Skip to main content
May 25

Fiscal and Macro-prudential Policies with Credit Market Frictions: Theory and Empirics

Location:

Gerri C. LeBow Hall
939
3220 Market Street
Philadelphia, PA 19104

In the first chapter of my dissertation I address two main questions: how does the economy respond in a crisis experiment when credit frictions originate from both the supply-side and the demand-side of credit markets? How are alternative unconventional credit policies different in their real effects in an environment where both types of credit frictions are present? To answer these questions I extend the standard financial accelerator framework of Bernanke, Gertler and Gilchrist (1999) to include a fully-fledged banking sector subjected to a leverage constraint. I show that in my model, higher aggregate risk results in increased leverage for both firms and financial intermediaries, leading to an endogenous amplification mechanism which appears much stronger than what predicted by the benchmark financial accelerator framework. Furthermore, I find, that, following a severe recession, a credit policy entailing equity injections into the banking system performs better than one involving direct lending to non-financial firms.

In the second chapter, I document empirically a negative relationship between shocks to government spending and credit spreads. Using a SVAR methodology on US data, I show that after a positive shock to government spending, credit spreads drop up to 14 basis points. This negative relationship can be attributed to the negative effect that government spending has on the default probability since after a positive shock to government spending net interest margins, which are spreads corrected for losses from default, do not change significantly. When decomposing government spending into government investment and government consumption, the analysis shows that it is in particular government investment that has a negative effect on the spreads as opposed to government consumption.

In the third chapter, given the empirical evidence documented in the second chapter of my dissertation, I examine the interaction between productivity-enhancing government spending and credit spreads in a New Keynesian-DSGE model where the probability of default of heterogeneous firms and the costly-state verification due to asymmetric information between borrowers and the lender, lead to increasing credit spreads faced by financially constrained firms. In this context increased borrowing to expand production increases the threshold productivity level below which firms choose to default, and, thus, entails a higher risk premium. However, when government spending contributes to aggregate production the threshold level of default and the probability of default decrease, leading to a lower risk premium.

Many thanks to Sofia’s dissertation committee: • Committee co-Chair: Marco Airaudo, Ph.D., Associate Professor of Economics • Committee co-Chair: Maria Pia Olivero, Ph.D., Associate Professor of Economics • Committee Member: Richard Barnett, Ph.D., Clinical Professor of Economics • Committee Member: Irina Murtazashvili, Ph.D., Assistant Professor of Economics • Committee Member: George Tavlas, Ph.D., Director General, Bank of Greece

PhD Candidate