Essays on incomplete market and aggregate fluctuation

This thesis consists of three chapters on incomplete markets and aggregate fluctuations. Chapter 1 examines the impact of frictional financial intermediation in a heterogeneous agents new Keynesian (HANK) model. An incentive problem restricts banking sector leverage and gives rise to an equilibrium spread between the returns on savings and debt. The interest rate spread that impacts on the wealth distribution and movements in it subjects borrowers and savers to different intertemporal prices. The model generates a financial accelerator that is larger than in a representative agent setting, derives mainly from consumption rather than investment, and works through a countercyclical interest rate spread. Credit policy can mute this mechanism while stricter regulation of banking sector leverage inhibits households' ability to smooth consumption in response to idiosyncratic risk. Thus, although leverage restrictions stabilize at the aggregate level, we find substantial welfare costs. In Chapter 2, we show that it is optimal to pay more attention to employment stabilization when both a heterogeneity of households and the matching friction exist even though the price adjustment cost is substantial. This implies that the optimal policy needs to strike a balance between price adjustment and employment stability rather than to pursue complete price stabilization in order to make the poor better off. In addition, we study the effect of a time-varying transfer rule on the volatility of inflation and employment with respect to a volatile job separation shock. We find that the Ramsey planner pays less attention to employment stabilization when a countercyclical transfer rule is in operation. Chapter 3 analyzes the transmission mechanism of monetary policy to consumption in New Keynesian models with heterogeneous households. We show that in these models the countercyclical nature of profits, empirically false, plays a large role in amplifying the intertemporal substitution channel. On the other hand, the interest rate exposure channel, empirically large, plays a small role. We suggest expanding the role of the interest rate exposure channel, while dampening the amplification effect of countercyclical profits, is of primary quantitative importance in future work