Essays on financial sector and optimal monetary policy
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[ACCESS RESTRICTED TO THE UNIVERSITY OF MISSOURI AT AUTHOR'S REQUEST.] The 2007-2009 economic events have renewed interests in the relationship between the financial sector and the macroeconomy and suggested that shocks originated in the financial sector may be a potential source of business cycle uctuations. In this regard, this dissertation focuses on quantifying and assessing the role of shocks originated from the financial sector in driving business cycle uctuations and how monetary policy could possibly respond from a welfare prospective. The dissertation consists of three chapters. The first chapter attempts to model the relationship between the financial sector and the macroeconomy theoretically. Specifically, I build a dynamic stochastic general equilibrium (DSGE) model by incorporating a financial sector with frictions between investors and banks. The existence of such frictions affect the healthiness of the financial sector and increase its riskiness, whereas would not affect those of the non-financial sector by much. I regard this type of frictions as supply-side financial shocks that are originated in the financial sector. Under this framework, the external finance premium in the financial sector can be determined endogenously. To study how the financial shocks would affect the dynamics of the model, impulse responses are used to show that the inclusion of those financial shocks yield larger amplification effects. Thus the model is able to generate higher volatility in aggregate outcomes, especially in the financial sector. This provides theoretical grounds to study the role of supply-side financial shocks for the next two chapters. Chapter two seeks to quantify empirically the effects of the financial shocks on the macroeconomy in a structural vector autoregression (SVAR) model. Based on the model implications derived from Chapter one, two types of financial shocks can be discriminated|the demand-side financial shock that comes from the entrepreneurial sector and the supply-side financial shock that comes from the financial sector. The identification strategy is that these two types of shocks affect the standards deviation of the equity returns in financial and entrepreneurial sectors in opposite directions. The overall SVAR results show that the effects of financial shocks on the real economic activities are non-trivial, although not major. In particular, the supply-side financial shocks originating from the financial sector explain a non-negligible part of the variabilities for the key macro variables; whereas for the financial variables, they are the main drivers, especially during the 2007-2009 crisis period. Chapter three studies how monetary policy should respond to this type of supplyside financial shocks from a prospective of social welfare. In particular, I consider a Taylor-type monetary policy rule augmented with a financial variable|the external finance premium. By doing so, it allows the central bank to react to the changes in the riskiness of the financial sector, in addition to the conventional output and in ation targets. The welfare results show that it is optimal for the central bank to respond to the financial variable. In other words, when there are shocks originated in the financial sector, the riskiness of the financial sector increases, and so do the external financing costs and the external finance premium in the financial sector. The banks' balance sheet conditions worsen and the central bank should cut its policy rate. The welfare analysis also implies that the in ation stabilization is still the most important target of the central bank, which in line with the literature that emphasizes the importance of infl ation targeting.
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