Essays on Volatility in Credit Constrained Economies

Empirical evidence shows that while aggregate output volatility has declined in recent decades especially in the last 30 years (the so called Great Moderation) barring the 2008 financial crisis, volatility at the firm level has in fact increased over the last 60 years. The fact that macroeconomic and microeconomic volatilities are disconnected seems paradoxical. In this dissertation I look at the roles played by credit constraints, innovation and the informal sector in explaining macro and micro volatilities and especially if any of these can explain the volatility divergence. I find that financial development increases firm volatility significantly but causes small declines or no changes in volatility of aggregate output of an economy. Accounting for innovation or R&D type spending in a more financially developed economy is associated with monotonically decreasing aggregate volatility and increasing firm volatilities. Constraints on informal sector borrowing, causes small increases in volatility of aggregate consumption relative to income but the effects are much more pronounced at the household level. All problems are set in a dynamic stochastic general equilibrium framework with heterogeneous agents.