Financial instability and economic activity in Brazil: Theoretical and empirical evidence

The current financial instability experienced by Latin American countries, with the persistence of high and unstable inflation, was in part the motivation behind this project. Particularly, this work provides theoretical and empirical support to the idea of "non-neutrality" of the financial sector in a developing economy like that of Brazil.We focus throughout this work on a particular segment of the Brazilian financial sector, i.e. the market of bank credit. We believe that in the absence of well developed capital markets, that is, poor substitutability between debt and equity, the provision of credit from the banking system to the productive sector ought to be a macroeconomic concern. In Brazil, the almost twenty years of monetary instability, led to a situation of near-absence of long-term financing for businesses. In this context, unexpected fluctuations in bank credit should have an effect on production.Moreover, considering the price instability that plagues the Brazilian economy, we modelled the bank-firm relationship, taking into account the uncertainties introduced by relative-price shocks. This is particularly important if we consider that firms may command an informational advantage over banks when observing relative-price shocks to individual outputs. This informational asymmetry may lead to a situation where relative-price instability has an effect on the allocation of credit and therefore on the performance of the economy. Furthermore, it may be the case that the credit market is not merely "neutral", i.e. that exogenous shocks are not passively transmitted to the real side via their impact on the allocation of credit. Instead, however, under asymmetric information, relative-price shock's impact on the allocation of credit may magnify output fluctuations.Once the non-neutrality of bank credit is demonstrated, the next question is whether the government can play a role in reducing macroeconomic fluctuations by intervening in the market. Or to what extent can the current intervention in credit markets in Brazil be justified on pure economic efficiency grounds?U of I OnlyETDs are only available to UIUC Users without author permissio