Three essays on banking frictions, uncertainty and business cycles
Bae, Byoung Ho
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This dissertation studies the role of financial frictions and uncertainty on business cycles in the context of a DSGE (Dynamic Stochastic General Equilibrium) model. In the first chapter, I study the role of the banking sector on business cycles, mainly by focusing on the friction that arises from a bank's portfolio adjustment. Based on empirical evidence, I construct a DSGE model with a banking sector, in which banks adjust the composition of their asset portfolios in response to the economic environment. The quantitative experiment shows that the credit supply-side friction arising from a bank's time-varying portfolio adjustment generates an amplification mechanism and leads to a deeper credit crunch. Furthermore, an economy with an inefficient financial system that requires higher intermediation costs creates a higher level of credit supply-side frictions and that, in turn, leads to the amplification effect of business cycles. The second chapter studies the role of bank capital requirements on business cycles. To this end, I develop a DSGE model with financial frictions arising from moral hazard problems as in Holmstrom and Tirole (1997) together with regulatory capital requirements on the banking sector. I find that financial deepening as measured by a decrease of a financial intermediary's monitoring costs could contribute to mitigating business cycle fluctuations. In addition, this study finds that imposing and increasing capital requirements on the banking sector could lead to a decrease in bank lending, thereby amplifying business cycles. The third chapter studies the effect of uncertainty shocks on the housing market with collateral constraints under a DSGE framework. The quantitative experiment shows that with a standard calibration, increasing volatility in structural shock processes negatively affects housing prices and investment, and that leads to a decrease in output. I also find that higher leverage with a large loan-to-value parameter in collateral constraints amplifies business cycles under uncertainty shocks. In addition, a monetary policy experiment shows that flexible monetary policy with a lower interest smoothing parameter helps to mitigate the fluctuation caused by uncertainty shocks.
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