Clymo, Alex
(2015)
Essays in macroeconomics and finance.
PhD thesis, London School of Economics and Political Science.
Abstract
I present a thesis in three chapters on the topics of Macroeconomics and Finance. In the first chapter, I study the ex ante effects of the fear of future financial crises. Crises are modelled through multiple equilibria driven by a self-fulfilling fall in asset prices. I study the effects of allowing agents to anticipate such an event. In a financial crisis, capital is pushed away from experts and towards less productive households, worsening the allocation of capital. Anticipation of this lowers asset prices, investment, and growth today, even if experts are currently well enough capitalised to survive a crisis. The possibility of future crises also creates a state-dependent“financial crisis accelerator” which can amplify business-cycle shocks. In the model, prudential policy can simultaneously increase growth and stabilise the economy, in contrast with common arguments that prudential policy should decrease growth.
In the second chapter, I present evidence that countries which experienced greater declines in total factor productivity (TFP) during the Great Recession experienced milder contractions in hours worked. Thus I show that there is a tension between the crisis manifesting itself either as a problem with productivity or with labour markets. Additionally, countries with larger falls in real wages tend to be those with TFP, and not labour market, problems. Inspired by these facts, I build a model of sticky wages, and prove that wage adjustment determines the extent to which a financial crisis leads to declines in TFP or hours worked. Larger falls in real wages protect labour markets from reductions in hours. However, lower real wages reduce the incentive to reallocate resources across firms during the crisis, leading to larger declines in productivity.
In the final chapter, I introduce financial frictions into the labour market matching model, and study interactions between the two frictions. I demonstrate a feedback between asset and labour markets which amplifies the model’s response to exogenous shocks. Shocks which increase equity holders’ net worth allow them to fund more vacancies, raising market tightness and lowering the ease with which firms can hire workers. This increases the value of being an existing firm, causing stock prices to appreciate. This increases experts’ net worth further, amplifying the initial shock in a mechanism akin to the traditional financial accelerator. I derive an arbitrage equation in my model similar to the standard free entry condition. I show that any matching model which possesses this arbitrage equation, including the standard matching model, is able to match 82% of the volatility in US market tightness if calibrated to match the volatility in asset prices.
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