Essays in Heterogeneous Agent Monetary Economics

Download or read book Essays in Heterogeneous Agent Monetary Economics written by Christian D. Bustamante Amaya and published by . This book was released on 2019 with total page 119 pages. Available in PDF, EPUB and Kindle. Book excerpt: In these essays, I study the interplay of monetary policy with agent heterogeneity in economies with frictional markets. While accounting for the heterogeneity observed at the micro level, I investigate the implications of having persistent differences in firms and households' balance sheets and their consequences for business cycle fluctuations in monetary economies during both normal times and in times of economic distress. In the first chapter, “Debt Overhang, Monetary Policy, and Economic Recoveries After Large Recessions”, I explore why conventional monetary policy was so ineffective in mitigating the severity of the 2007 U.S. recession and unsuccessful thereafter in stimulating aggregate demand. Linking firm-level data with predictions from a model, I show that accounting for individual firms’ debt structures is crucial in explaining why business investment fell so dramatically through the recession and remained low for several years, despite the Federal Reserve repeatedly cutting its target interest rate until conventional policy tools were exhausted. Using a sample of publicly traded firms, I establish that firms with greater long-term debt exposure experienced larger contractions and slower recoveries in their investment expenditure. Next, I show that debt overhang episodes were unusually prevalent over the years following the onset of the recession, and particularly so among firms relying more heavily on long-maturing debt. To understand these microeconomic observations and their implications for aggregates, I develop a New Keynesian model where heterogeneous firms finance investment using defaultable nominal long-term debt and where the central bank faces an explicit zero lower bound constraint. There, the greater a firm’s leverage, the higher its likelihood of experiencing a debt overhang episode following a large aggregate shock. Moreover, the severity of debt overhang problems, and their consequences for the distribution and level of aggregate investment, compounds with (1) an increased real value of debt, i.e., debt deflation, and (2) the monetary authority’s inability to restore inflation once nominal interest rates reach the zero lower bound. Together, firms’ long maturity debt positions and the binding zero lower bound are critical in transmitting the consequences of a deep recession into a remarkably anemic recovery in aggregate investment.