Essays On Financial Crises PDF Download

The global financial crisis made clear that the financial sector and financial frictions play an integral role in the macroeconomy. Modelers are quickly incorporating these in different ways. This dissertation research also investigates both the causes and effects of financial crises. The first essay, which is mostly empirical, analyzes the impact of the recent U.S. financial crisis on Mexico while the second one, which is theoretical, introduces the Minsky financial friction into the literature as one of the causes of banking and financial crises. In the first essay, we simulate the impact of the U.S. financial crisis on Mexico, a major trading partner with close financial linkages, with the Gali and Monacelli (2005) small open economy DSGE model under two exchange rate regimes: the actual floating and the counterfactual fixed exchange rate regime. We assume the financial crisis generates a supply side shock (a productivity shock) and a demand side shock (a preference shock), which are the driving forces of the model. The results indicate that for both the demand and supply side shocks, the floating exchange rate ameliorates much of the impact on the Mexican economy vis- & agrave;-vis the counterfactual fixed exchange rate regime. Then I consider interest rate adjustments initiated in response by both the U.S. and Mexican monetary authorities. For the fixed exchange rate regime the impulse responses due to the productivity shock on most of Mexico & rsquo;s macroeconomic variables dissipate in less than thirteen quarters, with inflationary effects on price variables and permanent effects on the CPI and Mexico & rsquo;s home goods prices. Under the flexible exchange rate regime the effects of this shock are much smaller, and there is a deflationary effect and negative permanent effects on the nominal exchange rate, the CPI and Mexico & rsquo;s home goods prices. The variance decompositions indicate that the effects on real variables are larger under the fixed exchange rate regime and the external linkages are tighter. Welfare analysis shows that losses under the float are also less vis-a-vis the fixed and two other alternative central bank policy rules. The second essay introduces a new mechanism for financial frictions in a monetary dynamic stochastic general equilibrium model following Minsky & rsquo;s financial instability hypothesis (1977). We expand the Christiano, Trabandt and Walentin (2011) model by introducing three different types of entrepreneurs or borrowers: hedge, speculative and Ponzi borrowers. We change the role of banks from a non-risk taking financial intermediary in the CTW (2011) model to a risky debt accumulator. Then we link the accumulation of debt to the endogenous state of nature, which is absent in the current DSGE literature. The state of nature is endogenously a function of past history and the relative state of the business cycle. So ultimately the bank & rsquo;s profit function is a function of business cycle fluctuations. We also introduce a new type of shock, which we call the & ldquo;Minsky system risk & rdquo; shock. This shock captures excessive system risk that occurs within a banking network due to intermediation and interconnection among banks. Then we calculate the likelihood of a Minsky moment (or financial crisis) endogenously based on the bank & rsquo;s profit maximization problem.