressively to stabilize the economy during Volcker, whereas fiscal policy does so during the Great Recession. Second, we find a high degree of interactions between monetary and fiscal policy. They behave as substitutes for both the spending and monetary policy shocks but as compliments for a taX, shock. Third, government revenues largely infhience decisions on spending, while spending does not influence tax decisions. Fourth, the spending multiplier is large and persistent, in particular during recessionary periods. We conclude that the spending stimuli are more effective in expanding output than tax cuts by as much as ?O percent. Under certain conditions regarding private agent expectations, spending increases can result in high and persistent growth.
Supervisor: Not available Sponsor: Not available
Qualification Name: Thesis (Ph.D.) Qualification Level: Doctoral
EThOS ID:  DOI: Not available
Keywords: Macroeconomics, Finance