Financial Frictions in Macroeconomic Models

The purpose of this thesis is to examine the interaction between financial frictions and macroeconomic variables. A range models are used which encompasses both theoretical and empirical approaches. The thesis attempts to address several questions with the interaction between changes in borrowing constraints, and so credit markets, and their impact on macroeconomic variables the main themes throughout the chapters. The thesis explores the role of changes in borrowing limits on the amplification of shocks. Utilising the theoretical collateral constraints model it also draws together two separate literatures to examine the interaction between collateral constraints and the steady state interest rate. Finally the thesis conducts an empirical analysis of the impact of an array of financial frictions and financial stress measures on macroeconomic aggregates. The empirical approach used allows this analysis to be conducted in a multi-country setting and so allow the issue of the international propagation of shock to be taken into account.

In terms of results, from the theoretical models it is found that financial liberalisation, as modelled by a loosening of the borrowing constraint, leads to a greater amplification of financial shocks compared to conventional shocks. In relation to the steady state interest rate the results suggest that a financial disruption can lead a persistently low interest rate. It is also found that an ageing population and higher debt levels could influence the probability of an economy entering a situation of persistently low interest rates. From the empirical analysis it is found that many measures proposed in the literature are not strong transmitters of financial stress, this is particularity true of credit which is a commonly used shock measure in the literature. It is found that measures of financial frictions that are constructed from corporate bond market data have the most impact on macroeconomic variables.