Three Essays on Monetary Policy and Macroeconomics Stability

Book excerpt: The three chapters of the thesis are centered around monetary policy and macroeconomic stability. In the first chapter, a DSGE model is simulated and estimated to evaluate the macroeconomic effect of credit-demand shocks versus credit- supply shocks. The model features two financial shocks originating on the credit-demand side and one shock originating on the credit-supply side. Model simulations show that credit-demand shocks could generate significant macroeconomic fluctuations, up to three times the impact of credit-supply shocks. Bayesian estimation of the parameters of the shocks and variance decomposition show that credit-demand shocks caused 17\% of the fluctuation in output. The second paper investigates the role of monetary policy in the rise of household debt in the periods leading to the Great Recession. A Factor-Augmented Vector Autoregression (FAVAR) model is estimated in multiple periods. Tests of stability of the estimated coefficients suggest the existence of a structural break, which is interpreted as a change in the transmission mechanism in periods of low versus high household debt. Monetary policy shocks during both periods are identified by Cholesky decomposition. The paper shows that during the period of higher household debt, the volatility of monetary policy shocks was lower and the impulse responses of output and household debt to monetary policy shocks were stronger. Estimates of monetary policy reaction functions in the two periods suggest the stronger response of output and household debt in the second period might have been due to a combination of a stronger transmission mechanism and a weaker monetary policy reaction. The final chapter of the thesis investigates whether monetary policy surprises affect home equity excess returns, and whether the effect transmits through expected future interest rates, expected future dividends, or expected future excess returns. Home equity excess returns are decomposed into three components using a forecasting VAR model. The three decomposed components are then used to estimate a VAR model where monetary policy shocks are identified by Cholesky decomposition. Analysis of the generated impulse responses shows that, unlike its effect on stock equity returns, the effect of monetary policy surprises on home returns transmits through interest rate and future dividends channels more than through the risk premium channel.