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Title: Essays on Financial Frictions in Macroeconomic Models
Authors: Mendo Lopez, Fernando Jerico
Advisors: Brunnermeier, Markus
Contributors: Economics Department
Keywords: Financial fragility
Financial frictions
Safe assets
Subjects: Finance
Issue Date: 2019
Publisher: Princeton, NJ : Princeton University
Abstract: This collection of essays investigates the role of financial frictions in macroeconomic models. Chapter 1 entitled “Risk to Control Risk” explores the interactions between two fragilities that arise due to incomplete markets: amplification of real shocks and exposure to systemic bank runs. In a continuous-time macroeconomic model, I show that low measured volatility may disguise the buildup of hidden systemic run risk. Runs trigger large drops in asset prices and real production and propel the economy into a highly unstable crisis regime. Agents take on too much leverage in the hidden risk regime because they disregard their contribution to the economy’s exposure to systemic runs. Surprisingly, a leverage cap can increase hidden run risk by deepening crises that follow runs. Economies exposed to less volatile fluctuations due to real shocks are more prone to systemic runs: stability breeds instability. Chapter 2 entitled “Financial Frictions: Amplifying or Hedging Fundamental Shocks?” highlights that financial frictions lead to multiplicity in the response of economic outcomes to fundamental shocks. In particular, asset prices can amplify or hedge the effect of real shocks. The hedging equilibrium Pareto dominates the one with amplification and both are observationally equivalent when the productive agents are well capitalized. However, after a sequence of bad shocks, equilibrium selection is key. I propose a policy that ensures the hedging equilibrium prevails: commitment to support asset prices for an intermediate range of capitalization of productive agents. In Chapter 3 entitled “Safety Traps in a Global Economy” joint with Julius Vutz, we investigate the consequences of global safe asset shortages for aggregate economic activity. The model has two countries, Home and Foreign, and emphasizes two heterogeneities: Home has (i) more developed financial markets and (ii) a smaller share of risk-averse agents compared to Foreign. Safe asset demand by Foreign causes a safety trap, i.e. a liquidity trap in the market for safe assets, which depresses output in both countries. Safe public debt provision expands economic activity in both countries but the associated tax distortions are borne only by the issuing country. This externality results in a global under-provision of safe public debt.
Alternate format: The Mudd Manuscript Library retains one bound copy of each dissertation. Search for these copies in the library's main catalog:
Type of Material: Academic dissertations (Ph.D.)
Language: en
Appears in Collections:Economics

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